Macroeconomics

Prof. Binilkumar Amarayil S

asbinilkumar@iimmumbai.ac.in
 Leaning Objectives

This lecture introduces you to

• What is Macroeconomics?
• the issues macroeconomists
study
• the tools macroeconomists use
• Relevance of Macroeconomics
in Business Decision Making
 Session Plan
Sl. No Time Slot Session Details

1 9.00 -9.15 Introduction

2. 9.15 -10.00 GDP, Definition, components and Measurements with Exercise

3. 10.00-11.00 Inflation, Unemployment, definition and Measurements with Exercise

4 11.15-12.00 Fiscal Policy, Fiscal Stimulus and Government Expenditure Multiplier

5. 12.00-12.30 Money, Monetary Policy, Credit Creation and Money multiplier

6. 12.30-1.00 Macroeconomics and business Decision making- Case discussion and

Presentation
 What is
Macroeconomics?

• Macroeconomics is the study of the

structure and performance of
economy as a whole and of the
policies that governments use to
influence the economic
performance.

• it examines the behavior of

economic aggregates such as
aggregate income, consumption,
investment, and the overall level of
prices.
National Income
Accounting
The Economy’s
Income and Expenditure
When judging whether the economy is doing well
or poorly, it is natural to look at the total income
that everyone in the economy is earning.
 The Circular-Flow
Diagram

 The equality of
income and
expenditure can
be illustrated
with the circular-
flow diagram.

7
 GDP is the
market value
of all final
goods and
services
produced
within a
country in a
given period.
The Measurement of GDP
 Output is valued at market
prices.
 It records only the value of
final goods, not intermediate
goods (the value is counted
only once).
 It includes both tangible
goods (food, clothing, cars)
and intangible services
(haircuts, housecleaning,
doctor visits).
 GDP = (Price of apples × Quantity of apples)
+ (Price of oranges × Quantity of oranges)
= ($0.50 × 4) + ($1.00 × 3) GDP = $5.00

2) Used goods are not included in the calculation of GDP.

3) The treatment of inventories depends on if the goods are stored or
if they spoil. If the goods are stored, their value is included in GDP.
If they spoil, GDP remains unchanged. When the goods are finally
sold out of inventory, they are considered used goods (and are not
counted). 10
 Year GDP Growth (%) Annual Change
7.20%
2022-23 -17.20%

2021-22 8.70% 15.28%

2020-21 -6.60% -10.33%
2019-20 3.74% -2.72%

India’s GDP
2018-19 6.45% -0.34%
2017-18 6.80% -1.46%

Growth 2016-17
2015-16
8.26%
8.00%
0.26%
0.59%
Rate 2014-15 7.41% 1.02%
2013-14 6.39% 0.93%
2012-13 5.46% 0.22%
2011-12 5.24% -3.26%
2010-11 8.50% 0.64%
2009-10 7.86% 4.78%
2008-09 3.09% -4.57%
12
 Y = C + I + G + NX

Total demand Investment

for domestic is composed spending by
output (GDP) of businesses and
households Net exports
or net foreign
Consumption Government demand
spending by purchases of goods
households and services

This is the called the national income accounts identity.

13
The Components of GDP

 Consumption (C) :
 The spending by households
on goods and services, with
the exception of purchases
of new housing.
 Investment (I) :
 The spending on capital
equipment, inventories,
and structures, including
new housing.
The Components of GDP
 Government Purchases (G) :
 The spending on goods
and services by local,
state, and federal
governments.
 Does not include transfer
payments because they
are not made in exchange
for currently produced
goods or services.
 Net Exports (NX):
 Exports minus imports.
The value of final goods and services measured at current prices is
called Nominal GDP . It can change over time either because there is a
change in the amount (real value) of goods and services or a change in
the prices of those goods and services.

Hence, Nominal GDP Y = P × y, where P is the price level and y is real

output– and remember we use output and GDP interchangeably.

Real GDP or, y = Y÷P is the value of goods and services measured
using a constant set of prices.

16
Real vs. nominal GDP

n
GDPt = ∑ Pit Qit
i=1
n
RGDPt = ∑ PiBQit
i=1

17
NOW YOU TRY:
Real & Nominal GDP

2006 2007 2008

P Q P Q P Q

good A $30 900 $31 1,000 $36 1,050

good B $100 192 $102 200 $100 205

 Compute nominal GDP in each year.

 Compute real GDP in each year using 2006 as the
base year.
NOW YOU TRY:
Answers
nominal GDP multiply Ps & Qs from same year
2006: $46,200 = $30 × 900 + $100 × 192
2007: $51,400
2008: $58,300

real GDP multiply each year’s Qs by 2006 Ps

2006: $46,200
2007: $50,000
2008: $52,000 = $30 × 1050 + $100 × 205
 Limitations of the GDP Concept
The Underground Economy
underground
economy The part
of the economy in
which transactions
take place and in
which income is
generated that is
unreported and
therefore not counted
in GDP.
 Macroeconomics and Business
Output Growth

• business cycle The cycle of short-term

ups and downs in the economy.

• aggregate output The total quantity of

goods and services produced in an
economy in a given period.

• recession A period during which aggregate

output declines. Conventionally, a period
in which aggregate output declines for two
consecutive quarters.
Macroeconomics and Business: Output
Growth

• expansion or boom The period in the

business cycle from a trough up to a peak
during which output and employment grow.

• contraction, recession, or slump The

period in the business cycle from a peak down
to a trough during which output and
employment fall.
UNEMPLOYMENT
Unemployment

• Recessions are usually

accompanied by high
unemployment: the
number of people who
are available for work
and are actively seeking
it but cannot find jobs.
Unemployed
Unemployme nt Rate = × 100%
Labour Force
 Labour Force and Labour Force
Participation Rate
• Labour Force is the proportion of total population
who are employed or actively seeking employment. It
consists of the total adult population of working age
(15+years).
• Labour Force participation rate is the proportion of
Labour Force in the total population, or it measures
the percentage of the total adult population of a
country in the labor force and is consists of employed
and those who are actively searching for jobs.
Inflation
 Inflation

• When prices of most goods

and services are rising over
time it is inflation. When
they are falling it is
deflation.
• The inflation rate is the
percentage increase in the
average level of prices.
• Moderate rate of inflation keeps- economic
outlook optimistic, promotes economic activity,
prevents economic stagnation, mobilizes
resources by increasing S and I
• A rate of inflation higher than the desirable
rate of inflation is considered “considerable”
• Economy gets overheated and aggregates
get adversely affected
• 2-3% in developed and 4-6% in developing
countries is desirable
Measures of inflation

• % change in price index number (PIN)

• Rate of inflation = (PINt – PINt-1/PINt-1 ). 100
• CPI- 1981-82=100 increased from 182.7 in 1990-
91 to 207.8 in 1991-92
• Rate of inflation = (207.8 – 182.7/182.7) . 100
• = 13.75%
Exercise
Exercise
 Money Supply and Inflation
 The quantity equation
MxV=PxY
follows from the preceding
definition of velocity.

 It is an identity:
it holds by definition of the
variables.
 This is the classical theory of
money demand. Classical
economists like Irving Fischer
believed that money demand
is a function of income
33
 Money Supply and Inflation, cont.

The growth rate of a product
equals
the sum of the growth rates.
 The quantity equation in growth
rates:

34
Money Supply and Inflation, cont.

π (Greek letter “pi”)

denotes the inflation rate:

The result from the

preceding slide:

Solve this result

for : π

35
 The quantity theory of money, cont.

 Normal economic growth requires a certain amount of

money supply growth to facilitate the growth in transactions.
 Money growth in excess of this amount leads to inflation.

36
 Hyper Inflation

• Hyper inflation-more than three digit rate

per annum, paper currency becomes
worthless, from Jan 1922 to Nov 1923 the
German price index rose from 1 to 10,
000,000,000
• Germany- to pay large costs of World War 1
Germany suspended convertibility of its
currency into gold and war was funded by
borrowing, exchange rate of the Mark
against the US $ fell and hyperinflation
broke out
What causes hyperinflation?

• Hyperinflation is caused
by excessive money supply
growth:
• When the central bank
prints money, the price
level rises.
• If it prints money rapidly
enough, the result is
hyperinflation.
38
Cure of Inflation
Anti inflationary
measures

• Monetary Measures
• Fiscal Measures
• Regulatory Measures
 Fiscal Stimulus and Multiplier
A Fiscal Stimulus is an
attempt by a government
to increase economic
activity by reducing taxes,
increasing government
spending, or both.
The Multiplier In Action - 2

Suppose the government The government could increase

increases public expenditure by transfer payments. Alternatively, the
$1 million, keeping taxation at its government might wish to invest in
existing level. public works or social capital (e.g.
road construction).
 Further stages of
Households spend 0.8 income generation
Initial increase in of their increase in occur, with each
income large income on consumption successive stage being
($800,000) smaller than the
previous one.
Covid-19
Economic
Stimulus
Package
 Money: Definition
Money is the stock
of assets that can be readily used to make transactions.

46
Money: Functions
 medium of exchange
we use it to buy stuff
 store of value
transfers purchasing
power from the present to
the future
 unit of account
the common unit by
which everyone measures
prices and values
47
Money: Classifications
1. Fiat money
 has no intrinsic
value
 example: the
paper currency we
use
2. Commodity money
 has intrinsic value
 examples:
gold coins,
cigarettes in
P.O.W. camps48
 Money Supply

M=C+D

C = Currency: coins & bills

(13.5%)

D = Demand Deposits: checking

account deposits (86.5%)
Concepts of
Money
 A few preliminaries
• Reserves (R ): the portion of deposits that banks have not lent.
• To a bank, liabilities include deposits,
assets include reserves and outstanding loans

• 100-percent-reserve banking: a system in which banks hold all

deposits as reserves.

• Fractional-reserve banking:
a system in which banks hold a fraction of their deposits as
reserves.
Money creation in the banking
system

A fractional reserve banking system

creates money,
but it doesn’t create wealth:
bank loans give borrowers
some new money
and an equal amount of new debt.
 Money Multiplier
•Money multiplier is the process through which banks create more money through
its excess reserves, thereby expanding money supply.

•In other words, its process of creating more money by banks from reserve money.
 Macroeconomic Scenarios and Business

Group Presentation
& Discussion
 Thank you Very much
For your Active Participation