Download The term `macro` was first used in economics by Ragner Frisch in 1933

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Module 1: Introduction to Macro Economics:
Macro Economics- meaning, types, scope importance and
limitations.
Basic concepts of macro economics-Stocks, flow equilibrium - short
term and long term
National Income- Concepts GNP, GDP, NNP, NDP, NI, PI, DI,
Measurement of National Income, Difficulties in its measurement
(simple calculations)
Macro economics: introduction
The term ‘macro’ was first used in economics by Ragner Frisch in
1933. But as a methodological approach to economic problems, it
originated with the mercantilists in the 16th and 17th centuries.
They were concerned with the economic system as a whole. From
the 18th century physiocrats to modern economists have
contributed to the development of macro economic analysis. But
credit goes to Keynes who finally developed a general theory of
income, output and employment in the wake of the great
depression.
Definition of macro economics:
Macro economic is concerned with aggregates and averages of the
entire economy.
Such as national income, output, total
employment, total consumption etc. In other words, macro
economics studies how the aggregates and averages of the
economy as a whole are determined and what causes fluctuations
in them. From the theoretical reasoning and on the basis of
empirical reasoning and knowledge the old assumption of full
employment is not valid and therefore, it is very vital that we
should investigate how these aggregates are determined and how
to ensure maximum level of income and employment.
Macro economics has been defined in various ways, they are:
“Macro economic theory is the theory of income, employment,
prices and money”.
Macro economics is,” that part of economics which studies the
overall averages and aggregates of the system”.
Macro economics is,” the study of the forces of factors that
determine the levels of aggregate production, employment and
prices in an economy and their rates of change over time”.
Prof. Gardner Ackley defines, macro economics thus:” macro
economics itself with such variables as the aggregates volume of
output of an economy, with the extent to which its resources are
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employed, with the size of national income, with the general price
level”.
It is evident from the above definitions that the subject-matter of
macro economics is to explain what determines the level of total
economic activity, that is, the size of the national income and
employment and fluctuations in it in the short-run. It also
explains what causes the general price level to rise and
determines the rate of inflation in the economy.
Macro economics deals with how an economy grows, it analyses
the chief determinates of economic development and the various
stages and process of economic growth. The problem of increasing
productive capacity and national income in the long run. The
problem of increasing productive capacity and national income
over time is called the problem of economic growth. Thus, what
determines rate of growth of an economy is also the concern of
macro economics.
The justification of a separate macro approach to the study of
several economic problems lies in the fact that micro approach is
not only inadequate but may lead to misleading conclusions. In
economics, what is true of the parts is not necessary true of the
whole. After all, the problem of the aggregates is not merely a
matter of adding or multiplying what happens in respect of the
various individual parts of the economy. It may be quite different
and far more complicated than a mere summation or
multiplication.
Nature of macro economics:
Macro economics is the study of aggregates or averages covering
the entire economy, such as, total employment, national income,
national output, total investment, total consumption, total
savings, aggregate supply, aggregate demand, and general pricelevel, wage level and cost structure. In other words, it is
aggregate economics which examines the interrelations among the
various aggregates, their determination and causes of fluctuations
in them. Thus in the words of Prof. Ackley,” macroeconomics
deals with economic affairs.’ In the large’, it concerns the overall
dimensions of economic life. It looks at the total size and shape
and functioning of the entire economy. It studies the character of
the forest independently of the trees which compose it”.
Macro economics is also known as the theory of incomes and
employment, or simply income analysis. It is concerned with the
problems of unemployment, economic fluctuations, inflation or
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deflation. International trade and economic growth. It is the
study of the causes of unemployment, and the various
determinants of employment. In the field of business cycles it
concerns itself with the effect of investment on total output, total
income, and aggregate employment. In the monetary sphere it
studies the effect of the total quantity of money on the general
price-level. In international trade, the problems of balance of
payments and foreign aid fall within the purview of
macroeconomics analysis. Above all, macroeconomics theory
discusses the problems of determination of the total income of a
country and causes of its fluctuations. Finally it studies the
factors that retard growth and those which bring the economy on
the path of economic development.
Scope and importance of macro economics:
Macro economics:
Macro economics is of theoretical and practical importance. They
are:
1. To understand the working of the economy:
The study of macro economics variables is indispensable for
understanding of the working of the economy. Our main economic
problems are related to the behaviour of total income, output,
employment and the general price level in the economy. These
variables are statistically measurable, thereby facilitating the
possibilities of analyzing the effects on the functioning of the
economy. As Timbergen observes, macro economic concepts help
in,” making the elimination process understandable and
transparent”. For instance, one may not agree on the best method
of measuring different prices, but the general price level is helpful
in understanding the nature of the economy.
2. In economic policies:
Macro economics is extremely useful from the point of view of
economic policy.
Modern governments, especially of the
underdeveloped countries, are confronted with innumerable
national problems. They are the problems of overpopulation,
inflation, balance of payments, general under-production etc. The
main responsibility of these governments rests in the regulation
and control of overpopulation general prices, general volume of
trade, general output etc. Timbergen says,” Working with macro
economics concepts is a bare necessity in order to contribute to the
solutions of the great problems of our times”. No government can
solve these problems in terms of individual behaviour.
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Macroeconomic study helps in the solution of certain complex
economic problem like:
a. general unemployment:
The Keynesian theory of employment is an exercise in macro
economics. The general level of employment in an economy
depends upon effective demand which in turn depends on
aggregate
demand
and
aggregate
supply
functions.
Unemployment is thus caused by decrease in effective demand. In
order to eliminate it, effective demand should be raised by
increasing total investment, total output, total income and total
consumption. Thus, macro economics has special significance in
studying the causes, effects and remedies of general
unemployment.
b. National income:
The study of macro economics is very important for evaluating the
overall performance of the economy in terms of national income.
With the advent of the great depression of the 1930s it became
necessary to analyse the causes of general unemployment. This
led to the construction of the data on national income. National
income data help in forecasting the level of economic activity and
to understand the distribution of income among different groups of
people in the economy.
c. Economic growth:
The economics of growth is also a study in macro economics. It is
on the basis of macro economics that the resources and
capabilities of an economy are evaluated. Plans for the overall
increase in national income, output, and employment, are framed
and implemented so as to increase the level of economic
development of the economy as a whole.
d. Monetary problems:
It is in terms of macroeconomics that monetary problems can be
analyzed and understood properly. Frequent changes in the value
of money-inflation or deflation- affect the economy adversely.
They can be counteracted by adopting monetary, fiscal and direct
control measures for the economy as a whole.
e. Business cycles:
Further macro economics as an approach to economic problems
started after the great depression. Thus its importance lies in
analyzing the causes of economic fluctuations and in providing
remedies.
f. For understanding the behaviour of individual units:
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Macro economics helps in the understanding the behaviour of
individual units. Demand for individual products depends upon
aggregate demand in the economy. Unless the causes of deficiency
in aggregate demand are analyzed, it is not possible to understand
fully the reasons for a fall in the demand of individual products.
The reasons for increase in costs of a particular firm or industry
cannot be analyzed without knowing the average cost conditions of
the whole economy. Thus, the study of individual units is not
possible without macro economics.
Thus macro economics
enriches our knowledge of the functioning of an economy by
studying the behaviour of national income, output, investment,
saving and consumption. Moreover, it throws much light in
slowing the problems of unemployment, inflation, economic
instability and economic growth.
Subject matter of macro economics (Central issues of macro
economics):
The subject matter of macro economics are as follows:
1. Determination of national income:
The first major issue in macro economics is to explain what
determines the level of employment and national income in an
economy and therefore what causes involuntary unemployment.
The level of national income and employment are very low in
times of depression as in 1930s in various capitalist countries of
the world. This will explain the cause of huge unemployment that
emerged in these countries. Classical economists denied that
there could be involuntary unemployment of labour and other
resources for a long time. Classical economist thought that with
changes in wages and prices, unemployment would be
automatically removed and full employment established. But this
did not appear to be so at the time of great depression in the
thirties (1930) and after.
Keynes explained the level of
employment and national income is determined by aggregate
demand and aggregate supply. With aggregate supply curve
remaining unchanged in the short run, it is the deficiency of
aggregate demand that causes under employment equilibrium
with the appearance of involuntary unemployment. According to
Keynes it is the changes in private investment that causes
fluctuations in aggregate demand and is, therefore, responsible for
the problems of cyclical unemployment.
2. General price-level and inflation:
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Another macro economic issue is to explain the problem of
inflation. Inflation had been a major problem faced by both the
developed and developing countries in the last 50 years. Classical
economists thought that it was quantity of money in the economy
that determined the general price level in the economy and
according to them, rate of inflation depended on the growth of
money supply in the economy. Keynes criticized the ‘quantity
theory of money’ and showed that the expansion in money supply
did not always lead to inflation or rise in price-level. Keynes who
before the second world war explained that involuntary
unemployment and depression were due to the deficiency of
aggregate demand, during the war period when prices rose very
high, he explained in his booklet’ how to pay for war’ that just as
unemployment and depression were caused by the deficiency of
aggregate demand, inflation was due to the excessive aggregate
demand. Thus, Keynes put forward what is now called ‘demandpull theory of inflation’. After Keynes, theory of inflation has
further developed and many theories of inflation depending upon
various causes have been put forward, to analyze the problem of
inflation is an important issue in macroeconomics.
3. Business cycles:
Throughout history market economics have experiences business
cycles. Business cycles refer to fluctuations in output and
employment with alternating periods of boom and recession.
During boom or prosperity both output and employment are at
high levels, whereas in recession both output and employment fall
as a consequence large unemployment came into existence in the
economy. When recession is extremely severe, they are called
depression. What are the causes of these business cycles is an
important macro economic issue which has been highly
controversial. The objective of macro economic policy is to achieve
economic stability with equilibrium at full- employment, level of
output and income.
4. Stagflation:
During the decade of 1970s and in the subsequent decades market
economies have experienced a still more intricate problem which
has been described as stagflation. While in business cycles,
recession or depression is accompanied by not only high degree of
unemployment but also rapid inflation. This is a period which has
high unemployment and recession (stagflation) which co-exists
with high inflation. This problem is called stagflation. Stagflation
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could not be explained with Keynesian theory, which focuses on
the demand side. Therefore, a new economic thought which is
called supply-side economies emerged which explained stagflation
by laying stress on the supply side of economic activity.
Stagflation is an important issue of modern macro economics.
5. Economic growth:
Another important issue in macro economics is to explain what
determines economic growth in a country. Theory of economic
growth has been recently developed as an important branch of
macro economics. The problem of growth is a long-run problem
and Keynes did not deal with it. It was Harrod and Domar who
extended the Keynesian analysis to the long-run problem of
growth with stability. They laid stress on the dual role of
investment- one of income generating, which Keynes ignored
because of his preoccupation with the short-run. Harrod and
Domar in their models showed that investment adds to productive
capacity (capital stock), and then if growth with stability (without
stagnation or inflation) is to be achieved, income or demand must
be increasing at a rate large enough to ensure the full utilization
of the increasing capacity. Thus, macro economic models of
Harrod and Domar have explained the rate if growth of income
that must take place if the steady growth of the economy is to be
achieved.
These days growth economics has been further
developed and extended a good deal and new theories of growth
have been put forward by Solow, Meade, Kaldor and Joan
Robinson.
Since the growth theories of Harrod, Domar, Kaldor, Meade and
others apply particularly to the present day developed countries,
special theories which explain the causes of underdevelopment
and poverty in less developed countries and they also suggest
strategies for initiating and accelerating growth in them have also
been propounded. These special growth theories relating to lessdeveloped countries are generally known as economies of
development.
6. Balance of payments and exchange rate:
Balance of payments is the record of economic transactions of the
residents of a country with the rest of the world during a period.
The objective of preparing such a record is to present an account of
all the receipts of goods imported, services rendered, and capital
received by the residents of a country and the payments made for
goods imported, services received and capital transferred to other
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countries by residents of a country. There may be deficit or
surplus in balance of payments. Both create problems for an
economy. An important effect is that the transactions in balance
of payments are influenced by the exchange rate. The exchange
rate is the rate at which a country’s currency is exchanged for
foreign currencies. The instability in exchange rate has been a
major problem in recent years which has given rise to serious
balance of payments problems.
Limitations of macro economics:
There are, however certain limitations of macro economic
analysis. Mostly these stem from attempts to yield macro
economic generalizations from individual experiences.
1. Fallacy of composition:
In macro economic analysis the,’ fallacy of composition’ is
involved, that is, aggregate economic behaviour is the sum total of
individual activities. But what is true of individuals is not
necessarily true of the economy as whole. For instance, savings
are a private virtue but a public vice. If total savings in the
economy increase, they may initiate a depression unless they are
invested. Again, if an individual depositor withdraws his money
from the bank there is no danger but if all the depositors do this
simultaneously the banking system will be adversely affected.
2. To regard the aggregates as homogeneous:
The main defect in macro analysis is that it regards as
homogeneous without taking into consideration their internal
composition and structure. The average wage in a country is the
sum total of wages in all occupations, that is, wage of clerks,
typists, teachers, nurses etc. But the volume of aggregate
employment depends on the relative structure of wages rather
than on the average wage. If, for instance, wages of nurses
increase but of typists fall, the average may remain unchanged.
But if the employment of nurses fall and typists rises much,
aggregate employment would increase.
3. Aggregate variables may not be important necessarily:
Aggregate variables which form the economic system may not be
of much significance. For instance, the national income of a
country is the total of all individual incomes. A rise in national
income does not mean that individual incomes have risen. The
increase in national income might be the result of the increase in
the incomes of a few rich in the country. Thus a rise in the
national income of this type has little significance from the point
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of view of the community. Prof. Boulding calls these difficulties
as, “macro economics paradoxes”, which are true when applied to
a single individual but which are untrue when applied to the
economic system as a whole”.
4. Indiscriminate use of macro economic is misleading:
An indiscriminate and uncritical use of macro economics in
analyzing the problems of the real world can often be misleading.
For instance, if the policy measures needed to achieve and
maintain full employment in the economy are applied to
structural unemployment in individual firms and industries, they
become irrelevant. Similarly, measures aimed at controlling
general prices cannot be applied with much advantage for
controlling prices of individual products.
5. Statistical and conceptual difficulties:
The measurement of macro economic concepts involves a number
of statistical difficulties. These problems relate to the aggregation
of micro-economic variables. If individual units are almost similar
aggregation does not present much difficulty.
But if
microeconomic variables relate to dissimilar individual units,
their aggregation into macro economic variable may be wrong and
dangerous.
Types of Macro economics:
Macro static’s, Macro dynamics and comparative static’s
Macro static’s:
The word ’static’s is derived from the Greek word ‘statike’ which
means bringing to s standstill. In physics, it means a state of rest
where there is, no movement. In economics, it implies a state
characterized by movement at a particular level without any
change. It is a state, according to Clarke, where five kinds of
changes are conspicuous by their absence. The size of population,
the supply of capital, methods of production, forms of business
organization and wants of the people remain constant, but the
economy continues to work at a steady pace. “It is to this active
but unchanging process,” writes Marshall,” that the expression
static economics should be applied”.
Static economy is thus a timeless economy where no changes occur
and it is necessarily in equilibrium.
Indices are adjusted
instaneously, current demand, output and prices of goods and
services. As pointed out by Prof. Samuelson,” Economic static
concerns itself with the simultaneous and instaneously or timeless
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determination of economic variables by mutually interdependent
relations.”
There is neither past nor future in the static state. Hence, there is
no element of uncertainty in it. Prof. Kuznets, therefore, believes
that, “static economics deals with relations and processes on the
assumption of uniformity and persistence of either the absolute or
relative economic quantities involved”.
Macro static analysis explains the static equilibrium position of
the economy. This is best explained by Prof. Kurihara in these
words,” If the object is to show a ‘still picture’ of the economy as a
whole, the macro-static method is the appropriate technique, for
this technique is one of investigating the relations between macro
variables in the final position of equilibrium without reference to
the process of adjustment implicit in that final position “. Such a
final position of equilibrium may be shown by the equation
Y=C+I
Where Y is the total, C is the total consumption expenditure and I
the total investment expenditure. It simply shows a timeless
identity equation without any adjusting mechanism. This macrostatic model is illustrated with the aid of Kurihara’s diagram
reproduced below.
Diagram 1:
of equilibrium to the other. According to this static Keynesian
model, the level of national income is determined by the
interaction of aggregate supply function and the aggregate
demand function, in the above figure 45 degree line represents the
aggregate supply function and C+I line, the aggregate demand
function. 45 degree line and C+I curve intersect at point E, the
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point of effective demand which determines OY level of national
income.
Thus, economic static refer to a timeless economy, it neither
develops nor decays, it is like a snapshot from a ‘still’ camera
which would be the same whether the previous and subsequent
positions of the economy were subject to changes or not.
Macro Dynamics:
Economics dynamics, on the other hand, is the study of change of
acceleration or deceleration. It is the analysis of the process of
change which continues through time. An economy may change
through time in two ways: without changing its pattern and by
changing pattern. Economic dynamics relates to the latter type of
change. If there is a change in population, capital, techniques of
production, forms of business organizations and tastes of the
people- in any one or all of them- the economy will assume a
different pattern, and the economic system will change its
direction.
Prof. Hicks in his” Value and capital” defines economic dynamics,”
as those parts where every quantity must be dated”. But Prof.
Harrod does not agree with this when he says, “In dynamics
dating is no more necessary than in static.” He, therefore,
suggests that dynamics should concern itself with the analysis of,
“continuing changes generated by the special nature of a growing
economy”. According to him, dynamic economics concerns itself
with, “the necessary relations between the rates of growth of the
different elements in a growing economy”. Harrod considers onceover changes to fall within the domain of economic statics. Such
changes imply a shift from one position
Ragner Frisch, however, regards economic dynamics not only a
study of continuing change but also of the process of change.
According to him, it is a system in which;” variables at different
points of time are involved in an essential way”. Thus, the study
of economic dynamics involves the discovery of functional
relationships of economic variables at different points of time.
The knowledge of such relationships is essential for forecasting.
Prediction, thus, becomes the essence of the Frischian definition,
according to Baumol economic dynamics is,” the study of economic
phenomena in relation to preceding and succeeding events”.
Economic dynamics is, thus, concerned with time lags, rates of
change. In a dynamic economy, data change and the economic
system take time to adjust it accordingly. We may conclude with
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the words of Prof.Kuznets,” economic theory, which seeks to
explain the phenomenon of economic change, and to examine the
factors at work in bringing about a given change and trace the
process of that change and the consequences of succeeding
movements step by step is called economic dynamics”.
Comparative statics:
Comparative statics, is a method of economic analysis which Was
first used by a German economist F. Oppenheimer, in 1916.
Schumpeter described it as, “an evolutionary process by a
succession of static models. In the words of Schumpeter,”
Whenever we deal with disturbance of a given state by trying to
indicate the static relations obtaining before a given disturbance
impinged upon the system and after it, had time to work it out.
This method of procedure is known as,”Comparitive statics”. To
be precise, comparative statics is the method of analysis in which
different equilibrium situations are compared.
The distinction between static and dynamic situations is explained
with the help of a diagram
If the economy is working at situation A, where it is producing at
a constant rate without any change in the variable, it is a static
state which is functioning at a point of time. When the economy
moves from the equilibrium point A to point B through time it is
economic dynamics which traces out the actual path of movement
of the economy between the two static equilibrium points. Thus
comparative statics is not concerned with the transitional period
but,” involves the study of variations in equilibrium positions
corresponding to specified changes in underlying data”.
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Conclusion:
The discussion on macro statics, macro dynamics and comparative
statics can be concluded thus:” economic statics is the study of
relations between economic variables at appoint of time. Where
as economic dynamics explains the relationship of economic
variables at a point of time, where as economic dynamics explains
the relationship of economic variables through time. In a static
economics there is movement but no change in economic
phenomena while in dynamic economics the fundamental forces
themselves change.
The former (statics) studies movement
around the point of equilibrium, but the latter (dynamics) traces
the path from one point of equilibrium to the other, both backward
and forward. On the other hand, comparative statics studies and
compares two static equilibrium positions. If savings at a point of
time are s' and at another point of time s'' this is once over change
which is comparative statics. But if a given rise in savings leads
to increase in investment, output, income and a further rise in
savings, this sequence of interdependent events of continuous
changes is dynamics in nature.
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