Macroeconomic Theory and Policy

BM 2022-24

P C Padhan
pcpadhan@xlri.ac.in
Introduction

“…No area in Economics is today more vital and controversial than

Macroeconomics”.
P A Samuelson.
(Nobel Laurate in Economics, 1970)
Macroeconomic Questions
How Macroeconomic is useful for Business
• Why should TATA motors be worried about GDP of India?
• How Managers Making Choices at Tata Motors?
• What Happens When US Firms Move to China?
• How Lucent Technologies dealt with unemployment and inflation rate?
• How expected inflation plays an important role in wage polices of the
company like Boeing?
• How Business Cycles affected Ford Motor company?
• Why does Whirlpool care about Monetary Policy?
• Why India and China wasn’t affected much by recent Global recession?
• Why Japanese companies are interested in Investing in India?
• Why is Russia-Ukraine war affected stock market across globe?
Macroeconomic Questions
➢ Why do some countries grow quickly while others stagnant?
➢ What determines GDP, employment, exchange rate, interest rates, inflation , fiscal
deficit, etc.
➢ How big is the Economy?
➢ What determines expansions and recessions?
➢ How will the Euro affect monetary policy in Europe?
➢ Can monetary policy be used to prevent a recession of an economy?
➢ Why is inflation so much lower today than it was in the past?
➢ Should the United States reduce its trade deficit?
➢ Why do growth rates differ so much across countries, even over long periods?
➢ Has the United States entered a New Economy, in which growth will be much higher in
the future?
➢ Can other countries emulate China and grow at the same rate?
What is Economics?
• Economics is the social science that studies Economic Activities.
• Economy is the study of Production, Consumption and Exchange of Goods &
Services.
• Etymologically the word economics comes from a Greek word ‘oikos and nomos’,
means ‘home’ and ‘Management’.
• “Economics” means ‘management of a household’
• “Economy” means ‘one who manages a household’
Ex1. Robison Crusoe Economy
Ex.2. Individual/ Family/Household/State/Country/ World Economy
What is Economics?
➢ Basic Economic Problems

• Unlimited wants or desire, and Limited Resources

• Alternative Uses/Efficient Uses: Need for Choice and Optimization

➢ Fundamental Economic Problem ( Samuelson’ three Questions?)

➢ What to Produce? Production Problem
o What commodity, which qty, how much?
o Need, Tradeoff, PPF
➢ How to Produce? Allocation/Utilization of Resources Problem
o Based on Max Q with Min Cost
o Choice of Techniques : Lab vs capital
➢ Whom to Produce? Consumption/Distribution Problem:
o Who gets how much? Based on Consumer Pref. MB=MC, Income,
o How to distribute? Based market forces of S=D

These problem difficult to solve, but we need solution

What is Economics? Solution To Decision Problem:
A. How People ( Household/Firms/Govt) Make Decisions ??
• They face trade-offs: No free lunch. Efficiency vs. Equity.
• The cost of something is what you give up to get it: Opportunity Costs
• Rational people think at the Margin: Marginalistic Principles
• People respond to incentives.

B. How People ( Household/Firms/Govt) Interact ??

• Trade can make everyone better off. Comparative advantage
• Markets are usually a good way to organize economic activity: D & S
• Governments can sometimes improve economic outcomes:
– property right,
– market failure: a) externality, b) market power

C. How The Economy ( Household/Firms/Govt) as a Whole Works??

• A country’s standard of living depends on its ability to produce goods and services:
Productivity, Production Possibility Curve
• Prices rise when the government prints too much money: Inflation
• Society faces a short-run trade-off between inflation and unemployment: Business
Cycle
What is Economics?
Scarcity Definition:
• Economics is the study of how society/economy manages its scarce resources.

• “Economics is the science which studies the human behavior as a relationship

between scarce means which have alternative uses”. Lionel Robbins (1932)

• Since the economy(society) has scarce resources, which have alternative uses
and society has unlimited wants, its’ essential to take wiser decision (choice)
to maximize the objective function.

• This makes ‘Economics is a science of choice under uncertainty’..

What is Economics?
Economic Agents Unlimited Wants Scarce Resources Make Choice
(Max. Objective (Alternative Uses) (Sol to Decision
Functions) Problem)

• Individual/Household Satisfaction • Production • Tradeoff

s/Society (need, tradeoff) • Opportunity Costs
• Marginalistic Principle
• Allocation of
• Firms/ Industry Profit Resources • Production
(Max Q with Min Possibility Frontier
Cost, Choice of
• Government (All) High Growth Technique • Property Rights
rate, Price • Market Failure
Stability, • Consumption/
Full Employment, Distributions/
Welfare Exchange)
(MB=MC, D=S)
• Foreign Sector High Export & • Comparative and
Low Import absolute advantage
What is Micro and Macro Economics?

➢ Microeconomics(Small) – studies the

economic behavior of individual economic
agents.
o Households
o Firms/Industry

➢ Macroeconomics(Large)– studies the

aggregate economic activities/behaviour of
all the economic agents.

o Households
o Firms/Industry Closed Open
o Government Econo Economy
o Foreign Sector my
What is Macroeconomics? : The Structure
Monetary Policy
Business Cycle( Output, Employment and Prices)
Fiscal Policy

Producer

Production Q=F(L,N,K.O) Factor Market Households

Short Run Goods
Medium Firms
Economy Distribution Financial or /Industry
run (Exchange) Price Money Market
Government
Long-Run Services Allocation Goods Market Foreign
Z=C+I+G+Nx
(Consumption) Country
Consumer
Technology Monetary Policy
Economic Growth and Stability
Fiscal Policy
Percapita productivity
What is Macroeconomics? The Structure
Macroeconomics studies the Aggregate Economic behavior of all economic agents who interacts
in various markets (Factor, Product and Financial markets) to maximize their respective objectives
with limited resources and unlimited wants over a period of time.

4 Economic Agents: 4 Markets

• Individual/Household/Society • Factor Market ( Land, labour)
• Firms/Industry • Product Market (goods and services)
• Government • Financial Markets (capital)
(local/municipal/state/center) • Foreign Exchange Market
• Foreign Sector 3 Objectives
2 Objects • Economic Growth
• Goods • Price Stability
• Services • Full Employment (Low unemployment)
4 Factors of Production 2 Policy
• Land, • Monetary Policy
• Labour • Fiscal Policy
• Capital 3 Time Period
• Entrepreneur/organisation • Short run: Business Cycle
• Medium run: Labour market
• Long run: sustainable economic growth
Major Macroeconomic Goals/Objectives
Primary Objectives:

1. Output: High and rapid Economic Growth ( of output).

> Sustainable economic growth
> Inclusive growth

2. Employment: High level of Employment with low

involuntary

3. Price Level Stability: Low inflation rate with stable

price level
Major Macroeconomic Goals/Objectives
Subsidiary Macroeconomic Goals
1. Complementary Goals
– Low unemployment and high economic growth
2. Conflicting Goals
– Low unemployment and low inflation
3. Social Welfare
– Health, education, sanitation etc.
4. Equitable Justice
– Law and order condition
– Equal justice to every body
References

• Ch1,2 of Principles of Economics by N G Mankiw, 7th edition, Cengage Learning.

• Ch 1 and 27 of Macroeconomics by Olivier Blanchard

Thanks!!!!!!!!