KEY CONCEPT OF

MACROECONOMICS
MISS KIRAN SHEIKH

Chapter 01
The whole purpose of the economy is production of goods or services for consumption now or in
the future. I think the burden of proof should always be on those who would produce less rather
than more, on those who would leave idle people or machines or land that could be used. It is
amazing how many reasons can be found to justify such waste: fear of inflation, balance-of-
payments deficits, unbalanced budgets, excessive national debt, loss of confidence in the dollar.
James Tobin,
National Economic Policy
 outline
• DEFINATION
• OBJECTIVES AND INSTRUMENTS OF
MACROECONONICS
• THE TOOLS OF MACROECONOMICS
POLICY
• AGGREGATE SUPPLY AND DEMANDS
 DEFINATION
 OBJECTIVES AND INSTRUMENTS
OF MACROECONONICS
 THE TOOLS OF
MACROECONOMICS POLICY
 AGGREGATE SUPPLY AND
DEMANDS
 Macroeconomics
• Macroeconomics is the study of the
behaviour of the economy as a whole. It
concerns the business cycles that lead to
unemployment and inflation,
• As well as the longer-term trends in
output and living standards.
OUTLINE
 DEFINATION

 OBJECTIVES AND INSTRUMENTS OF

MACROECONONICS
 THE TOOLS OF MACROECONOMICS
POLICY
 AGGREGATE SUPPLY AND DEMANDS
 Potential and Actual GNP
Real GNP
($)

Potential GNP

Actual GNP

Years
 Objectives and Instruments

• How do economists evaluate the success of an

economy’s overall performance?

• What are the tools that governments can use

to pursue their economic goals?
 Macroeconomic Goals/Measuring Economic
Success
• Output
–High level and sustainable growth
• Employment
–High level of employment and low
involuntary unemployment
• Stable Prices
• International trade
–Export and import equilibrium and exchange
rate stability
 Measuring Economic Success
• The major macroeconomic goals are:

– High level and Rapid growth of output.

– Low unemployment and employment.
– Stable Prices or general price level.
 Output
•The ultimate objective of economic activity is to
provide the goods and services that the population
desires.

•What could be more important for an economy than

to produce ample shelter, food, education, and
recreation for its people.

•The most comprehensive measure of the total

output in an economy is the gross domestic product
(GDP).
 GDP
•GDP is the measure of the market value of all final
goods and services produced in a country during a
year.
• Like beer,car,rocks
•There are two ways to measure GDP.
• Nominal GDP is measured in actual market prices.
• Real GDP is calculated in constant or variant prices.
• Real GDP is the most closely watched measure of
output; it serves as the carefully monitored pulse of
a nations economy.
• % growth rate of real GDP in year t
• =100* GDPt – GDPt-1/GDPt-1
• For example, real GDP in 2006 was $11,294.8 billion
• and in 2007 was $11,523.9 billion (both in 2000
prices).
• A calculator will show that the growth of real GDP
in 2007 was 2.0 percent over the year.
• It is worthwhile making sure you can replicate this
• calculation.
• Note the sharp economic decline during the Great
Depression of the 1930s, the boom during World
War II,
• the recessions in 1974, 1982, 1991, and 2008.
 Potential GDP
• Despite the short term fluctuations seen in business
cycles, advanced economies generally exhibit a steady
long term growth in real GDP and an improvement in
living standards; this process is know as Economic
Growth.

• Potential GDP represents the maximum amount the

economy can produce while maintaining price stability.
• Capital,land,labor

• Potential output is also sometimes called the high-

employment level of output.
 Potential and Actual GDP
Real GDP
($)

Potential GNP

Actual GDP

Years
•When an economy is operating at its potential,
unemployment is low and production is high.

•Potential output is determined by the economy’s

productive capacity, which depends upon the inputs
available (capital, labour, land) and the economy’s
technological efficiency.

•Potential GDP tends to grow slowly and steadily

because inputs like labour and capital and the level of
technology change quite slowly over time.

•By contrast, actual GDP is subject to large business-

cycle swings if spending patterns change sharply.
•Economic policies (like monetary and fiscal policy)
can affect actual output quickly, but the impact of
policies on potential output trends operates slowly
over a number of years.

•During business downturns, actual GDP is below

its potential and unemployment rises.

•Economic downturns are called “Recessions”

when real output declines for a year or two.
• A severe and protracted downturn is called a
“Depression”.
 Employment
•Of all the macroeconomic indicators, employment and
unemployment are most directly felt by individuals.

•People want to be able to get high-paying jobs without

searching or waiting too long, and they want to have job
security and good benefits.
•In macroeconomic terms these are the objectives of high
employment.

•The unemployment rate tends to reflect the state of the

business cycle:
• when output is falling, the demand for labour falls, and
the unemployment rate rises.
 Stable Prices
• The third macroeconomic goal is to
maintain stable prices within free
markets.
• A market economy uses prices as a
yardstick to measure economic
values.
• Rapid price changes lead to economic
inefficiency.
 Stable Prices
•What exactly do economists look at when they talk
about “the overall price level?”

•The most common price measure is the consumer price

index, known as CPI.

•The CPI measures the cost of a basket of goods

(including items such as food, shelter, clothing and
medical care) bought by majority of people.

•The overall price level is often denoted by the letter P.

 Stable Prices
•The rate of inflation denotes the rate of growth or
decline of the price level from one year to the next.

•Rate of Inflation = CPI (this year)-CPI (last year)/CPI

(last year) x100

•A deflation occurs when prices decline (which means

that the rate of inflation is negative).

•At the other extreme is a hyperinflation, a rise in the

price level of a thousand or a million percent a year.
• Rate of inflation in year t =100 *Pt - Pt-1% Pt-1
We thus calculate the inflation rate for 2007 as

Rate of inflation in 2007 = 100* 207.3 -201.6%201.6

=2.8% per year

 Summary
• The goals of macroeconomic policy are:

1. A high and growing level of national output.

2. High employment

3. A stable or gently rising price level

 outline
 DEFINATION
 OBJECTIVES AND INSTRUMENTS OF
MACROECONONICS
 THE TOOLS OF MACROECONOMICS
POLICY
 AGGREGATE SUPPLY AND DEMANDS
 Tools of Macroeconomic Policy
• Tools of macroeconomics are used to counter when:

Unemployment is rising and GDP is falling.

Productivity growth has declined.

Country has a balance of payment crisis.

Large trade deficit.

Attack on currency.
 Tools of Macroeconomic Policy
•Governments have certain instruments that they can use to
affect macroeconomic activity.

•A policy instrument is an economic variable under the

control of government that can affect one or more of the
macroeconomic goals.

•By changing monetary, fiscal, and other policies,

governments can avoid the worst excesses of the business
cycle or increase the growth rate of potential output.

•The two major instruments of macroeconomic policy are

“Fiscal Policy” & “Monetary Policy”.
 Fiscal Policy
•Fiscal policy denotes the use of taxes and government
expenditures.

•Government expenditures come in two distinct forms.

•First there are government purchases. These comprise

spending on goods and services purchases of tanks,
construction of roads, salaries for judges, and so forth.

•In addition there are government transfer payments,

which boost the incomes of targeted groups such as the
elderly or the unemployed.
 Fiscal Policy
•From a macroeconomic perspective, government
expenditure also affect the over all level of spending
in the economy and thereby influence the level of
GDP.
•The other part of fiscal policy, Taxation, affects the
overall economy in two ways.

•Taxes affect people’s incomes. By leaving households

with more or less disposable income, taxes tend to
affect the amount people spend on goods and
services as well as the amount of private saving.
 Fiscal Policy
• Private consumption and saving have important
effects on investment and output in the short and
long run.

• In addition taxes affect the prices of goods and

factors of production and thereby affect incentives
and behaviour.
 Monetary Policy
•The second major instrument of macroeconomic
policy is monetary policy, which the government
(through central bank) conducts through managing
the nation’s money, credit and banking system.

•Central bank, the federal reserve system, operates to

regulate the money supply.

•Money consists of the means of exchange or method

of payment. People use currency and checking
accounts to pay their bills
 Monetary Policy
•By engaging in central bank operations, the federal
reserve can regulate the amount of money available
to the economy.

•But how does such a minor thing as the money

supply can have such a large impact on
macroeconomic activity.

•By changing the money supply, the federal reserve

can influence many financial and economic variables,
such as interest rates, housing prices and foreign
exchange rates.
 Monetary Policy
• Restricting the money supply leads to higher
interest rates and reduced investment,
• which, in turn, causes a decline in GDP and lower
inflation.

• If the central bank is faced with business downturn

it can increase the money supply and lower interest
rate to stimulate economic activity.