Macroeconomics: Theory and Policy

Prof. Rupa Chanda

Week 1

Introduction

Hello welcome to this course titled Macroeconomics: Theory and Policy. I am your
instructor Rupa Chanda professor of Economics in the Economics and Social Sciences area at
the Indian Institute of Management, Bangalore. First let us understand what is
Macroeconomics.

Well in economics there are two broad branches micro-economics and macro-economics.
Micro-economics is the study of individual consumers and producers. Macro-economics is the
study of the economy at the aggregate level where we add up all the individual consumers
and producers to understand how the economy behaves as a whole.

The study of macro-economics really emerged during the great depression when around the
world economies went into a severe downturn. So, it became important to understand what
had caused this downturn and how economies could be revived again. Following that there
has been a lot of work in the area of macro-economics and the focus has been on
understanding the interaction of the various markets.

For instance the goods market, labor market, the asset markets and to see how they
interrelate and how policies impact upon the behavior of these markets. So, the goals of
macro-economics are 5; first and foremost all economies want to achieve full employment of
all their resources: land, labor, capital. So, this is the primary objective. A 2nd important
objective is to achieve price stability: no economy wants to have volatility in prices. So,
certainty and predictability in prices is very important.

A 3rd objective is to have efficiency in economies. So, whatever is achieved should be done
efficiently with the best possible utilization of resources within given constraints. A 4th
objective is to expand the economic pie and therefore, economic growth is very important.

And finally, whatever the growth process may be we want to do so, equitably. So, that it is
distributed across all sections of the economy. So, why is macro-economics important? It is
needed by everybody because a firm grounding in the core concepts and principles of macro-
economics helps us to understand economic events and their impact in our lives. It is also
important to understand the many indicators of the economy, for instance what is GDP, what
is GNP, what is inflation.

We need to understand these indicators, what their trends reveal and what their implications
are. Similarly, we need to understand the implications of various policies and the measures
that are taken by governments or central banks around the world on various social, economic
and other outcomes. And finally, once we understand all this, we need to see how to
incorporate our interpretation of the economic outlook and the various policy measures into
our decision making process.

© All Rights Reserved. This document has been authored by Professor Rupa Chanda and is permitted for use only within the course
“Macroeconomics: Theory and Policy" delivered in the online course format by IIM Bangalore. No part of this document, including any logo,
data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any form or by any means – electronic,
mechanical, photocopying, recording or otherwise – without the prior permission of the author.
 Macroeconomics: Theory and Policy

Prof. Rupa Chanda

Week 1

This course provides a broad overview of the basic principles of macro-economics. So, what
it will attempt to do is to provide you with the theoretical and conceptual frameworks that
are key to understanding macro-economic behavior. And will also supplement this with
empirical and policy related evidence and applications from India and around the world.

Its main objectives are to understand how the economy works in the aggregate, what are the
interrelationships among the different macro-economic variables such as GDP, inflation,
interest rates, money supply, etcetera. It would also help understand the significance of
macro-economic indicators and the different measures we are often discussing.

And finally, it will help understand the implications of various macro-economic policies. There
will be a variety of variables that we will be looking at throughout the course, these include
for instance output, employment, wages, prices, money supply, interest rates, debt, balance
of payments and so on.

And what we will try to do is not only explain the importance of these variables, what they
mean definitionally, how are they measured, what are their limitations, but also how to
interpret them in terms of the decision making that we undertake in whatever sphere of
activity we engage in.

Let me provide a brief overview of the course and how it is structured. So, first we will have
6 modules, each of these modules will build on the other. In module 1, we will start by
understanding the basic accounts and indicators of the economy. This is because without
knowing the basic indices and how to interpret them we cannot proceed to understanding
the theories around them.

In the 2nd module, we will deal with some specific variables namely consumption savings and
investment. Here we will touch upon some of the key theories and conceptual

frameworks which explain how consumption is determined, how investment behavior is

determined.

In the 3rd module we will build the actual framework for understanding an economy, this is
called the aggregate demand and supply framework. It is very similar to what we have in
microeconomics, but blown up for the aggregate economy. So, here we will understand how
shifts in aggregate demand or in supply affect the overall economic outcomes such as growth
and inflation.

In the subsequent module in module 4, we will focus on the government and basically look at
its fiscal policy in terms of spending behavior, taxation and what sort of impact it has on the
economy. So, here we will touch upon a variety of indicators like fiscal deficit, revenue deficit,
primary deficit. We look at issues of fiscal sustainability and public debt and how they impact
the economy.

© All Rights Reserved. This document has been authored by Professor Rupa Chanda and is permitted for use only within the course
“Macroeconomics: Theory and Policy" delivered in the online course format by IIM Bangalore. No part of this document, including any logo,
data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any form or by any means – electronic,
mechanical, photocopying, recording or otherwise – without the prior permission of the author.
 Macroeconomics: Theory and Policy

Prof. Rupa Chanda

Week 1

In module 5, we will touch upon the role of central banks and how they influence the money
supply of the economy. So, here our focus will be on monetary tools and instruments and we
will also contextualize and look at how certain policies affect things like interest rates, the
liquidity availability in the economy, credit availability etcetera.

In the final module we will look at an economies engagement with the rest of the world
through trade and capital flows. And here we will try to understand the external sector
accounts, the imbalances an economy may have with other countries, how exchange rates
are determined, how do capital flows impact on domestic variables and so on.

So, this will be the part where we bring everything together and look at an economy and its
integration with the rest of the world. So, using a mix of lectures, readings assignments and
group discussions. We hope to provide a good understanding of all the theories and concepts
that are essential to get a grounding in the macro-economics and we will also provide a lot of
contextual applications. So, that you can relate these theories and frameworks to ground
realities.

© All Rights Reserved. This document has been authored by Professor Rupa Chanda and is permitted for use only within the course
“Macroeconomics: Theory and Policy" delivered in the online course format by IIM Bangalore. No part of this document, including any logo,
data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any form or by any means – electronic,
mechanical, photocopying, recording or otherwise – without the prior permission of the author.