ABM 601

Unit I
Lesson 1
Concept and Evolution of Macro Economics

After going through this lesson, students shall be able to:

 Understand the basic concept of economic analysis.
 Distinguish between Macro and Micro Economics
 Comprehend the concept of Macroeconomics and its development, and

Macro-Economic Analysis

Gross Domestic Capital Formation

India
45.0
40.0
35.0
30.0
25.0
20.0
15.0 GDCF
10.0
5.0
0.0
2005-06
1951-52
1954-55
1957-58
1960-61
1963-64
1966-67
1969-70
1972-73
1975-76
1978-79
1981-82
1984-85
1987-88
1990-91
1993-94
1996-97
1999-00
2002-03

2008-09
2011-12

Introduction:
Economics is the study of the way individual and society make choices to satisfy unlimited
wants in the light of scarcity of goods and services. This scarcity of goods and services is
caused by availability of productive resources in limited quantity. Thus, economics as a
positive science analyses various economic variables and as normative science tries to
optimize the decision situations of making choices.
1. Economic Analysis
Economics being the core of all material human activities call for specific analysis of variety
of economic variables and their interactions so as to facilitate economic decision making of
choices in the light of scarcity. In other words, optimization of productive resources is the
main focus of all types of economic analysis. Economic analysis encompasses both
individual and general (societal) actions and behaviour.
Analysis of economic variables and their interconnections are broadly divided into two
categories:
 Micro Economic Analysis (Microeconomics), and
 Macro-Economic Analysis (Macroeconomics)

Microeconomics
Microeconomics deals with individual units of economic behaviour, viz. firms and individual
consumers. The focus of microeconomics is to analyse the way individual firm or individual
consumer uses the available resources to maximize output or satisfaction. Microeconomics
particularly analyses the way prices are fixed for goods and services under various conditions
of demand and supply. Both micro and macroeconomics deals with demand and supply
phenomenon but the nature of demand and supply situation differs under micro economic
analysis. Under microeconomics, specific attention is given to individual demand and supply
conditions influencing market and prices.

90
80
70
60
50 Demand
40
Supply
30
20
10
0
1 2 3 4 5 6 7 8 9 10

Interaction of Demand and Supply 1

Microeconomics is also popularly known as individual price mechanism, i.e., the way
prices of individual commodities are fixed by way of interaction of demand and supply.

Macroeconomics
Macroeconomics, on the other hand, analyses the economic behaviour as a whole, viz.
national income and output, general level of unemployment, general price level etc.
Macroeconomics studies the nature and causes of economic performance in general. Under
macroeconomics, specific attention is given to policy direction to economic performance as a
whole impacting both individual and market variables.
(Note: Macro Economic Analysis and Micro Economic Analysis are complementary to each
other. Understanding the process of making economic choices requires deep analysis of
individual as well as general economic variables. It is important to understand that individual
and general economic variables influence each other adding to the complexity of economic
analysis)

Some specific Distinction between Microeconomics and Macroeconomics are as follows:

Basis Micro Economic Analysis
Unit of Analysis Individual Firm or Consumer
Approach Bottom-up (from individual
components to Aggregate)
Nature of Equilibrium Individual Equilibrium
Market Mechanism Individual Demand and
Supply
Popular Models Theories of Consumption,
Production and Distribution
Macro-Economic Analysis
Economy as a whole
Top-down (from Aggregate
to individual components)
General Equilibrium
Aggregate Demand and
Supply
Theory of Money, Inflation
and Unemployment

2. Macro Economics: Meaning and Features

General behaviour and pattern of economic system are studies under macroeconomics. It
deals with the way economy functions and behaves on account of interactions of economic
variables such as policy, money movement, inflation, level of employment, international
economic dimensions etc.
The term Macro has been derived from Greek word ‘makro’ meaning large.
Macroeconomics deals with aggregate indicators of decision processes in contrast to
individual indicators of economic choices. The aggregate indicators of economic
performance are National Income, level of Unemployment, Supply and Demand of Money in
market, Inflation, level of National Savings and Investments etc.
There are three important dimensions of macroeconomics;
 Structure of Economy
 Behaviour and Performance of Economy, and
 Decision-process in economy as a whole.
Structure of Economy refers to the basic building block of economic system. It indicates the
inherent approach to run a particular economic system. Structure of economy guides
economic decision processes. The economic decision processes in an economic system with
socialist approach function differently from an economy with capitalist approach. The basic
nature of economy and its ultimate performance is largely dependent on the structure of
economy.
 Illustration 1
Macro-Economic Performance of India in terms of Gross Domestic Output over a period of
Time

GDP at Factor Cost (Constant Prices)

India
1966-67

2005-06
1951-52
1954-55
1957-58
1960-61
1963-64

1969-70
1972-73
1975-76
1978-79
1981-82
1984-85
1987-88
1990-91
1993-94
1996-97
1999-00
2002-03

2008-09
2011-12
Macro-Economic Analysis answers some general questions related to economic
performances, like:
 What are the reasons for fluctuations in general price level of goods and services?
 Why is there a widening gap between rich and poor in the society?
 What is the level of savings and investment in the economy?
 Why one economy grows faster than other?
 What role does government play in economic activities?
 What are the reasons for sudden economic shocks?

Development of Macroeconomics Thought

Norwegian economist Ragnar Frisch coined the terms ‘microeconomics’ and
‘macroeconomics’ in 1933 in his paper on ‘Business Cycle’. However, Macroeconomics
originated from two popular economic models:

 Business Cycle Theory, and

 Monetary Theory

Monetary theory dates back to 16th century and Business Cycle theory originated in mid 19th
century.
Business Cycle Theory

Business cycle theory explains the cyclical movement of economic activities that at times
causes violent shifts in economic activities. British economist William Stanley Jevons and
French statistician Clement Juglar pioneered the business cycle theory.

Monetary Theory

The relationship between price level and output was explained by Quantity Theory of Money.
Scottish economist David Hume presented the quantity theory in his work ‘Money’ in 1752.
The monetary theory looks at economy from the perspective of famous Say’s Law of Market.
Say’s Law states that market is clearing, meaning, whatever is supplied to market shall be
sold by market. It infers that market automatically corrects itself and money supply does not
affect the output level in the economy. American economist Irving Fisher developed the
quantity theory and concluded that velocity of money and real income are constant and thus
money supply brings about changes in price level in the economy. His theory is reflected in
the following equation:
M*V=P*Q
Where V = Velocity of Money
Q = Real Income
M = Money Supply and
P = Price Level

Beyond Monetary Theory and Business Cycle Theory

J.M. Keynes and Keynesian Macroeconomics

Concept of modern macroeconomics is largely attached with the publication of British

Economist John Maynard Keynes’s famous work ‘The General Theory of Interest,
Employment and Money’ in 1936.

Explaining causes of widespread global market failure and recession in 1930s, Keynes
refuted the quantity theory of money and proved that Say’s Law of Market breaks down
when confronted with dynamic nature of economic variable.

Keynes contended that money velocity directly correlate with output. He explained this
relationship with the help of liquidity preference during the time of recession.

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