Concept

The term’ economics’ is derived from the Greek words oikos- for ‘house’ or settlement and
norms for ‘laws and hence economics is related to household management. Economics is
the study of how individuals and societies choose to utilize Scarce resources to satisfy unlimited
human wants. It is branch of Social Science which studies human activity of the allocation of
resources in the production and distribution of goods and services to satisfy unlimited wants of
society. To examine important issues which are studied in economics, modern economists have
divided the whole economic theory into two parts that is microeconomics and macroeconomics.
Meaning of macroeconomics
The word macro is derived from the Greek word ‘makros’ meaning large so macroeconomics
studies the economic activity as a whole or large scale. The word micro and macro both were
first used by Ragnar Frisch in 1943 AD. Macroeconomics is defined as the branch of economics
which deals with economy as a whole. Basically it is concerned with national aggregates or total
value such as national income, aggregate consumption, aggregate saving, total investment etc.
that relates to the whole economy. It examines how general price level are determined and how
resources are allocated at the level of the economic system as a whole.

According to K E Boulding,” Microeconomics deals not with individual quantity but with
aggregate of these quantities, not with individual income but with national income, not with
individual price but with price level, not with individual output but with national output”.

According to P A Samuelson,” macroeconomics is the study of behaviour of the economy as a

whole. It examines the overall level of national output employment price and foreign trade. Thus,
macroeconomic is the study of the economy as a whole in terms of the total amount of goods and
services produced, total income earned, total consumption and investment made, the level of
employment of productive resources and the general behaviour of prices, money and capital.

Scope of macroeconomics
The word ‘scope’ refers to the range covered by the subject or topic so the area covered
by macroeconomics is called scope of macroeconomics. Macroeconomics which was introduced
by J M Keynes in 1936 AD by publishing his book named ’general theory of employment
interest and money’ includes factors that determine both the level of aggregate variables like
gross domestic product, total employment, general price level and how the variables change over
time.
The major study areas or scope of macroeconomics are as follows.
1. Theory of income and employment: In macroeconomics, we study how the level of income
and employment is determined in the economy and what factors affect the level of income and
employment in an economy. The theories of consumption function and investment function are
related to this branch of macroeconomics. In this branch of macroeconomics, we also study the
concept of national income, its different components, methods of measuring national income etc.
2. Theory of money and general price level: In macroeconomics, different theories related to
demand and supply of money are studied. In macroeconomics, we study how the general price
level is determined in the economy and what factors affect it. Theories of inflation and deflation
are the main subjects related to the theory of general price level.
3. Theory of economic growth: This is another important branch of macroeconomics. This
branch of macroeconomics explains how an economy grows in the long run and what factors
affect the economic growth of an economy. Hence in this branch of macroeconomics, we study
different theories related to economic growth and development. The issues like balanced
development, privatization, economic liberalization, poverty, inequality etc. are also studied in
this branch of macroeconomics.
4. Theory of trade cycle: Trade cycle refers to the rise and fall in the level of aggregate
economic activities in the economy. In macroeconomics, we study different theories that explain
the causes of trade cycle. Macroeconomics also studies the various aspects related to
international trade such as balance of payments, balance of trade, exchange rate etc.
5. Macro theory of distribution: This is another important branch of macroeconomics. This
branch of macroeconomics explains how the relative shares of different classes of people
(especially workers and capitalists) in the national income are determined. In other words, this
branch of macroeconomics explains how the national income is distributed among different
classes of people. Hence, different macro theories of income distribution are studied in this
branch of macroeconomics.
6. Macroeconomic policies: In macroeconomics, we study the nature of macroeconomic
policies and their effectiveness in solving economic problems in an economy. Macroeconomic
policies include monetary policy, fiscal policy, employment policy, income policy etc.

Importance of Macroeconomics.
Macroeconomics studies the economy as a whole. It tries to explain how the economy as a whole
works and seeks to find out ways to make it work more efficiently. It is the study of aggregates
such as national income, national output, total Saving, consumption investment, level of
employment etc. Thus, macroeconomics is very important for anybody that lives in a modern
economic society such as a business firm, government policy makers, academicians, persons etc.
Its major importance and uses are as follows.

1.It helps to understand the functioning of the complicated modern economic system. It describes
how the economy as a whole functions and how the level of national income and employment
are determined on the basis of aggregate demand and supply.
2 It helps to achieve the goal of economic growth, higher level of GDP and higher level of
employment and analyzing the forces which determine economic growth of a country and
explain how to reach the highest state of economic growth and sustain it.
3.It helped bring stability in price level and analysis fluctuations in business activities. It suggests
policy measures to control inflation and deflation.
4. It helps to formulate correct macroeconomic policies and also coordinate international
economic policies.
5. It helps to solve economic problems like poverty, unemployment, business cycle etc.
6. It explains factors which determine balance of payment. At the same time, it identifies causes
of deficit in the balance of payment and suggests remedial measures.
7. It is useful to evaluate the performance of the economy.
8. It is very essential for the development and expansion of microeconomics.
9. It is very important in business decision making
Limitations of Macroeconomics

In spite of evergreen implication and popularity, macroeconomics is not free from limitations.
There are some certain limitations of macroeconomics; they are as follows.
 1. Dependence on individual units:
Several conclusions of macroeconomics are based on the sum total of individual units. In fact, it
is not correct, because what is true for individuals may not necessarily be true for the whole
economy. For example, an individual may save in terms of money but if everybody starts saving,
there will be negative effects in the economy.

2. Heterogeneous units:
Under macroeconomics, heterogeneous units are studied. But it is not possible to express the
units in uniform numbers or homogenous measures. Heterogeneous units can be measured only
in terms of money in economics.

3. Different effects of aggregate:

Macroeconomic variables have no uniform effects on all sectors of an economy. For example, a
rise in price level benefits the flexible income group of people (traders and the industrialists)
while the fixed income groups are the losers.

4. Limited application:
Another limitation of macroeconomics is that most of the models relating to macroeconomics
have only theoretical significance. They have very little use in practical life.

5. It ignores the contribution of individual units:

Macroeconomic analysis is only important on the functioning of the aggregates. However, in
real life, the economic activities and decisions taken by individuals on private level have their
effects on the economy as a whole. Such effects are not known by the study of macroeconomics
alone.

Distinction between microeconomics and macroeconomics

Generally, the concept of economics can be divided into two types as micro and
macroeconomics. There are many differences between them that are given below:

Basis of Microeconomics Macroeconomics

comparison
1. Meaning Micro means small. Macro means large
2. Nature Microeconomics studies individual units macroeconomics studies the
of the economy. economy as a whole

3. Objective The main objective of microeconomics The main objective of

is to maximize utility and profit and
minimize the cost.
4. Assumption Microeconomics is based on the
assumption of full employment of
resources.
macroeconomics are full
employment, price stability
economic growth and favourable
balance of payment.
Macroeconomics rejects the
assumption of full employment.
 5. Methods of Economics is based on the partial
study equilibrium analysis It is the study of
equilibrium condition at a particular
period. Hence, it is static analysis.
6. Area of study The major or in the areas of
microeconomic is theory of value and
theory of economic welfare.
Macroeconomics is based on the
general equilibrium analysis it is
the study of equilibrium
condition based on time, rate of
change in variables. Hence, it is
dynamic analysis.
The major areas of
macroeconomics are income and
Employment theory, monetary
theory, public finance, growth
theory and international trade.

7. Basis The basis of microeconomics is the The basis of macroeconomics is

price mechanism level which operates
with the help of demand and supply.
8. Problem Microeconomics deals with the problem
in the determination of price of a
commodity, factors of production etc.
the general price level which is
determined by aggregate demand
and aggregate supply.
macroeconomics deals with the
problem of unemployment, trade
cycle, international trade etc.

Macroeconomic concept
stock and flow variables
Stok refers to a quantity of a commodity accumulated at a point of time. The quantity of the
current production of a commodity which moves from a factory to the market is called flow.
Stock is the quantity of an economic variable relating to a point of time. For example, store of
cloth in a shop at a point of time is stock. Flow is the quantity of an economic variable relating to
A period of time. The monthly income and expenditure of an individual, receipt of yearly interest
rate on various deposit in a bank are some examples of flow.
The concept of stock and flow used more in macroeconomics or in the theory of income, output,
and employment. Wealth is a stock and income is a flow. Saving by a person within a month is a
flow while the total savings on a day is a stock. Some macro variables like imports, exports,
wages, income, tax payment, social security benefit and dividends are always flows. Such flows
do not have direct stock but they can affect other stocks indirectly, just as imports can affect the
stock of capital goods. A stock can change due to flows but the size of flows can be determined
itself by changes in stock.
Equilibrium and Disequilibrium
The concept of equilibrium and equilibrium are used in microeconomics as well
as macroeconomics. Microeconomics uses partial equilibrium analysis and macroeconomics uses
general equilibrium analysis. The concept of equilibrium and disequilibrium are briefly described
below
1. Equilibrium: In economics equilibrium refers to a situation in which opposite economic
forces that demand and supply are in balance and there is no tendency of change over
time. We know that aggregate demand is the sum of all individual consumers' demand and
aggregate supply is the sum of the supply of all individual supply. So, at macro level an economy
is said to be equilibrium when aggregate demand and aggregate supply equal
2.Disequilibrium: This is the situation in which the positive forces that is demand and supply
are in imbalance or in macroeconomics, disequilibrium refers to the situation in which aggregate
demand and aggregate supply are not equal.

Types of Macroeconomics
(Static and Dynamic Analysis of Macroeconomics)

A. Static Analysis
1. Macro-statics (Simple macro-statics)
Macro-statics studies the relationship between different macroeconomic variables at a
particular point of time under the condition of equilibrium. It deals with the final
equilibrium of the economy at a particular point of time. Macro-statics does not involve
time element. It is timeless analysis. Hence, macro-statics studies the static equilibrium
of the economy at a particular point of time. But it does not explain the process by
which the economy reaches final equilibrium position. The final equilibrium position
of the economy can be shown by the following Keynesian equation.
Y=C + I
Where, Y= Aggregate income.
C= Aggregate consumption.
I= Aggregate investment

The above equation shows the static equilibrium of an economy at a particular point of
time. Macro-statics can be illustrated by the following figure.

In the above figure, 45o line and C+I line intersect each other at point E. Hence, the
economy is in equilibrium at point E where equilibrium level of income is OY. In the figure, point
E shows the equilibrium of the economy at a particular point of time. Hence, point E in the figure
shows the static equilibrium of the economy. Such static equilibrium position of the economy is
studied under macro-statics.
 2. Comparative Macro-statics: The change in time brings about change in the conditions
of macroeconomic variable. The change in the conditions of macroeconomic variables
disturbs the original equilibrium position and after certain adjustment process, a new
equilibrium between macroeconomic variables is established. In such a case,
comparative macro-statics makes comparison between original equilibrium and new
equilibrium attained by the economy at different points of time. In other words,
comparative micro-statics makes comparative study of different equilibrium positions
attained by the economy at different points of time. But it does not explain the process
by which the economy moves from one equilibrium position to another equilibrium
position. Comparative macro-statics can be illustrated by the following figure.

In the above figure, E is the original equilibrium point for the economy where OY is the
equilibrium level of income. When the investment in the economy increases by ΔI, C+I line shifts
upward and becomes C+I+ ΔI. Now E1 is the new equilibrium point for the economy where
equilibrium level of income is OY1. In such a case, comparative macro-statics makes comparative
study of two equilibrium points E and E1. But it does not explain the process by which the economy
moves from equilibrium point E to equilibrium point E1.

B. Macro-dynamics (Dynamic analysis)

The change in time brings about change in the conditions of macroeconomic variables. The
change in the conditions of macroeconomic variables disturbs the original equilibrium
position and after certain adjustment process a new equilibrium between macroeconomic
variables is established. In such a case macro-dynamic explains the whole process by which
the new equilibrium of the economy has been attained. In other words, macro-dynamics
explain the whole process by which the economy moves from original equilibrium position
to new equilibrium position. Thus, macro-dynamics considers the time taken by the
 economy to reach the new equilibrium from the old one. Macro-dynamics can be illustrated
by the following figure.

In the above figure, initially, the economy is in equilibrium at point E where equilibrium level of
income is OY. When the investment increases in the economy by ΔI in time period t, the income
rises by the amount of increased investment in time period t+1. Now, this increase in income leads
to an increase in consumption expenditure in the economy. As a result, income rises further in time
period t+2. This increase in income leads to further increase in consumption expenditure in the
economy. As a result, income rises still further in time period t+3. This process will continue till
the new equilibrium point E1 is reached. Finally, the new equilibrium of the economy is established
at point E1 where equilibrium level of income is OY1. Thus macro-dynamics explains the whole
process by which the economy moves from one equilibrium position to another equilibrium
position.

Circular Flow of Income and Expenditure in a Two-Sector Model ( Economy)

Circular flows of income and expenditure in a two-sector economy can be explained on the basis
of the following assumptions:
a. The economy consists of two sectors households and firms.
b. Households spend their total income on goods and services produced by the firms. They
do not hoard any part of their income.
c. Firms produce goods and services only as much as demanded by the households. They do
not maintain any inventory.
d. Firms make factor payments to the households in the form of wages, rent, interest and
profits.
e. There is no inflow or outflow of income or of goods and services from any outside source.
f. The firms retain nothing as undistributed profits.
The working of a two-sector economy and the circular flows of income and expenditure are
illustrated in the following figure.
 In the above figure, a line drawn from the ‘households’ to the ‘firms’ divides the diagram into
two parts – the upper half and the lower half. The upper half represents the factor market and the
lower half represents the commodity market. Both the markets generate two kinds of flows – real
flows and money flows. Let us first examine the real and money flows in the factor market. In the
factor market (upper half of the diagram), the continuous arrow shows the flow of factors of
production from the households to the firms. This is the real flow from the households to the firms.
The real flow causes another and a reverse flow, i.e., the flow of factor incomes (wages, rent,
interest and profit) from the firms to the households. Since all factor payments are made in terms
of money, the flow of factor incomes represents the money flow. The money flow from the firms
to the households is shown by dashed arrow in the upper part of the diagram. Money flow in the
form of factor incomes comprises the total income of the households. In factor market, it will be
seen that factor services and factor incomes flow in the opposite direction.

Now, let us examine the real and money flows in the commodity market. In the commodity market
(lower half of the diagram), the continuous arrow shows the flow of goods and services from the
firms to the households. This is the real flow from the firms to the households. This real flow
causes another and a reverse flow, i.e., the flow of consumption expenditure from the households
to the firms. The payment made by the households for the goods and services produced by the
firms represent the money flow. The money flow from the households to the firms is shown by
dashed arrow in the lower part of the diagram. In commodity market, goods and services and
consumption expenditure flow in the opposite direction.

By combining the continuous arrows in the commodity and factor markets, we get the circular
flow of goods and services. Similarly, by combining the dashed arrows in the commodity and
factor markets, we get the circular flow of money.

An important feature of flows of income and expenditure in a two-sector economy is that the values
that flow are equal. For example, factor payment is equal to factor income and household
expenditure is equal to the value of output.
 Circular Flow of Income and Expenditure in a Three-Sector Model(Economy)

When we add government sector to the two-sector model, the three-sector model is formed.
Hence, a three-sector model depicts a more realistic economy which includes government,
households and business sectors. Government activities affect the economy in a number of ways.
Hence, it is necessary to analyze the effect of fiscal operation of the government while analyzing
the circular flows of income and expenditure in a three-sector model. However, to simplify the
analysis, we include only three fiscal variables, i.e., taxes, government spending on goods and
services and transfer payments. These fiscal variables have different kinds of effects on income
and expenditure flows.

Taxes are withdrawals from the income and expenditure flows because they reduce consumption
expenditure by reducing private disposable income. On the other hand, government expenditure is
an injection into the circular flows of income and expenditure because government expenditure
adds to aggregate demand for factor services supplied by households and goods and services
supplied by firms. Transfer payments (unemployment allowances, old aged pension etc.) made by
the government are injections into the circular flow of income and expenditure because transfer
payments add to the household income which leads to increase in household demand for consumer
goods. The circular flows of income and expenditure in a three-sector model are shown in the
following figure.

In the above figure, the circular flows of income and expenditure between households and firms
are same as in two-sector model. But the magnitude of flows of income and expenditure between
households and firms is reduced because a part of their incomes flows to the government sector.
The figure shows that factor services flow from the households to the firms and as its counter-
flow, factor payments flow from the firms to the households. Similarly, goods and services flow
from the firms to the households and as its counter-flow, consumption expenditures flow from the
households to the firms. If the households save a part of their income, such household savings flow
 to the financial market and finally, the household savings flow from the financial market to the
firms in the form of investment.

The above figure shows only the money flows from and to the government sector. The real flows
from and to the government sector have been excluded to avoid overcrowding in the figure. The
figure shows that a part of the household income flows to the government sector in the form of
direct taxes. Similarly, a part of firms’ earning flows to the government sector in the form of
corporate income tax (direct tax). The government imposes indirect taxes also which are collected
by the firms from the households and passed on to the government. The government spends a part
of its tax revenue on wages, salaries and transfer payments to the households and a part of it on
purchases from the firms and payment of subsidies. Thus, the money that flows from the
households and the firms to the government sector in the form of taxes flows back to these sectors
in the form of government expenditure.

Circular Flow of Income and Expenditure in a Four-Sector Model

OR
Circular Flow of Income and Expenditure in a Four-Sector Economy
If we add foreign sector to the three-sector model, the four sector model is formed. Hence, four-
sector model includes government, household, business and foreign sectors. The foreign
transactions make a complex system. Hence, to simplify the analysis of circular flows of income
and expenditure, we make the following assumptions.
a. The foreign sector consists only of exports and imports of goods and services.
b. The exports and imports of goods and non-labor services are made only by the firms.
c. The households export only labor.
The circular flows of income and expenditure in a four-sector model are shown in the following
figure.

The middle part of the above figure shows that factor services flows from the households to
the firms and as its counter-flow, factor payments flow from the firms to the households. Similarly,
goods and services flow from the firms to the households and as its counter-flow, consumption
expenditures flow from the households to the firms. If the households save a part of their income,
such household savings flow from the households to the capital market and finally, the household
savings flow from the capital market to the firms in the form of investment. Similarly, the upper
part of the figure shows that money flows from the government sector to the household sector in
the form of wages, salaries and transfer payments. On the other hand, money flows from the
household sector to the government sector in the form of direct taxes. Similarly, money flows from
the government sector to the business sector in the form of government purchases and subsidies.
On the other hand, money flows from the business sector to the government sector in the form of
direct and indirect taxes.

Lower part of the figure shows the circular flows of money in respect of foreign trade. The exports
(X) make the flow of goods and services out of the country and make money flow into the country
in the form of export earnings. This is the flow of foreign income into the economy. Hence, exports
represent injections into the circular flows of income and expenditure. Similarly, imports (M) make
inflow of goods and services and flow of money out of the country. This is the flow of expenditure
out of the economy. Hence, imports represent withdrawals from the circular flows of income and
expenditure. Similarly, export of manpower by the households generates inflow of income. The
export of manpower brings in foreign remittances in terms of foreign exchange. Hence foreign
remittances are injections into the circular flows of income and expenditure. These inflows and
outflows go on continuously so long as there is foreign trade.

The effect of foreign sector on the magnitude of circular flows of income and expenditure depends
on the trade balance which equals exports minus imports (X – M). Exports represent injections
and imports represent withdrawals. Hence, if X > M, it means inflow of foreign income is greater
than the outflow of the domestic income. This is the net gain from foreign trade. The net gain from
foreign trade increases the magnitude of circular flows of income and expenditure. If X < M, it
reduces the magnitude of circular flows of income and expenditure and if X = M, inflows and
outflows of income are equal. In such a case, magnitude of circular flows of income and
expenditure remains unaffected.