Macroeconomics and Public Policy

MBA (2023-25)

Jagadish Prasad Sahu

Office: D2/10, Academic Building, IIM Kashipur
Email: jagadish.sahu@iimkashipur.ac.in
 • Macroeconomics is concerned with the overall performance of the economy.

• Unlike microeconomics (which studies the behaviour of individual entities),

macroeconomics studies the behaviour of the economy as a whole.

Introduction to • The book - General Theory of Employment, Interest and Money (1936) by
John Maynard Keynes provides the foundation of modern macroeconomics.

Macroeconomics
• Macroeconomics covers a wide range of issues such as:
• Why some countries grow rapidly while others experience
stagnation?
• How total investment and consumption are determined?
• How central banks manage money supply and interest rates?
• What causes financial crisis?
 1. Government makes most economic decisions (Command economy)

2. Decisions are made in markets (Market economy)

• In a market economy individuals and firms make decisions about
production and consumption. A system of prices determine what, how and
for whom to produce.
Different ways
of organizing an • In contemporary times, all societies/countries are mixed economies (with
elements of market and command/ Govt. regulations).

economy • The extreme case of a market economy, in which the government keeps its
hands off economic decisions, is called a laissez-faire economy.
• No contemporary society falls completely into either of these polar categories.
Rather, at the present time, all societies are mixed economies, with elements of
market and command.
 • What is a mixed economy?
• A mixed economy includes both private enterprises (working
through the marketplace) and the government (including
government regulations).

• What are the principles that lie behind the market economy / What is the
market mechanism?
• No single individual or organization or government is responsible
for making the decisions in a market economy. Millions of buyers
and sellers involve in voluntary trade and their actions are
Mixed Economy invisibly coordinated by a system of prices and markets.

• A market is a mechanism through which buyers and sellers

interact to determine prices and exchange goods, services and
assets.

• The central role of markets is to determine the prices of goods &

services.
 • Prices serve as signals to producers and consumers
• If consumers want more of any good, the price will rise, sending
signal to producers that more supply is needed.

• Prices are the balance wheel of the market mechanism

How market • Prices coordinate the decisions of producers and consumers in a

market.

mechanism
• Higher prices tend to reduce consumer purchases and encourage
production.
• Lower prices encourage consumption and discourage production.

works? • A market equilibrium represents a balance among all the different buyers and
sellers
• Depending upon the price of a product, households and firms want to
buy and sell different quantities.
• The market finds the equilibrium price that simultaneously meets the
desires of buyers and sellers.
The Market System Relies on Supply and Demand to Solve the Trio of Economic Problems
 • Advanced economy is characterized by an elaborate
network of trade that depends on Specialization and
division of labour.
Distinguishing
features of a • Extensive use of money as the means of payment and for
measuring economic values.
modern economy
• Modern industrial technologies based on vast capital
stocks.
 • Governments have three main economic
functions in a market economy:

Role of • Increase efficiency by promoting competition, curbing

government externalities and providing public goods.

in a market • Promote equity through taxation and expenditure on

government programs to redistribute income towards
economy particular groups.

• Foster macroeconomic stability and growth – reducing

unemployment and inflation while encouraging economic
growth through fiscal and monetary policy.
How governments solve the shortcomings of the market

Failure of market economy Government Intervention Examples of Government Policy

Inefficiency:
Monopoly Encourage competition Antitrust laws, deregulation
Externalities Intervene in market Antipollution laws, antismoking ordinances
Public goods Encourage beneficial activities Provide public education & health, build roads
Inequality:
Unacceptable inequalities of income and Redistribute income Progressive taxation of income and wealth, income-
wealth support or transfer programs
Macroeconomic problems:
Business cycle (high inflation and Stabilize through macroeconomic policies Monetary policies (change in money supply and interest
unemployment) rates)
Fiscal policies (taxes and spending programs)
Slow economic growth Stimulate economic growth Improve efficiency of tax system, Raise national savings,
reducing budget deficit
 Question
Major expenditure categories of Central Government of India (Hypothetical data)

Budget category Central government spending

(Rs. Crores), 2022
Health care 750
National defence 675
Social security 550
Income security 150
Natural resources and environment 50
International affairs 100

Question. The above table shows some of the major expenditures of the central government of India. Explain how
each one relates to the economic role of the government.

Ans. Social security helps to promote equity in the distribution of income. National defence represents
provision of a public good. Unemployment insurance provides for stability through the business cycle.
Administration of justice often deals with imperfect competition and market failure. Pollution control battles a
negative externality, while funding for basic science encourages a positive externality.
 Question

• Consider the following cases of government intervention:

• Regulations to limit air pollution,
• Income support for the poor
• Price regulation of a telephone monopoly

• For each case (a) explain the market failure, (b) describe the government
intervention to treat the problem.

Answer: Pollution limitations: improving efficiency (public bad)

Income supplements: equity (redistribution program)
Phone regulation: efficiency (prices higher, output lower with monopoly)
 Key Macroeconomic variables
• Measuring economic success
• The major macroeconomic goals are a high level and rapid growth of output, low unemployment, and stable
prices.

• The most comprehensive measure of the total output in an economy is the gross domestic product (GDP).

• GDP is the measure of the market value of all final goods and services produced within a country during a given
period usually a year or quarter.

• There are two ways to measure GDP

• Nominal GDP (measured in actual market prices)
• Real GDP (measured in constant or invariant prices)

• Real GDP is the most closely watched measure of output.

• Potential GDP represents the maximum sustainable level of output that the economy can produce.

• Potential output is determined by the economy’s productive capacity which depends upon the inputs available
(capital, labour and land) and the economy’s technological efficiency.

• Price stability is measured by the rate of inflation (percentage change in the overall level of prices) during a
given period.
 Goals and Instruments of Macroeconomic Policy

Objectives
Output: High level and rapid growth of output
Employment: High level of employment with low involuntary unemployment
Stable prices: Low level of inflation
Instruments
Monetary policy: Buying and selling of bonds, regulating financial institutions
Fiscal policy: Government expenditures, Taxation
Thank you