Macro Economics Lectures

MIRPUR UNIVERSITY OF SCIENCE AND TECHNOLOGY (MUST), MIRPUR
DEPARMENT OF ECONOMICS
Macroeconomics
COURSE CODE:)
(BC-2303)
Course Outline
Mariam Yassar
(Jr.Lecturer)
Date:2020
COURSE DESCRIPTION
This course aims at giving students knowledge about the working of a mixed
economy at the aggregate level under pinning of aggregate output and income
determination, key macro-economic problems and major policy debate. The basic
themes are extended to find out how the disciplines of national income, macro
-economics in closed and open economy, macroeconomic stabilization policies,
macro-economic components (consumption, saving, private investment, interest
etc.), public finance, money and banking link up with conventional
macroeconomics.
Macroeconomics 3
COURSE OBJECTIVES
At the end of this course, students will be able to:

1. To become familiar with and readily use economic terminology.
2. To learn about the analytical approach economists take to the problem of
scarcity.
3. To gain an intuitive understanding of macroeconomic theory and application.
4. To acquire better critical thinking skills through the analysis of present day
economic issues.
5. To provide a foundation for possible careers in business, government, academic
or other sectors.
6. To develop a conscious recognition of economics in the world around us.
Macroeconomics 4
COURSE SCHEDULE
Till Mid Term
Topic 1… Introduction
Topic 2… National Income Accounting
Topic 3…. Money and Interest
Topic 4….Aggregate Demand and Aggregate Supply
Topic:5…. Consumption ,Investment and Savings
After Mid Term
Topic 1… Inflation and Unemployment
Topic 2… Taxation
Topic 3 …. Business Cycles
Macroeconomics 5
COURSE SCHEDULE
After Mid Term
Topic 4… Monetary Policy
Topic 5… Fiscal Policy
Topic 6 …. Presentation Sessions
Macroeconomics 6
COURSE TEXTBOOKS
• RECOMMENDED BOOKS
• Shapiro Edward, latest edition, Macroeconomic Analysis.
• Mankiw N. Gregory, fifth edition, Macroeconomics.
• Mankiw N. Gregory, fourth Edition, Brief Principles of Macroeconomics.
• REFERENCE BOOKS:
• Sumuelson, Economics Seventh Edition,
• Shahid Hamid Macroeconomics.
Subject Name 7
GRADING POLICY
Mid Term: 30%
Quizzes: [ 10 %]
Assignments: [10 %]
Semester Project: [ 0%]
Final Exam: [ 50%]
Macroeconomics 8
HOMEWORK & ASSIGNMENT POLICY
Point 1…Individual assignment to evaluate different monetary policies of Pakistan.

Make a comparison study.
Point 2…Research articles of different economists work on monetary economics.
Point 3…Compare the ten years of monetary policy and check pegging interest rate
is better or inflation ???
Subject Name 9
THANKS
MACROECONOMICS
BC -2303
Lecture :1 Macroeconomics ,its principles and tools
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
DEFINITION
Macroeconomics is a branch of economics that studies how an overall

economy –the market system that operates on a large scale –behaves.
Macroeconomics is a branch of economics dealing with the

performance, structure, behavior, and decision-making of an economy
as a whole.
MACROECONOMICS 13
Cont’
Macroeconomics is the branch of economics that studies the behavior

and performance of an economy as a whole. It focuses on the aggregate
changes in the economy such as unemployment, growth rate, gross
domestic product and inflation.
MACROECONOMICS 14
PRINCIPLES OF MACROECONOMICS
1.WHO WILL WORK

2.WHAT GOODS AND HOW MANY OF THEM SHOULD BE
PRODUCESD?’
3. WHAT RESOURCES SHOULD BE USED IN PRODUCTION?
4.AT WHAT PRICE THE GOODS BE SOLD?
MACROECONOMICS 15
PRINCIPLES OF MACROECONOMICS
5. HOW PEOPLE MAKE DECISIONS ?

6. HOW PEOPLE INTERACT EACH OTHER?
7.THE FORCES AND TRENDS THAT AFFECT HOW THE
ECONOMY AS A WHOLE WORKS?
8. THERE IS NO SUCH THING AS A FREE LUNCH.
9.TO GET ONE THING ,WE USUALLY HAVE TO GIVE UP OTHER
THING
10.EFFICIENCY AND EQUITY.
MACROECONOMICS 16
TOOLS OF MACROECONOMICS
Macroeconomic policy aims to provide a stable economic environment

that is conducive to fostering strong and sustainable economic growth.
The key pillars of macroeconomic policy are :
1.FISCAL POLICY
2.MONETARY POLICY
3. EXCHANGE RATE POLICY
MACROECONOMICS 17
FISCAL POLICY
Fiscal policy is the means by which a government adjusts its spending

levels and tax rates to monitor and influence a nation's economy.
It refers to the use of government spending and tax policies to influence
economic conditions, especially macroeconomic conditions, including
aggregate demand for goods and services, employment, inflation, and
economic growth.
MACROECONOMICS 18
MONETARY POLICY
Monetary policy is the macroeconomic policy laid down by the central

bank. It involves management of money supply and interest rate and is
the demand side economic policy used by the government of a country
to achieve macroeconomic objectives like inflation, consumption,
growth and liquidity.
MACROECONOMICS 19
EXCHANGE RATE POLICY
An exchange rate is the value of one nation's currency versus the

currency of another nation or economic zone.
• The exchange rate of an economy affects aggregate demand through
its effect on export and import prices, and policy makers may exploit
this connection.
• Deliberately altering exchange rates to influence the macro-economic
environment may be regarded as a type of monetary policy. Changes
in exchanges rates initially work there way into an economy via their
effect on prices.
MACROECONOMICS 20
NOTE:
DETAILS ARE GIVEN IN LECTURE 14 AND I5 .
MACROECONOMICS 21
MACROECONOMICS
BC -2303
Lecture :2 National Income Accounting
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
MEANING OF NATIONAL INCOME
National Income of a country is the total market value of all goods
and services produced within a country in a year.
Final Goods
Intermediate Goods
National Income = National Product = National Expenditure
MACROECONOMICS 24
CIRCULAR FLOW
• Two Sectors, between HH and Firms

• Three Sectors, between HH, Financial Sector, Firms
• Four Sectors, between HH, FS, Firms, Govt.s
• Full, Five Sectors, HH, FS, Firms, Govt.s
MACROECONOMICS 25
NATIONAL INCOME IDENTITIES
Two Sectors
◦ Y=C+I
◦ Y=C+S
◦ C+S == Y == C+I
◦ C+S=C+I
◦ S=I
◦ Three Sectors?
◦ Four or Five Sectors?
MACROECONOMICS 26
GROSS NATIONAL PRODUCT
Gross National Product
Total Market Value of all final goods and services in a country in a year
◦ Monetary Value
◦ Counting Care, e.g. count products/service each only once. Avoid problem of double/multiple
counting
Final Goods?
Intermediate Goods?
Normal Residents? Both national and foreigners dwell in a country.
MACROECONOMICS 27
COMPONENTS OF GNP
• Value of Final Goods/Consumed by Consumers, C
• Value of New Capital/Investment Goods, consumed by Firms, I
• Value of expenditure by Govt/Govt Consumption, G
• Net Exports, Exports minus Imports
• Net Factor Income, include wages, rents, interest/profits etc
MACROECONOMICS 28
WHAT INCOMES ARE ADDED IN GNP
GNP=
Net Factor Income from Abroad (FI) +
Gross Private Investment (I) +
Net Exports (Xn) +
Govt Expenditure (G) +
Private Consumption ( C )
MACROECONOMICS 29
GROSS DOMESTIC PRODUCT
THE VALUE OF ALL GOODS AND SERVICES PRODUCES IN AN ECONOMY DURING A

CERTAIN PERIOD OF TIME IS CALLED AS GROSS DOMESTIC PRODUCT.
MACROECONOMICS 30
CONT’
GNP GDP
Net Factor Income from Abroad (FI)
Gross Private Investment (I) + Gross Private Investment (I) +
Net Exports (Xn) + Net Exports (Xn) +
Govt Expenditure (G) + Govt Expenditure (G) +
Private Consumption ( C ) Private Consumption ( C )
MACROECONOMICS 31
THANKS
MACROECONOMICS
BC-2303
Lecture :3 National Income Accounting
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
NET NATIONAL PRODUCT
Depreciation?
NNP=GNP-Depreciation
Note, includes some indirect taxes which are not meant to be levied on the payer specially. Like
some sales tax which is actually paid by the firms on selling points. Hence, actual price of
products is different than what consumers really pay. Consumers paid price includes indirect
taxes or subsidies. Hence, care is needed for considering it before final counting.
Indirect Tax? Cost Price plus Tax, Tax is collected by Govts from firms
Subsidy? Cost Price minus Subsidy, Subsidy is paid by Govts to businesses
MACROECONOMICS 35
CONT’
GNP= GDP= NNP=
Net Factor Income from Abroad
(FI) +
(Subtract Depreciation from Gross
private Investment)
=Ig-Depreciation=In
Gross Private Investment (I) + Gross Private Investment (Ig) + Net Private Investment
(In) +
Net Exports (Xn) + Net Exports (Xn) + Net Exports (Xn) +
Govt Expenditure (G) + Govt Expenditure (G) + Govt Expenditure (G) +
Private Consumption ( C ) Private Consumption ( C ) Private Consumption ( C )
MACROECONOMICS 36
NATIONAL INCOME
When NNP is accounted for Indirect Taxes and Subsidies
So NNP-Tax/Subsidies=NNI
MACROECONOMICS 37
PERSONAL INCOME
As each final income receiver has also to pay some more types of taxes and get other benefits in
addition to what is stated earlier, like Indirect Taxes and Subsidies, So final income at the
disposal of normal consumers to spend/consume is a different entry/value.
NNI - Undistributed Corporate Profits, Corporate Taxes and Social Security Contribution
+ transfer payments (any payment that is not related to get back something in return like
pensions, unemployment compensation, relief payment, interest payment on public debt, etc.)
Personal Income can be at disposal for consumption if any further personal income tax are
paid by the recipient.
MACROECONOMICS 38
MEASUREMENT OF NATIONAL INCOME
Value Added Method
Income Method
Expenditure Method
MACROECONOMICS 39
MEASUREMENT OF NATIONAL INCOME
Adjusting for Price Changes: Real vs Nominal GDP
Nominal GDP
the total value of all final goods and services produced in the economy
during a given year, calculated with the prices current in the year in which
the output is produced
Real GDP
the total value of all final goods and services produced in the economy
during a given year, calculated using the prices of a selected base year.
MACROECONOMICS 40
THANKS
MACROECONOMICS
BC -2303
Lecture :4 INFLATION AND UNEMPLOYMENT
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
Unemployment & Inflation
Defining Unemployment:
Occurs when worker who’s not currently employed is searching for a job without
success
Labor Force: people who are willing and able to work (Have to be seeking
work!)
Unemployment Rate: # of unemployed persons/labor force
MACROECONOMICS 44
TYPES OF UNEMPLOYMENT
Unemployment has different types but broadly it can be divided into three types:
1. Structural Unemployment
2. Frictional Unemployment
3. Cyclical Unemployment
MACROECONOMICS 45
WHAT IS NOT INCLUDED IN UNEMPLOYMENT
RATE
Hidden Unemployment (Discouraged workers)
Those who are able to work, but not actively seeking work because they are
discouraged about their prospects. (NOT included in labor force)
Part-time workers (listed as employed, but they are unhappily only part-time)
In sum, reported µ UNDER-ESTIMATES degree of unemployment or under-employment!
Natural Rate of Unemployment (full unemployment rate, NAIRU): No cyclical

Unemployment
MACROECONOMICS 46
INFLATION
Inflation: General increase in the price level
Deflation : Occurs when overall prices fall
Disinflation: Occurs when there is a SLOWING of inflation (prices still rising)
MACROECONOMICS 47
MEASURING INFLATION
CPI–Consumer Price Index
Total Cost of Current Year/Total Cost of Base Year
Weighted average of prices of a basket of consumer goods and services, such
as transportation, food and medical care
 Includes anything that consumers typically buy, including foreign goods/services.
MACROECONOMICS 48
MEASURING INFLATION
GDP Deflator
Nominal GDP/Real GDP
 Imports (foreign goods/services) NOT included
Includes all goods and services –producer and consumer goods/services
MACROECONOMICS 49
MEASURING INFLATION
GDP Deflator
Nominal GDP/Real GDP
 Imports (foreign goods/services) NOT included
Includes all goods and services –producer and consumer goods/services
MACROECONOMICS 50
LIMITATIONS OF MEASURES OF INFLATION
Limitations of most price gauges (CPI, PPI & GDP deflator)
Don’t take into consideration improvements in quality.
Results in an OVER-estimates price increases (not pricing in quality

enhancements)
 For example, electronics (computers, cellphones, televisions)
MACROECONOMICS 51
COSTS OF INFLATION
 Financial Wealth is eroded
 Savings are discouraged
 Menu Costs (higher costs for businesses to re-price their goods)
 Shoe leather costs (misallocation of resources looking for lower prices)
 Rewards borrowers, hurts lenders
 Inflation tax –wealth is redistributed from lenders to borrowers
 Tends to lead to more debt, as going into debt is beneficial to borrowers
 Government in general is the largest debtor!
MACROECONOMICS 52
THANKS
MACROECONOMICS
BC -2303
Lecture :5 Aggregate demand and Supply
MARIAM YASSAR
(JR.LECTURER)
Date:, 2020
Why to Study Aggregate Demand and Supply Model
Purpose of AS/AD Model is to build a model that explains why the economy
moves in cycles, and to better anticipate the effects of policy proposals.
MACROECONOMICS 56
WHAT IS AGGREGATE DEMAND CURVE
A curve that shows the relationship between the level of prices and the quantity of
real GDP demanded.Horozontal gdp
Verticle
MACROECONOMICS 57
FACTORS AFFECTING AGGREGATE DEMAND
CURVE
As the purchasing power of money changes the aggregate demand curve affect in
various ways.
i) Wealth
ii) Interest rates
iii) International trade
MACROECONOMICS 58
WHAT SHIFTS THE AGGREGATE DEMAND CURVE
What shifts the Aggregate Demand Curve?
Any changes that effect the components of GDP, i.e. C, I, G, XM!
Both fiscal & monetary policy actions effect AD, not AS!
MACROECONOMICS 59
CONT’
What might explain this shift to the right of AD?
Stock market appreciation
Consumer confidence rises
Government spending increases (tax cuts)
Expansive monetary policy (increase MS)
MACROECONOMICS 60
Long-RUN Aggregate Supply
Classical Economic Theory
Say’s Law: Supply creates its own demand: this concept basically says that
supply drives the economy.
Vertical supply curve: prices have no effect on Long-run aggregate supply
Shifts in Aggregate Demand have no effect on Long-run full employment GDP.
Prices need to be able to move freely to re-establish equilibrium.
MACROECONOMICS 61
Short run Aggregate Supply
SRAS is upward sloping. Why?
• Input prices move more slowly than output prices (Sticky wages)
• Misunderstanding that price increases are effecting their products only.
MACROECONOMICS 62
WHAT SHIFTS SRAS?
Changes is resource availability
• Natural disasters tend to be SRAS specific events
• Resource discoveries, immigration, education
Changes in productivity/technology
• New technologies that benefit producers shift aggregate supply to right
• Relaxing government regulation can increase productivity and shift AS right
Changes in expected price level (shifts ONLY SRAS, not LRAS)
MACROECONOMICS 63
EQUILIBRIUM IN THE AD-AS MODEL
A common price level where aggregate demand intersects aggregate Supply.
Note;(see the figure in the reference book)
MACROECONOMICS 64
RECESSIONARY GAP OR COST PUSH INFLATION
When prices rise because of a shift to the left in Aggregate Supply. Supply shock.
Leads to Recessionary gap, stagflation.
MACROECONOMICS 65
INFLATIONARY GAP OR DEMAND PULL
INFLATION
When prices rise because of a shift to the right in Aggregate Demand. Leads to Inflationary gap.
MACROECONOMICS 66
THANKS
MACROECNOMICS
BC-2303
Lecture 6: CONSUMPTION
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
CONSUMPTION
Consumption is the sole end and purpose of all production.
Adam Smith
Why consumption is addressed as a macroeconomic question or topic?

How do households decide how much of their income to consume today and how much to
save for the future? This is a microeconomic question because it addresses the behavior of
individual decision makers. Yet its answer has important macroeconomic consequences.
The consumption decision is crucial for long-run analysis because of its role in economic
growth.
For example:
The Solow growth model shows that the saving rate is a key determinant of the steady-state
capital stock and thus of the level of economic well-being.
MACROECONOMICS 70
CONT’
The saving rate measures how much of its income the present generation is not
consuming but is instead putting aside for its own future and for future
generations.
The consumption decision is crucial for short-run analysis because of its role in
determining aggregate demand. Consumption is two-thirds of GDP, so fluctuations
in consumption are a key element of booms and recessions.
The IS–LM model shows that changes in consumers’ spending plans can be a source
of shocks to the economy and that the marginal propensity to consume is a
determinant of the fiscal-policy multipliers.
We are going to examine the consumption function in greater detail and develop a
more thorough explanation of what determines aggregate consumption.
MACROECONOMICS 71
CONT’
Since macroeconomics began as a field of study, many economists have written about the
theory of consumer behavior and suggested alternative ways of interpreting the data on
consumption and income. This topic presents the views of six prominent economists to
show the diverse approaches to explaining consumption.
THE DIVERSE APPROACHES TO EXPLAIN CONSUMPTION:
i) John Maynard Keynes Consumption Function
ii) Irving Fischer and Intertemporal Choice
iii) Franco Modigliani and the Life Cycle Hypothesis
iv) Milton Friedman and the Permanent-Income Hypothesis
v) Robert Hall and the Random-Walk Hypothesis
vi) David Laibson and the Pull of Instant Gratification
MACROECONOMICS 72
JOHN MAYNARD KEYNES AND THE
CONSUMPTION FUNCTION
Keynes Conjectures:
Keynes made conjectures about the consumption function based on introspection and
casual observation instead of statistical data analysis.
First and most important, Keynes conjectured that the marginal propensity to
consume—the amount consumed out of an additional dollar of income—is between
zero and one.
He wrote that the “fundamental psychological law, upon which we are entitled to
depend with great confidence, . . . is that men are disposed, as a rule and on the
average, to increase their consumption as their income increases, but not by as much as
the increase in their income.’’ That is, when a person earns an extra dollar, he typically
spends some of it and saves some of it.
MACROECONOMICS 73
CONT’
Second, Keynes posited that the ratio of consumption to income, called the
average propensity to consume,falls as income rises.
He believed that saving was a luxury, so he expected the rich to save a higher
proportion of their income than the poor.
Although not essential for Keynes’s own analysis, the postulate that the average
propensity to consume falls as income rises became a central part of early
Keynesian economics.
MACROECONOMICS 74
CONT’
Third, Keynes thought that income is the primary determinant of consumption
and that the interest rate does not have an important role.
This conjecture stood in stark contrast to the beliefs of the classical economists
who preceded him.
The classical economists held that a higher interest rate encourages saving and
discourages consumption. Keynes admitted that the interest rate could influence
consumption as a matter of theory.
Yet he wrote that “the main conclusion suggested by experience, I think, is that the
short-period influence of the rate of interest on individual spending out of a given
income is secondary and relatively unimportant.’’
MACROECONOMICS 75
CONT’
On the basis of these three conjectures, the Keynesian consumption

function is often written as:
C= C--- +cY, C>0, 0 <c <1
where C--- is consumption, Y is disposable income, C--- is a constant, , and

c is the marginal propensity to consume. This consumption function,
shown in Figure 17-1, (consult the chapter from the book) is graphed as
a straight line. C--- determines the intercept on the vertical axis, and c
determines the slope.
MACROECONOMICS 76
THREE PROPERTIES OF KEYNES CONSUMPTION
FUNCTION
a)It satisfies Keynes’s first property because the marginal propensity to
consume c is between zero and one, so that higher income leads to higher
consumption and also to higher saving.
b)This consumption function satisfies Keynes’s second property because
the average propensity to consume APC is:
APC=C/Y= C--- /Y+c
As Y rises, C-- /Y falls, and so the average propensity to consume C/Y falls
c) Finally, this consumption function satisfies Keynes’s third property
because the
interest rate is not included in this equation as a determinant of
consumption
MACROECONOMICS 77
THE EARLY EMPIRICAL SUCCESSES
Soon after Keynes proposed the consumption function, economists
began collecting and examining data to test his conjectures. The
earliest studies indicated that the Keynesian consumption function was
a good approximation of how consumers behave.
In some of these studies, researchers surveyed households and
collected data on consumption and income. They found that
households with higher income consumed more, which confirms that
the marginal propensity to consume is greater than zero.
Many other studies also verified it as a strong theory.
MACROECONOMICS 78
CONT’
On the basis of the Keynesian consumption function, these economists predicted
that the economy would experience what they called secular stagnation—a long
depression of indefinite duration—unless the government used fiscal policy to
expand aggregate demand.
The second anomaly arose when economist Simon Kuznets constructed new
aggregate data on consumption and income dating back to 1869. Kuznets
assembled these data in the 1940s and would later receive the Nobel Prize for this
Work.
He discovered that the ratio of consumption to income was remarkably stable from
stable from decade to decade, despite large increases in income over the period
he studied. Again, Keynes’s conjecture that the average propensity to consume
would fall as income rose appeared not to hold.
MACROECONOMICS 79
CRITICISM
Secular Stagnation, Simon Kuznets, and the Consumption Puzzle
Although the Keynesian consumption function met with early
successes, two
anomalies soon arose. Both concern Keynes’s conjecture that the
average propensity to consume falls as income rises.
The first anomaly became apparent after some economists made a dire
—and, it turned out, erroneous—prediction during World War II. On
the basis of the Keynesian consumption function, these economists
reasoned that as incomes in the economy grew over time, households
would consume a smaller and smaller fraction of their incomes.
MACROECONOMICS 80
REFERENCES
For detail see Chapter :17 Consumption
Mankiw Macroeconomics 7th edition
MACROECONOMICS 81
THANKS
MACROECONOMICS
BC-2303
Lecture :8 BUSINESS CYCLES
Mariam Yassar
(Jr.Lecturer)
Date: 2020
Business Cycles
The repeated sequence of economic expansion giving way to temporary
decline followed by recovery, is known as the business Cycle.The business cycle is
a central concern in macroeconomics because business cycle fluctuations-the ups
and downs in overall economic activity-are felt throughout the economy. When
the economy is growing strongly, prosperity is shared by most of the nation's
industries and their workers and owners of capital.
MACROECONOMICS 85
DEFINITION
The definition given by NBER is as follows:
“Business cycles are a type of fluctuation found in the aggregate economic activity of
nations that organize their work mainly in business enterprises. A cycle consists of
expansions occurring at about the same time in many economic activities, followed by
similarly general recessions, contractions, and revivals which merge into the expansion
phase of the next cycle; this sequence of changes is recurrent but not periodic; in
duration business cycles vary from more than one year to ten or twelve years.”
MACROECONOMICS 86
CHARACTERISTICS OF BUSINESS CYCLE
Five points in this definition should be clarified and emphasized:
1. Aggregate Economic Activity
2. Expansions and Contractions
3. CO-Movement
4. Recurrent but not Periodic
5. Persistence
MACROECONOMICS 87
1.AGGREGATE ECONOMIC ACTIVITY
Business cycles are defined broadly as fluctuations of "aggregate economic activity"

rather than as fluctuations in a single, specific economic variable such as real GDP.
For example,
Although real GOP may be the single variable that closely measures aggregate
economic activity, it is important to look at other indicators of activity, such as
employment and financial market variables.
MACROECONOMICS 88
2.EXPANSIONS AND CONTRACTIONS
The period of time during which aggregate economic activity is falling is a

contraction or recession. If the recession is particularly severe, it becomes a
depression, After reaching the low point of the contraction, the (trough T),
aggregate economic activity begins to increase. The period of time during
begins to decline again The entire sequence of decline followed by recovery,
measured from peak to peak or trough to trough, is a business cycle.
MACROECONOMICS 89
3.COMOVEMENT
Business cycles do not occur in just a few sectors or in just a few economic
variables. Instead, expansions or contractions "occur at about the same time in many
economic activities“.
Many economic variables, such as prices, productivity, investment, and government
purchases, also have regular and predictable patterns of behavior over the course of
the business cycle .
The tendency of many economic variables to move together in a predictable way
over a business Cycle is called co-movement.
MACROECONOMICS 90
4.RECURRENT BUT NOT PERIODIC
The business cycle isn't periodic, in that it does not occur at regular ,predictable
intervals and doesn't last for a fixed or predetermined length of time.
Although the business cycle isn't periodic, it is recurrent; that is, the standard
pattern of contraction-trough-expansion-peak reoccurs again and again
in industrial economies .
MACROECONOMICS 91
5.PERSISTENCE
The duration of a complete business cycle can vary greatly, from about a year to
more than a decade ,and predicting it is extremely difficult.
However, once a recession begins, the economy tends to keep contracting for a
Period of time, perhaps for a year or more . Similarly, an expansion, once begun,
usually lasts a while.
This tendency for declines in economic activity to be followed by further
declines, and for growth in economic activity to be followed by more growth is
called ,persistence.
MACROECONOMICS 92
EXAMPLES OF BUSINESS CYCLES
1. The Pre-World War I Period

2. The Great Depressiorn arnd World War II
3. Post-World War II U.S. Business Cycles
4. The "long Boom“
5. Have American Business Cycles Become less Severe?
MACROECONOMICS 93
BUSINESS CYCLE FACTS
i) DIRECTIONS OF THE VARIABLE
The Cyclical Behavior of Economic Variables: Direction and Timing

Two characteristics of the cyclical behavior of macroeconomic variables are
important to our discussion of the business cycle facts .
i) The first is the direction in which a macroeconomic variable moves, relative to
the relative to the direction of aggregate economic activity .
a)Procyclical
An economic variable that moves in the same direction as aggregate economic
activity is called a procyclical variable.
MACROECONOMICS 94
cont’
b) Countercyclical
A variable that moves in the opposite direction to aggregate economic activity (up
in contractions, down in expansions) is countercyclical.
c) Acyclical
Variables that do not display a clear pattern over the business cycle are acyclical.
MACROECONOMICS 95
ii)TIMINGS OF THE VARIABLE
The second characteristic is the timing of the variable's turning points (peaks
and troughs) relative to the turning points of the business cycle.
a)Leading Variable
An economic variable is a leading variable if it tends to move in advance of

aggregate economic activity, In other words,the peaks and troughs in a leading
variable occur before the corresponding peaks and troughs in the business cycle,
MACROECONOMICS 96
cont’
b) Coincident Variable
A coincident variable is one whose peaks and troughs occur at about the same time
as the corresponding business cycle peaks and troughs .
c) Lagging Variable
A lagging variable is one whose peaks and troughs tend to occur later than the
corresponding peaks and troughs in the business cycle.
MACROECONOMICS 97
Examples of Variables
i) Production
ii) Expenditure
iii) Employment and Unemployment
iv) Average Labor Productivity and the real wage
v) Money Growth and Inflation
vi) Financial Variables
MACROECONOMICS 98
REFERENCE
ABEL,ANDREW B,BERNANKE,BEN S,MACROECONOMICS,4TH
MACROECONOMICS 99
THANKS
MACROECONOMICS
BC-2303
Lecture:8 Aggregate Demand and Supply shocks during the Business Cycles
Mariam Yassar
(Jr.Lecturer)
Date: 2020
International Aspects of The Business Cycle
The business cycle is an international phenomenon in another sense:
Frequently, the major industrial economies undergo recessions and expansions at
about the same time, suggesting that they share a common cycle.
MACROECONOMICS 103
BUSINESS CYCLE ANALYSIS :A PREVIEW
Macroeconomists are interested not only in happens during business cycles but also
in why it happens.
The advice that macroeconomists give to policy~ makers about how to respond to a
recession depends on what they think is causing the recession.
MACROECONOMICS 104
COMPONENTS OF THEORIES OF BUSINESS
CYCLES
The first is a description of the types of factors that have major effects on the
economy-wars, new inventions, harvest failures, and changes in government policy
are examples . Economists often refer to these (typically unpredictable) forces
hitting the economy as shocks.
The other component of a business cycle theory is a model of how the economy
responds to the various shocks.
MACROECONOMICS 105
TWO PRINCIPAL BUSINESS CYCLE THEORIES
The two principal business cycle theories that we discuss are the classical and
the Keynesian. Fortunately, to present and discuss these two we don't have to
develop two completely different models Instead, both can be considered
within a general framework called the aggregate demand –aggregate supply,
or AD-AS, Model. To introduced some of the key differences between the
classical and Keynesian approaches to business cycle analysis, we preview
the AD-AS model and how it is used to analyze business cycles.
MACROECONOMICS 106
AGGREGATE DEMAND AND AGGREGATE
SUPPLY:A BRIEF INTRODUCTION
The AD-AS model has three components:
(1) the aggregate demand curve
(2) the short-run aggregate supply curve
(3) the long-run aggregate supply curve
MACROECONOMICS 107
THE AGGREGATE DEMAND CURVE
The aggregate demand curve shows for any price level, p, the total quantity of
goods and services, Y, demanded by households, films, and governments. The
AD curve slopes downward implying that, when the general price level is higher,
people demand fewer goods and services.
The AD curve relates the amount of output demanded to the price level, if we
hold other economic factors constant. However, for a specific price level, any
change in the economy that increases the aggregate quantity of goods and services
demanded will shift the AD curve to the right (and any change that decreases the
quantity of goods and services demanded will shift the AD curve to the left)
MACROECONOMICS 108
THE AGGREGATE SUPPLY CURVE
An aggregate supply curve indicates the amount of output producers are willing to
supply at any particular price level .
I)Short –run Supply Curve
The short run aggregate supply curve, is a horizontal line. The horizontal SRAS
curve captures the ideas that in the short run the price level is fixed and that firms
are willing to supply any amount of output at that price .
The tendency of a producer to set a price for some time and then supply whatever is
demanded at that price is represented by a horizontal SRAS curve .
MACROECONOMICS 109
Cont’
2)Long –run Aggregate Supply Curve

Thus the aggregate supply curve is vertical, in the long run, all other firms in the
economy will adjust their prices as necessary so as to be able to produce their
normal level of output.
However, when some change occurs in the economy, the short run equilibrium can
differ from the long-run equilibrium.
MACROECONOMICS 110
AGGREGATE DEMAND SHOCKS
A theory of business cycles has to include a description of the shocks hitting the
economy The AD-AS framework identifies shocks by their initial effects-on
aggregate demand or aggregate supply.
Aggregate Demand Shock:
An aggregate demand shock is a change in the economy that shifts the AD
curve. For example, a negative aggregate demand shock would occurs` if
consumers became more pessimistic about the future and thus reduced their
current consumption spending, shifting the AD curve to the left.
MACROECONOMICS 111
EFFECT OF AN AGGREAGTE DEMAND SHOCK
Our analysis shows that an adverse aggregate demand shock, which shifts the
AD curve down, will cause output to fall in the short run but not in the long run
How long does it take for the economy to reach the long nm? This question is
crucial to economic analysis and is one to which classical economists and
Keynesian
economists have very different answers. Their answers help explain why classicals
and Keynesians have different views about the appropriate role of government
policy in fighting recessions.
MACROECONOMICS 112
CLASSICAL ANSWER TO AGGREGATE DEMAND
SHOCKS
The classical answer is that prices adjust quite rapidly to imbalances in quantities supplied and
demanded so that the economy gets to its long-run equilibrium quickly-in a few months or less. Thus a
recession caused by a downward shift of the AD curve is likely to end rathe! quickly, as the price level
falls and the economy reaches the original level of output, Y In the strictest versions of the classical
model, the economy is assumed to reach its long-run equilibrium essentially immediately, implying
that the short-run aggregate supply curve is irrelevant and that the economy always operates on the
long-run aggregate supply (LRAS) curve.
Because the adjustment takes place quickly, classical economists argue that little is gained by the
government actively trying to fight recessions.
MACROECONOMICS 113
KEYNESIANS VIEW ON AGGREGATE DEMAND
SHOCKS
In contrast to the classical view, Keynesian economists argue that prices (and
wages, which are the price of labor) do not necessarily adjust quickly in response
to shocks. Hence the return of the economy to its long-run equilibrium may be
slow, taking perhaps years rather than months. In other words, although
Keynesians agree with classicals that the economy's level of output will eventually return
from its recessionary level to its full employment level, Y, they believe that this process
may be slow. Because they lack confidence in the self-correcting powers of the economy,
Keynesians tend to see an important role for the government in fighting recessions.
MACROECONOMICS 114
AGGREGATE SUPPLY SHOCK
An aggregate supply shock is a change in the economy U1at causes the long-run
aggregate supply (LRAS) curve to shift The position of the LRAS curve depends
only on the full-employment level of output, Y, so aggregate supply shocks can also
be thought of as factors-such as changes in productivity or labor supply, for
example-that lead to changes in Y.
MACROECONOMICS 115
CLASSICAL AND KEYNESIAN VIEWS ON
AGGREGATE SUPPLY SHOCK
Although classical economists first emphasized supply shocks, Keynesian
economists also recognize the importance of supply shocks in accounting for

business cycle fluctuations in output .Keynesians agree that an adverse supply
shock
will reduce output and increase the price level in the long run.
MACROECONOMICS 116
References
CHAPTER :8,ABEL,ANDREW B,BERNANKE,BEN S,MACROECONOMICS,4TH
EDITION.
MACROECONOMICS 117
THANKS
MACROECONOMICS
BC-2303
Lecture :09 INVESTMENT
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
INVESTMENT
The social object of skilled investment should be to defeat the dark forces of
time and ignorance which envelope our future.
—John Maynard Keynes
Spending on investment goods is aimed at providing a higher standard of living at a

later date.
Investment is the component of GDP that links the present and the future.
Macroeconomics 121
Importance
Investment spending plays a key role not only in long-run growth but also
in the short-run business cycle because it is the most volatile component of
GDP. When expenditure on goods and services falls during a recession, much
of the decline is usually due to a drop in investment.
Subject Name 122

Cont’
Economists study investment to better understand fluctuations in the economy’s

output of goods and services. The models of GDP such as the IS–LM model ,were
based on a simple investment function relating investment to the real interest rate
Simple investment function relating investment to the real interest rate: I=I(r).
That function states that an increase in the real interest rate reduces investment.
Macroeconomics 123
Basic Questions Addressed by the models of Investment
The models will shed light on the following questions:
■ Why is investment negatively related to the interest rate?
■ What causes the investment function to shift?
■ Why does investment rise during booms and fall during recessions?
Macroeconomics 124
TYPES OF INVESTMENT
There are three types of investment spending:
1. Business fixed investment
2.Residential investment
3. Inventory investment
Macroeconomics 125
1.BUSINESS FIXED INVESTMENT
Business fixed investment Includes the equipment and structures that businesses buy
to use in production.
The largest piece of investment spending, accounting for about three-quarters of
the total, is business fixed investment. The term “business” means that these
investment goods are bought by firms for use in future production. The term
“fixed” means that this spending is for capital that will stay put for a while, as
MACROECONOMICS 126
cont’
opposed to inventory investment, which will be used or sold within a short time.
Business fixed investment includes everything from office furniture to factories,
computers to company cars.
Subject Name 127

Standard Model of Business Fixed Investment
The standard model of business fixed investment is called the neoclassical

model of investment.
The neoclassical model examines the benefits and costs to firms of owing capital
goods.
The model shows how the level of investment—the addition to the stock of capital—
is related to the marginal product of capital, the interest rate, and the tax rules
affecting firms.
Macroeconomics 128
Developing the Model
To develop the model, imagine that there are two kinds of firms in the economy.
1.Production firms produce goods and services using capital that they rent.
2.Rental firms make all the investments in the economy; they buy capital and rent
it out to the production firms.
Most firms in the real world perform both functions: they produce goods and
services, and they invest in capital for future production. We can simplify our
analysis and clarify our thinking, however, if we separate these two activities by
imagining that they take place in different firms.
Macroeconomics 129
THE RENTAL PRICE OF CAPITAL
Let’s first consider the typical production firm. This firm decides how much capital to rent by comparing the cost and
benefits of each unit of capital.:
The firm rents capital at a rental rate R and sells its output at a price P ;
The real cost of a unit of capital to the production firm is R/P.
The real benefit of a unit of capital is the marginal product of capital MPK—the extra output produced with one more
unit of capital.
The marginal product of capital declines as the amount of capital rises: the more capital the firm has, the less an
additional unit of capital will add to its output.
In order to maximize profit ,the firm rents capital until the marginal product of capital falls to equal the real rental
price.
Macroeconomics 130
COBB-DOGLOUS PRODUCTION FUNCTION
Many economists consider the Cobb–Douglas production function a good

approximation of how the actual economy turns capital and labor into goods and
services. The Cobb–Douglas production function is:
Y=A Kα L1-α
where Y is output, K is capital, L is labor, α is a parameter measuring the level
of technology, and alpha is a parameter between zero and the one that measures
capital’s share of output.
Macroeconomics 131
Cont’
The marginal product of capital for the Cobb–Douglas production function is
Because the real rental price R/P equals the marginal product of capital in
equilibrium, we can write:
R/P =Α α (L/K)1-α
Macroeconomics 132
Cont’
This expression identifies the variables that determine the real rental price. It
shows the following:
■ The lower the stock of capital, the higher the real rental price of capital.
■ The greater the amount of labor employed, the higher the real rental
price of capital.
■ The better the technology, the higher the real rental price of capital.
Events that reduce the capital stock (an earthquake), or raise employment (an
expansion in aggregate demand), or improve the technology (a scientific discovery)
raise the equilibrium real rental price of capital.
Macroeconomics 133
THANKS
Macroeconomics
BC-2303
Lecture :10 TYPES OF INVESTMENT
MARIAM YASSAR
(JR.LECTURER)
Date: 2020
THE COST OF CAPITAL
The cost of owning capital is more complex. For each period of time that it rents out a
unit of capital, the rental firm bears three costs:
1.When a rental firm borrows to buy a unit of capital, it must pay interest on the loan. If
PK is the purchase price of a unit of capital and i is the nominal interest rate, then iPK is
the interest cost. Notice that this interest cost would be the same even if the rental firm did
not have to borrow: if the rental firm buys a unit of capital using cash on hand, it loses
out on the interest it could have earned by depositing this cash in the bank. In either case,
the interest cost equals iPK.
MACROECONOMICS 137
CONT’
2.While the rental firm is renting out the capital, the price of capital can change. If
the price of capital falls, the firm loses, because the firm’s asset has fallen in value.
If the price of capital rises, the firm gains, because the firm’s fallen in value. If the
price of capital rises, the firm gains, because the firm’s asset has risen in value. The
cost of this loss or gain is −ΔPK.(The minus sign is here because we are measuring
costs not benefits).
MACROECONOMICS 138
COST OF CAPITAL
3.While the capital is rented out, it suffers wear and tear called depreciation, if δ is
the rate of depreciation—the fraction of capital’s value lost per period because of
wear and tear—then the dollar cost of depreciation is δ Pk
The total cost of renting out a unit of capital for one period is therefore
Cost of Capital = iPk - Δ Pk + δ Pk
This equation states that the real cost of capital depends on the relative price of a
capital good PK/P, the real interest rate r, and the depreciation rate δ.
MACROECONOMICS 139
THE DETERMINANTS OF INVESTMENT
We can now see the economic incentives that lie behind the rental firm’s investment
decision. The firm’s decision regarding its capital stock—that is, whether to add to it
or to let it depreciate—depends on whether owning and renting out capital is
profitable. The change in the capital stock, called net investment, depends on the
difference between the marginal product of capital and the cost of capital. If the
marginal product of capital exceeds the cost of capital, firms find it profitable to add to
their capital stock. If the marginal product of capital falls short of the cost of capital,
they let their capital stock shrink.
MACROECONOMICS 140
CONT’
Business fixed investment depends on the marginal product of capital, the cost of
capital, and the amount of depreciation.
MACROECONOMICS 141
INVESTMENT AND INTEREST RATE
Investment depends on the interest rate. A decrease in the real interest rate lowers
the cost of capital. It therefore raises the amount of profit from owning capital and
increases the incentive to accumulate more capital. Similarly, an increase in the real
interest rate raises the cost of capital and leads firms to reduce their investment. For
this reason, the investment schedule relating investment to the interest rate slopes
downward.
MACROECONOMICS 142
WHAT CAUSES INVESTMENT SCHEDULE TO
SHIFT
1. Marginal productivity of Capital
2. Technological Innovation
3. Interest rate
Steady State Investment
The speed of adjustment toward the steady state depends on how quickly
firms adjust their capital stock, which in turn depends on how costly it is to
build, deliver, and install new capital.
MACROECONOMICS 143
TAXES AND INVESTMENT
Tax laws influence firms’ incentives to accumulate capital in many ways.

Sometimes policymakers change the tax code to shift the investment function and
influence aggregate demand .
We consider two of the most important provisions of corporate taxation:
i) The corporate income tax
ii) The investment tax credit
MACROECONOMICS 144
CORPORATE INCOME TAX
The effect of a corporate income tax on investment depends on how the law
defines “profit’’ for the purpose of taxation. Suppose, first, that the law defined
profit as we did previously—the rental price of capital minus the cost of capital. In
this
case, even though firms would be sharing a fraction of their profits with the
government, it would still be rational for them to invest if the rental price of capital
exceeded the cost of capital and to disinvest if the rental price fell short of the cost
of capital.
MACROECONOMICS 145
THE INVESTMET TAX CREDIT
A tax provision that reduces a firm’s taxes by a certain amount for each dollar spent
on capital goods.
Because a firm recoups part of its expenditure on new capital in lower taxes, the
credit reduces the effective purchase price of a unit of capital PK. Thus, the
investment tax credit reduces the cost of capital and raises investment.
MACROECONOMICS 146
The Stock Market and Tobin’s q
Many economists see a link between fluctuations in investment and fluctuations
in the stock market. The term stockrefers to shares in the ownership of corporations,
and the stock marketis the market in which these shares are traded.
Stock prices tend to be high when firms have many opportunities for profitable
investment, because these profit opportunities mean higher future income for the
shareholders. Thus, stock prices reflect the incentives to invest.
MACROECONOMICS 147
CONT’
The Nobel Prize–winning economist James Tobin proposed that firms base
their investment decisions on the following ratio, which is now called Tobin’s q:
q= Market Value of Installed Capital /Replacement Cost of Installed Capital
The numerator of Tobin’s q is the value of the economy’s capital as determined
by the stock market. The denominator is the price of that capital if it were purchased
today.
MACROECONOMICS 148
CONT’
Tobin reasoned that net investment should depend on whether q is greater or less
than 1.
If q is greater than 1, then the stock market values installed capital at more than its
replacement cost. In this case, managers can raise the market value of their firms’
stock by buying more capital.
If q is less than 1, the stock market values capital at less than its replacement cost.
In this case, managers will not replace capital as it wears out.
MACROECONOMICS 149
Advantage of Tobin;s q
The advantage of Tobin’s qas a measure of the incentive to invest is that it reflects
the expected future profitability of capital as well as the current profitability.
MACROECONOMICS 150
Advantage of Tobin;s q
The advantage of Tobin’s q as a measure of the incentive to invest is that it reflects
the expected future profitability of capital as well as the current profitability.
The expected fall in the corporate tax means greater profits for
the owners of capital. These higher expected profits raise the value of stock today,
raise Tobin’s q, and therefore encourage investment today. Thus, Tobin’s q theory of
investment emphasizes that investment decisions depend not only on current

economic policies but also on policies expected to prevail in the future.
MACROECONOMICS 151
THANKS
Macroeconomics
BC-2303
Lecture :11 Efficient Market Hypothesis, Residential Investment and Inventory Investment
Mariam Yassar
(Jr.Lecturer)
Date: 2020
Alternative Views of the Stock Market: The Efficient
Markets Hypothesis Versus Keynes’s Beauty Contest
According to Efficient Markets Hypothesis market price of a company’s stock is the fully
rational valuation of the company’s value, given current information about the company’s
business prospects. This hypothesis rests on two foundations:
1. Each company listed on a major stock exchange is followed closely by many

professional portfolio managers, such as the individuals who run mutual funds. Every
day, these managers monitor news stories to try to determine the company’s value. Their
job is to buy a stock when its price falls below its value and to sell it when its price rises
above its value.
MACROECONOMICS 155
FOUNDATIONS OF EFFICIENTS MARKETS
HYPOTHESIS
2.The price of each stock is set by the equilibrium of supply and demand.
At the market price, the number of shares being offered for sale exactly equals the
number of shares that people want to buy. That is, at the market price, the number of
people who think the stock is overvalued exactly balances the number of people
who think it’s undervalued.
MACROECONOMICS 156
CONT’
According to this theory, the stock market is informationally efficient: it reflects all
available information about the value of the asset. Stock prices change when
information changes.
One implication of the efficient markets hypothesis is that stock prices should
follow a random walk. This means that the changes in stock prices should be
impossible to predict from available information.
MACROECONOMICS 157
FINANCING CONSTRAINTS
When a firm wants to invest in new capital—say, by building a new factory—it

often raises the necessary funds in financial markets. This financing may take
several forms: obtaining loans from banks, selling bonds to the public, or selling
shares in Future profits on the stock market. The neoclassical model assumes that if
a firm is willing to pay the cost of capital, the financial markets will make the funds
available.
MACROECONOMICS 158
RESIDENTIAL INVESTMENT
Residential investment includes the purchase of new housing both by people who
plan to live in it themselves and by landlords who plan to rent it to others.
MACROECONOMICS 159
THE STOCK EQUILIBRIUM AND THE FLOW
SUPPLY
There are two parts to the model:
First, the market for the existing stock of houses determines the equilibrium housing
price.
Second, the housing price determines the flow of residential investment.
MACROECONOMICS 160
SUPPLY
According to this model of the housing market, residential investment depends on
the relative price of housing. The relative price of housing, in turn, depends on the
demand for housing, which depends on the imputed rent that individuals expect to
receive from their housing.
Hence, the relative price of housing plays much the same role for residential
investment as Tobin’s q does for business fixed investment.
MACROECONOMICS 161
SUPPLY
NOTE:( FOR DETAIL SEE PANEL A AND B IN THE REFERENCE CHAPTER
GIVEN AT THE END).
MACROECONOMICS 162
CHANGES IN HOUSING DEMAND

GIVEN AT THE END).
MACROECONOMICS 163
CHANGES IN HOUSING DEMAND
When the demand for housing shifts, the equilibrium price of housing changes,
and this change in turn affects residential investment.
SHIFT FACTORS OF HOUSING DEMAND:
An economic boom raises national income and therefore the demand for housing.
A large increase in the population, perhaps because of immigration, also raises the
demand for housing.
GIVEN AT THE END).
MACROECONOMICS 164
Inventory Investment
• Inventory investment—the goods that businesses put aside in storage.
• It is one of the smallest components of spending, averaging about 1 percent of GDP.
• Its remarkable volatility makes it central to the study of economic fluctuations.
• In recessions, firms stop replenishing their inventory as goods are sold, and
• inventory investment becomes negative.
• In a typical recession, more than half the fall in spending comes from a decline in
inventory investment.
MACROECONOMICS 165
REASONS FOR HOLDING INVENTORIES
I) PRODUCTION SMOOTHING MOTIVE:
One use of inventories is to smooth the level of production over time
II) INVENTORIES AS A FACTOR OF PRODUCTION:
A second reason for holding inventories is that they may allow a firm to
operate more efficiently. The larger the stock of inventories a firm holds, the more
output it can produce.
MACROECONOMICS 166
CONT’
III) Stock-out avoidance:
A third reason for holding inventories is to avoid running out of goods when sales
are unexpectedly high.
IV) WORK IN PROCESS:
A fourth explanation of inventories is dictated by the production process. When a

product is only partly completed, its components are counted as part of a firm‘s
inventory. These inventories are called work in process.
MACROECONOMICS 167
REAL INTEREST RATE AND INVENTORY
INVESTMENT
Like other components of investment, inventory investment depends on the real

interest rate. When a firm holds a good in inventory and sells it Tomorrow rather
than selling it today, it gives up the interest it could have earned the real interest
rate. between today and tomorrow. Thus, the real interest rate measures the
opportunity cost of holding inventories
When the real interest rate rises, holding inventories becomes more costly, so
rational firms try to reduce their stock. Therefore, an increase in the real interest
rate depresses inventory investment.
MACROECONOMICS 168
INVENTORY INVESTMENT AND CREDIT
CONDITIONS
Because many firms rely on bank loans to finance their purchases of inventories,
they cut back when these loans are hard to come by.
As in many economic downturns, the decline in inventory investment was a key part
of the decline in aggregate demand.
MACROECONOMICS 169
CONCLUSION
First, all types of investment spending are inversely related to the real interest
rate.
Second, there are various causes of shifts in the investment function, e.g
improvement in technology and population.
Third, it is natural to expect investment to be volatile over the business cycle ,
cycle, because investment spending depends on the output of the economy as
well as on the interest rate.
MACROECONOMICS 170
References
Mankiw-Macroeconomics,7th Edition .
MACROECONOMICS 171
THANKS
MACROECONOMICS-I
BC-2303
Lecture [12] : Money its kinds and functions ,Difficulties of Barter System ,Banks
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
PREVIEW
• This chapter considers the structure and activities of central banks focusing
primarily on the European Central Bank and the Federal Reserve.
• Among the most important players in financial markets throughout the world are
central banks, the government authorities in charge of monetary policy.
• Central banks’ actions affect interest rates, the amount of credit, and the money
supply, all of which have direct impacts not only on financial markets but also on
aggregate output and inflation
Macroeconomics 174
PREVIEW
• This chapter considers the structure and activities of central banks focusing
primarily on the European Central Bank and the Federal Reserve.
• Among the most important players in financial markets throughout the world are
central banks, the government authorities in charge of monetary policy.
• Central banks’ actions affect interest rates, the amount of credit, and the money
supply, all of which have direct impacts not only on financial markets but also on
aggregate output and inflation
Macroeconomics 175
Learning Objectives
• Recognize the historical context of the development of the central banking
system.
• Describe the key features and functions of a central bank. Discuss the European
Central Bank (ECB) and the Federal Reserve System.
• Discuss the structure and degree of independence of the Bank of Canada, the
Bank of Japan, and the People’s Bank of China.
Macroeconomics 176
Learning Objectives
• Discuss the structure and degree of independence of banks in emerging market
economies.
• Assess the degree of independence of central banks around the world.
Macroeconomics 177
BARTER SYSTEM AND ITS DIFFICULTIES
• A barter system is an old method of exchange. Th is system has been

used for centuries and long before money was invented. People
exchanged services and goods for other services and goods in return.
The value of bartering items can be negotiated with the other party.
Macroeconomics 178
MAJOR DIFFICULTIES IN BARTER SYSTEM
1.DOUBLE COINCIDENCE OF WANTS

2.LACK OF A STANDARD OF UNIT
3.IMPOSSIBILITY OF SUBDIVISION OF GOODS
4.LACK OF INFORAMTION
5. PRODUCTION OF LARGE AND COSTLY FEASIBLE GOODS
Macroeconomics 179
FUNCTIONS OF MONEY
• Medium of Exchange: money is used to buy goods & services

• Unit of Account: money is used as a way to measure and compare
value
• Store of Value: money is used to accumulate wealth.
Macroeconomics 180
Cont’
• Fiat Money
Money that is not backed by an precious commodity, has no intrinsic
value.
Macroeconomics 181
MONEY SUPPLY
M1: Currency, demand deposits, travelers checks
M2: M1+ savings accounts, CDs, retail money market funds
Macroeconomics 182
THE FEDERAL RESERVE SYSTEM
• 12 branches of the Fed, located in major cities throughout US

• The POTUS appoints 7 members of Board of Governors of Fed
Reserve System
• POTUS appoint Chairman of Board (currently Janet Yellen), 4 year
term
• FOMC –12 member (7 Board of Governors, 5 presidents rotating 1
year terms)
Macroeconomics 183
FRACTIONAL RESERVE BANKING
• banks accept deposits, make loans or investments, and hold

reserves equal to a
• fraction of its deposit liabilities. Reserves are held as currency in the
bank, or as
• balances in the bank's accounts at the central bank.
Macroeconomics 184
POLICY TOOLS OF THE FED
• Reserve Requirement: Percentage of any deposit that must be held

aside.
• Discount Rate: The rate of interest the Fed charges banks for loaning
them .
• Open Market Operations: Activities in which the Fed buys and sells
government securities in the secondary market.
Macroeconomics 185
MONEY EXPANSION PROCESS
Money Multiplier: 1/Reserve Requirement

Example:
Res. Requirements 10% = 10 MM
Fed buys $10m bonds=> $100m increase in MS
Macroeconomics 186
T-ACCOUNTS
COMMERCIAL BANK A
COMMERCIAL BANK B
COMMERCIAL BANK C
Macroeconomics 187
THE ORIGIN OF CENTRAL BANKS
• The Sveriges Riksbank or the Bank of Sweden, was established in 1668, with its
main function being lending money to the government of Sweden.
• Rising global trade increased the volume of international payments in the
seventeenth century, hence the need to create more central banks throughout
Europe.
• The founding of the Bank of England (BoE) in 1694 marks the de facto origin of
central banking.
• Gradually, the central banking functions evolved in order to safeguard monetary
stability, which required central banks to answer to their parliaments.
Macroeconomics 188
THE ORIGIN OF CENTRAL BANKS
• To avoid the risk of power concentration, the structure of the Federal Reserve
System, which was established in 1913, was designed to distribute power over 12
regional Federal Reserve banks and remained privately owned by its member
banks.
• Most emerging market economies established their central banks after WWII.
The structure of these banks became similar to those of ECBs.
• Over the last two centuries, the functions of central banks throughout the world
expanded to regulating the value of the national currency, financing the
government, and acting as a ‘lender of last resort’ to banks suffering from
liquidity and/or credit crises.
Macroeconomics 189
WHO SHOULD OWN CENTRAL BANKS
• Arguments for public ownership:

• Central banks act in the ultimate public interest.
• Private ownership bias central banks toward self-serving profit-making interests, hence
increasing risk-taking and balance sheet troubles.
• The global financial crisis highlighted concerns that the profit-making target of private
shareholders could hamper them from saving the financial sector during financial crises.
• Arguments for private ownership:
• guarantees central bank independence
• restricts the distribution of dividends per share
• private owners are required to recapitalize the central bank in the case of losses which lifts
this burden off the fiscal budget.
MACROECONOMICS 190
VARIATIONS IN THE STRUCTURE AND
FUNCTIONS OF CENTRAL BANKS
• The roles of central banks have grown in importance as their activities
evolve over time.
• There are differences in the structure and policy tools that each
central bank adopts depending on the level of sophistication of the
banking and financial sectors.
• Central banks have taken on increasing responsibilities which required
more independence from fiscal authorities and political institutions.
Macroeconomics 191
THE EUROPEAN CENTRAL BANKS,THE EURO SYSTEM AND
THE EUROPEAN SYSTEM OF CENTRAL BANKS
• The European Central Bank (ECB) came into existence on June 1,

1998, to handle the transitional issues of the nations that comprise
the Eurozone.
• The Eurozone is an economic and monetary union consisting of the
member states of the European Union (EU) that have adopted the
euro as their currency.
• The creation of the Eurozone and of the new supranational
institution, the ECB, was a milestone of European integration.
• All of the member states of the European Union have to comply with
a set of economic and legal conditions..
Macroeconomics 192
• In January 1, 1999, only 11 EU member states had adopted the euro.

• All of the Eurozone or euro area countries—i.e., the EU countries that have
adopted the euro—retain their own National Central Banks (NCBs) and their
own banking systems.
• As of 2017, 19 countries out of the 28 member states of the European
Union have joined the euro area.
• The Eurosystem comprises the ECB and the NCBs of those EU member states
that have adopted the euro.
Macroeconomics 193
• Today, the EU is the world’s third largest economy after the United
States and China in terms of GDP. As of 2017, the Eurozone had a
population of 341 million citizens.
• There are 19 countries in the EU: Austria, Belgium, Cyprus, Estonia,
Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania,
Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and
Spain.
• In the U.K. referendum of June 23, 2016, 52% of British voters voted
to exit the EU. Accordingly, the United Kingdom is scheduled to exit
the EU in April 2019, a process that has come to be known as “Brexit.”
MACROECONOMICS 194
• Today, the EU is the world’s third largest economy after the United
States and China in terms of GDP. As of 2017, the Eurozone had a
population of 341 million citizens.
• There are 19 countries in the EU: Austria, Belgium, Cyprus, Estonia,
Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania,
Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and
Spain.
• In the U.K. referendum of June 23, 2016, 52% of British voters voted
to exit the EU. Accordingly, the United Kingdom is scheduled to exit
the EU in April 2019, a process that has come to be known as “Brexit.”
Macroeconomics 195
• Since not all of the EU member states have adopted the euro, the
European System of Central Banks (ESCB) was established alongside
the Eurosystem to comprise the ECB and the NCBs of all EU member
states whether or not they are members of the Eurozone.
• The NCBs of the EU member states that have retained their national
currencies are members of the ESCB which are allowed to conduct their own
respective national monetary policies
Macroeconomics 196
THANKS
MACROECONOMICS-I
BC-2303
Lecture [13] : THE MONEY SUPPLY PROCESS
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
PREVIEW
• This chapter provides an overview of how commercial banks create deposits and
describes the basic principles of the money supply creation process
Macroeconomics 199
LEARNING OBJECTIVES
• List and describe the “three players” that influence the money supply.
• Classify the factors affecting the Federal Reserve’s assets and liabilities.
• Identify the factors that affect the monetary base and discuss their effects on the
Federal Reserve’s balance sheet.
• Explain and illustrate the deposit creation process using T-accounts.
Macroeconomics 200
LEARNING OBJECTIVES
• List the factors that affect the money supply.
• Summarize how the “three players” can influence the money supply.
• Calculate and interpret changes in the money multiplier.
Macroeconomics 201
THREE PLAYERS IN THE MONEY SUPPLY
PROCESS
1. The Central bank: Federal Reserve System
2. Banks: depository institutions; financial intermediaries
3. Depositors: individuals and institutions
Macroeconomics 202
The Fed’s Balance Sheet
Federal Reserve System
Assets Liabilities
Securities Currency in circulation
Loans to Financial Reserves

Institutions
• Liabilities
• Currency in circulation: in the hands of the public
• Reserves: bank deposits at the Fed and vault cash
• Assets
• Government securities: holdings by the Fed that affect money
supply and earn interest
• Discount loans: provide reserves to banks and earn the discount
rate
CONDUCT OF THE MONETARY BASE
High-powered money
MB = C + R
C = currency in circulation
R = total reserves in the banking system
Macroeconomics 204
Open Market Purchase from a Bank
Banking System Federal Reserve System
Assets Liabilities Assets Liabilities
Securities -$100m Securities +$100m Reserves +$100m
Reserves +$100m
• Net result is that reserves have increased by $100

• No change in currency
• Monetary base has risen by $100
Open Market Purchase from the Nonbank
Public (1 of 2) Banking System Federal Reserve System
Reserve +$100m Checkable +$100m Securities +$100m Reserves +$100m
s deposits
• Person selling bonds to the Fed deposits the Fed’s

check in the bank
• Identical result as the purchase from a bank
Open Market Purchase from the Nonbank
Public (2 of 2) Nonbank Public Federal Reserve System
Securities -$100m Securities +$100m Currency in +$100m
circulation
Currency +$100m
• The person selling the bonds cashes the Fed’s check

• Reserves are unchanged
• Currency in circulation increases by the amount of the
open market purchase
• Monetary base increases by the amount of the open
market purchase
Open Market Sale
Nonbank Public Federal Reserve System
Securities +$100m Securities -$100m Currency in -$100m
circulation
Currency -$100m
• Reduces the monetary base by the amount of the sale

• Reserves remain unchanged
• The effect of open market operations on the
monetary base is much more certain than the effect
on reserves.
Shifts from Deposits into Currency
Nonbank Public Banking System
Checkable -$100m Reserves -$100m Checkable -$100m
deposits deposits
Currency +$100m
Federal Reserve System
Assets Liabilities
Currency in +$100m
circulation
Reserves -$100m
• Net effect on monetary liabilities is zero

• Reserves are changed by random fluctuations
• Monetary base is a relatively stable variable
Loans to Financial Institutions
Banking System Federal Reserve System
Reserve +$100m Loans +$100m Loans +$100m Reserves +$100m
s
(borrowing from Fed) (borrowing from
Fed)
• Monetary liabilities of the Fed have increased by $100

• Monetary base also increases by this amount
OTHER FACTORS THAT AFFECT THE
MONETARY BASE
• Float
• Treasury deposits at the Federal Reserve
• Interventions in the foreign exchange market
Macroeconomics 211
OVERVIEW OF THE FED’S ABILITY TO CONTROL
THE MONETARY BASE
• Open market operations are controlled by the Fed.
• The Fed cannot determine the amount of borrowing by banks from
the Fed.
• Split the monetary base into two components:
MB = MBn + BR
• The money supply is positively related to both the non-borrowed
monetary base MBn and to the level of borrowed reserves, BR, from
the Fed.
Macroeconomics 212
Multiple Deposit Creation: A Simple Model (1
of 2)
Deposit Creation: Single Bank
First National Bank First National Bank
Securities -$100m Securities -$100m Checkable +$100m
deposits
Reserves +$100m Reserves +$100m
Loans +$100m
• Excess reserves increase

• Bank loans out the excess reserves First National Bank
Assets Liabilities
• Creates a checking account
Securities -$100m
• Borrower makes purchases
Loans +$100m
• The Money supply has increased
Multiple Deposit Creation: A Simple Model (2
of 2)
Deposit Creation: The Banking System
Bank A Bank A
Reserves + Checkable + Reserves +$10 Checkable +
$100m deposits $100m deposits $100m
Loans +$90
Bank B Bank B
Reserves +$90 Checkable +$90 Reserves +$9 Checkable +$90
deposits deposits
Loans +$81
Table 1 Creation of Deposits (Assuming 10% Reserve Requirement and
a $100 Increase in Reserves)
MACROECONOMICS-I
BC -2303
Lecture [14] : QUANTITY THEORY OF MONEY DEMAND
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
QUANTITY THEORY OF MONEY
Velocity of Money and The Equation of Exchange:
M = the money supply

P = price level
Y = aggregate output (income)
P  Y  aggregate nominal income (nominal GDP)
V = velocity of money (average number of times per year that a dollar is spent)
P Y
V
M
Equation of Exchange
M V  P  Y
MACROECONOMICS 217
• Velocity fairly constant in the short run
• Aggregate output at full-employment level
• Changes in money supply affect only the price level
• Movement in the price level results solely from change in the quantity of money
MACROECONOMICS 218
Quantity Theory of Money (3 of 4)
Demand for money: To interpret Fisher’s quantity theory in terms of the
demand for money…
Divide both sides by V
1 1
M   PY k
V V
When the money market is in equilibrium
M = Md
Let
Md = k × PY
• Because k is constant, the level of transactions generated by a fixed level of
PY determines the quantity of Md.
• The demand for money is not affected by interest rates.
• From the equation of exchange to the quantity theory of money:

• Fisher’s view that velocity is fairly constant in the short run, so that
transforms the equation of exchange into the quantity theory of money,
which states that nominal income (spending) is determined solely by
movements in the quantity of money M.
P  Y  M V
MACROECONOMICS 220
QUANTITY THEORY AND THE PRICE LEVEL
• Because the classical economists (including Fisher) thought that

wages and prices were completely flexible, they believed that the
level of aggregate output Y produced in the economy during normal
times would remain at the full-employment level.
• Dividing both sides by Y̅, we can then write the price level as follows:
M V
P
Y
MACROECONOMICS 221

M V
P
Y
MACROECONOMICS 222
Quantity Theory and Inflation
• Percentage Change in (x × y) = (Percentage Change in x) + (Percentage
Change in y)
• Using this mathematical fact, we can rewrite the equation of exchange as
follows:
%M  %V  %P  %Y
• Subtracting from both sides of the preceding equation and recognizing that
the inflation rate is the growth rate of the price level,
  %P  %M  %V  %Y

• Since we assume velocity is constant, its growth rate is zero, so the quantity
theory of money is also a theory of inflation:
  %M  %Y

M V
P
Y
MACROECONOMICS 224
Testing the Quantity Theory: Relationship
Between Inflation and Money Growth
Sources: Panel (a): Milton Friedman and Anna Schwartz, Monetary

Trends in the United States and the United Kingdom:
Their Relation to Income, Prices, and Interest Rates, 1867–1975;
Federal Reserve Bank of St. Louis, FRED database:
http://research.stlouisfed.org/fred2/. Panel (b): International
Financial Statistics. International Monetary Fund,
http://www.imfstatistics.org/imf/.
Annual U.S. Inflation and Money Growth
Rates, 1965–2015
Source: Federal Reserve Bank of St. Louis, FRED database:

http://research.stlouisfed.org/fred2/series/CPIAUCSL; http://research.stlouisfed.org/fred2/series/M2SL.
BUDGET DEFICITS AND INFLATION
• There are two ways the government can pay for spending: raise
revenue or borrow
• Raise revenue by levying taxes or go into debt by issuing government bonds
• The government can also create money and use it to pay for the
goods and services it buys
MACROECONOMICS 227
BUDGET DEFICITS AND INFLATION
• The government budget constraint thus reveals two important facts:

• If the government deficit is financed by an increase in bond holdings by the
public, there is no effect on the monetary base and hence on the money
supply.
• But, if the deficit is not financed by increased bond holdings by the public, the
monetary base and the money supply increase (the method is called
monetizing the debt).
DEF = G – T = ∆MB + ∆B
MACROECONOMICS 228
HYPERINFLATIONS
• Hyperinflations are periods of extremely high inflation of more than

50% per month.
• Many economies—both poor and developed—have experienced
hyperinflation over the last century, but the United States has been
spared such turmoil.
• One of the most extreme examples of hyperinflation throughout
world history occurred recently in Zimbabwe in the 2000s.
MACROECONOMICS 229
HYPERINFLATIONS
• Hyperinflations are periods of extremely high inflation of more than

50% per month.
• Many economies—both poor and developed—have experienced
hyperinflation over the last century, but the United States has been
spared such turmoil.
• One of the most extreme examples of hyperinflation throughout
world history occurred recently in Zimbabwe in the 2000s.
MACROECONOMICS 230
THANKS
MACROECONOMICS -I
BC-2303
Lecture [15] : KEYNESIAN THEORY OF MONEY DEMAND
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
KEYNESIAN’S THEORY OF MONEY DEMAND
• Keynes’s liquidity preference theory

• Why do individuals hold money? Three motives:
• Transactions motive
• Precautionary motive
• Speculative motive
• Distinguishes between real and nominal quantities of money
MACROECONOMICS 233
TRANSACTION MOTIVE
• Keynes initially accepted the quantity theory view that the

transactions component is proportional to income.
• Later, he and other economists recognized that new methods for
payment, referred to as payment technology, could also affect the
demand for money.
MACROECONOMICS 234
PRECAUTIONARY MOTIVE
• Keynes also recognized that people hold money as a cushion against

unexpected wants.
• Keynes argued that the precautionary money balances people want to
hold would also be proportional to income.
MACROECONOMICS 235
SPECULATIVE MOTIVE
• Keynes also believed people choose to hold money as a store of

wealth, which he called the speculative motive.
MACROECONOMICS 236
SPECULATIVE MOTIVE
• Keynes also believed people choose to hold money as a store of

wealth, which he called the speculative motive.
MACROECONOMICS 237
PUTTING THE THREE MOTIVES TOGETHER
Md
 f (i, Y ) where the demand for real money balances is
P
negatively related to the interest rate i,
and positively related to real income Y
Rewriting
P 1

Md f (i, Y )
Multiply both sides by Y and replacing M d with M
PY Y
V 
M f (i, Y )
MACROECONOMICS 238
PUTTING THE THREE MOTIVES TOGETHER
• Velocity is not constant:

• The procyclical movement of interest rates should induce
procyclical movements in velocity.
• Velocity will change as expectations about future normal levels of
interest rates change
MACROECONOMICS 239
PROTFOLIO THEORIES OF MONEY DEMAND
• Theory of portfolio choice and Keynesian liquidity preference

• The theory of portfolio choice can justify the conclusion from the Keynesian
liquidity preference function that the demand for real money balances is
positively related to income and negatively related to the nominal interest
rate.
• Other factors that affect the demand for money:
• Wealth
• Risk
• Liquidity of other assets
MACROECONOMICS 240
Summary Table 1 Factors That Determine the Demand for
Money
Factors That Determine the Blank Blank Blank
Demand for Money
Change Money Demand
Variable in Variable Response Reason
Interest rates ↑ ↓ Opportunity cost of money rises
Income ↑ ↑ Higher value of transactions
Payment technology ↑ ↓ Less need for money in transactions
Wealth ↑ ↑ More resources to put into money
Riskiness of other assets ↑ ↑ Money relatively less risky and so more
desirable
Inflation risk ↑ ↓ Money relatively more risky and so less
desirable
Liquidity of other assets ↑ ↓ Money relatively less liquid and so less
desirable
Note: Only increases (↑) in the factors are shown; the effects of decreases in the variables on the exchange rate are the opposite
of those indicated in the “Response” column.
Copyright © 2019 Pearson Education, Ltd.

EMPIRICAL EVIDENCE ON THE DEMAND FOR
MONEY
• Precautionary demand:
• Similar to transactions demand
• As interest rates rise, the opportunity cost of holding precautionary balances
rises
• The precautionary demand for money is negatively related to interest rates
MACR0ECONOMICS 242
INTEREST RATES AND MONEY DEMAND
• We have established that if interest rates do not affect the demand

for money, velocity is more likely to be constant—or at least
predictable—so that the quantity theory view that aggregate
spending is determined by the quantity of money is more likely to be
true.
• However, the more sensitive the demand for money is to interest
rates, the more unpredictable velocity will be, and the less clear the
link between the money supply and aggregate spending will be.
MACROECONOMICS 243
STABILITY OF MONEY DEMAND
• If the money demand function is unstable and undergoes substantial,

unpredictable shifts as Keynes believed, then velocity is unpredictable, and
the quantity of money may not be tightly linked to aggregate spending, as it
is in the quantity theory.
• The stability of the money demand function is also crucial to whether the
Federal Reserve should target interest rates or the money supply.
• If the money demand function is unstable and so the money supply is not
closely linked to aggregate spending, then the level of interest rates the Fed
sets will provide more information about the stance of monetary policy than
will the money supply.
MACROECONOMICS 244
THANKS
MACROECONOMICS-I
BC-2303
Lecture [16] : FISCAL POLICY
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
PREVIEW
The Great Depression and John Maynard Keynes’s remedy for it.
Aggregate Demand shifted left after stock market crash of 1929
Recession/depression: high unemployment (>25%), business were

struggling and going bankrupt.
Prices were not adjusting lower, as sticky wages and other legacy
costs were bound to current prices.
Macroeconomics 247
PREVIEW
In an effort to fight deflation, price controls were enacted to keep

prices for many things stable/high.
Stuck in recession/depression.
Keynes recommended that the federal government boost its level of

spending, running a budget deficit, to shift AD to the right and not
wait for prices to adjust down.
Macroeconomics 248
FISCAL POLICY
Changes in government taxes and spending that affect the level of GDP.
Macroeconomics 249
CONTRACTIONARY AND EXPANSIONARY FISCAL
POLICIES
Expansionary policies
Government policy actions that lead to increases in aggregate demand.
Contractionary policies
Government policy actions that lead to decreases in aggregate demand.
Macroeconomics 250
THE MULTIPLIERS
Marginal Propensity to Consume (MPC):

=Change in Spending/Change in Income
Marginal Propensity to Save (MPS): 1 –MPC
Macroeconomics 251
SPENDING MULTIPLIERS
Spending Multiplier:
The ratio of the total shift in GDP to the initial shift in aggregate
demand based on a change in the level of spending.
Spending Multiplier: 1/1 − MPC= 1/MPS
Macroeconomics 252
TAX MULTIPLIERS
The ratio of the total shift in aggregate demand to the initial shift in
aggregate demand based on a change in the level of taxes.
 Negative because inversely correlated with GDP (higher taxes =>

lower GDP)
Tax Multiplier: −MPC/MPS(always 1 less than Spending Multiplier!)
Macroeconomics 253
THANKS
MACROECONOMICS-I
BC-2303
Lecture [17] : MONETARY POLICY
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
MONETARY POLICY
Changes in money supply (interest rates) to fight recessions or bouts of

inflation
MACROECONOMICS 256
DIFFERENT VIEWS ON THE MONETARY POLICY:
Classical View (Friederich Hayek)
Long-term view: vertical LRAS curve
Equation of Exchange: M(money supply)*V(velocity) = P(price) * Y(GDP)
Classicist believe that V and Y are constant; therefor as M↑=> P↑
Referred to this as Monetary Neutrality or Quantity Theory of Money
MACROECONOMICS 257
MONETARIST VIEW
Monetarist View (Milton Friedman)
Believed that V and Q stable, but not constant
 Uses SRAS (pos. slope). Changing the money supply has numerous
econ affects.
 Favored increasing money supply, but in an orderly, forecastable

manner.
MACROECONOMICS 258
KEYNESIAN VIEW
Keynesian View (John M. Keynes)
• Didn’t favor monetary policy because he believed it only effected

interest rates.
•
• Believed Investment would NOT be greatly effected by lower rates.
• Favored ‘responsible 'fiscal policy to more effectively effect AD.
MACROECONOMICS 259
DIFFERENT VIEWS ON THE MONETARY POLICY:
Keynesian View (John M. Keynes)

ß Didn’t favor monetary policy because he believed it only effected
interest rates.
ß Believed Investment would NOT be greatly effected by lower rates
ß Favored ‘responsible’fiscal policy to more effectively effect AD.
MACROECONOMICS 260
LEARNING OBJECTIVES
• Illustrate and explain the policy choices that monetary policymakers face under
the conditions of aggregate demand shocks, temporary supply shocks and
permanent supply shocks.
• Identify the lags in the policy process, and summarize why they weaken the case
for an activist policy approach.
• Explain why monetary policymakers can target any inflation rate in the long-run
but cannot target aggregate output in the long-run.
MACROECONOMICS 261
LEARNING OBJECTIVES
• Identify the sources of inflation and the role of monetary policy in propagating
inflation.
• Explain the unique challenges that monetary policymakers face at the zero lower
bound, and illustrate how nonconventional monetary policy can be effective
under such conditions.
MACROECONOMICS 262
RESPONSE OF MONETARY POLICY TO SHOCKS
• Monetary policy should try to minimize the difference between inflation and the
inflation target.
• In the case of both demand shocks and permanent supply shocks, policy makers
can simultaneously pursue price stability and stability in economic activity.
• Following a temporary supply shock, however, policy makers can achieve either
price stability or economic activity stability, but not both. This tradeoff poses a
dilemma for central banks with dual mandates.
MACROECONOMICS 263
RESPONSE TO AGGREGATE DEMAND SHOCKS
• Policy makers can respond to this shock in two possible ways:

• No policy response
• Policy stabilizes economic activity and inflation in the short run
• In the case of aggregate demand shocks, there is no tradeoff between
the pursuit of price stability and economic activity stability.
MACROECONOMICS 264
Figure 1 Aggregate Demand Shock: No
Policy Response
Figure 2 Aggregate Demand Shock: Policy Stabilizes Output and Inflation in the
Short Run
RESPONSE TO A PERMANENT SUPPLY SHOCK
• There are two possible policy responses to a permanent supply shock:

- No policy response
- Policy stabilizes inflation
MACROECONOMICS 267
Figure 3 Permanent Supply Shock: No Policy
Response
Figure 4 Permanent Supply Shock: Policy
Stabilizes Inflation
RESPONSE TO A TEMPORARY SUPPLY SHOCK
• When a supply shock is temporary, policymakers face a short-run

tradeoff between stabilizing inflation and economic activity.
• Policymakers can respond to the temporary supply shock in three
possible ways:
• No policy response
• Policy stabilizes inflation in the short run
• Policy stabilizes economic activity in the short run
MACROECONOMICS 270
Figure 5 Response to a Temporary Aggregate Supply Shock:
No Policy Response
Short-Run Inflation Stabilization
Short-Run Output Stabilization
THE BOTTOM LINE:THE RELATIONSHIP BETWEEN
STABILIZING INFLATION AND STABILIZING ECONOMIC
ACTIVITY
• We can draw the following conclusions from this analysis:

1. If most shocks to the economy are aggregate demand shocks or permanent
aggregate supply shocks, then policy that stabilizes inflation will also stabilize
economic activity, even in the short run.
2. If temporary supply shocks are more common, then a central bank must choose
between the two stabilization objectives in the short run.
3. In the long run there is no conflict between stabilizing inflation and economic
activity in response to shocks.
MACROECONOMICS 274
HOW ACTIVELY SHOULD POLICY MAKERS TRY TO STABILIZE
ECONOMIC ACTIVITY
• All economists have similar policy goals (to promote high employment
and price stability), yet they often disagree on the best approach to
achieve those goals.
• Nonactivists believe government action is unnecessary to eliminate
unemployment.
• Activists see the need for the government to pursue active policy to
eliminate high unemployment when it develops.
MACROECONOMICS 275
LAGS AND POLICY IMPLEMENTATION
• Several types of lags prevent policymakers from shifting the aggregate

demand curve instantaneously:
• Data lag: the time it takes for policy makers to obtain data indicating what is
happening in the economy
• Recognition lag: the time it takes for policy makers to be sure of what the
data are signaling about the future course of the economy
MACROECONOMICS 276
LAGS AND POLICY IMPLEMENTATION
• Several types of lags prevent policymakers from shifting the aggregate

demand curve instantaneously:
• Legislative lag: the time it takes to pass legislation to implement a particular
policy.
• Implementation lag: the time it takes for policy makers to change policy
instruments once they have decided on the new policy .
• Effectiveness lag: the time it takes for the policy actually to have an impact on
the economy .
MACROECONOMICS 277
FYI:THE ACTIVIST OR NON-ACTIVIST DEBATE OVER THE
OBAMAS FISCAL STIMULUS PACKAGE
• Many activists argued that the government needed to do more by

implementing a massive fiscal stimulus package.
• On the other hand, nonactivists opposed the fiscal stimulus package,
arguing that fiscal stimulus would take too long to work because of
long implementation lags.
• The Obama administration came down squarely on the side of the
activists and proposed the American Recovery and Reinvestment Act
of 2009, a $787 billion fiscal stimulus package that Congress passed
on February 13, 2009.
MACREOCONOMICS 278
THANKS
MACROECONOMICS-I
BC-2303
Lecture [18] : MONETARY POLICY
MARIAM YASSAR
(JUNIOR LECTURER)
Date: 2020
Why study economics?
• To make wise monetary decisions in life like, saving,

investment, education and health etc.
• To learn how to behave rationally
Macroeconomics 281
Why study economics?
Contd.,
• To learn how the tradeoffs work and marginal decisions are

taken
• To be well informed of world around you like international

trade, tax policy, or the causes of recessions and high
unemployment etc.
Macroeconomics 282
Defining Economics
• Economics is the study of how societies use scarce

resources to produce valuable goods and services and
distribute them among different individuals
Macroeconomics 283
Scarcity
• Resources are limited relative to desire i.e. scarcity
• Scarce resources are utilized to attain economic efficiency
https://minutes.co/our-economy-is-based-on-scarcity-and-its-failing-us-heres-why-the-abundance-model-is-what-we-need-next/
Macroeconomics 284
Economic Efficiency
• “ Economic efficiency requires that an economy produce

the highest combination of quantity and quality of goods
and services given its technology and scarce resources. An
economy is producing efficiently when no individual’s
economic welfare can be improved unless someone else is
made worse off”.
(samuelson and Nordhaus, 2010)
Macroeconomics 285
Major Subfields of Economics
Economics
Macroeconomics
Microeconomics
Macroeconomics 286
Contd.,
Macroeconomics
• Concerned with the overall performance of the economy
e.g. Aggregate Demand, aggregate Supply and total

government expenditures
• Born after 1936 great depression
Macroeconomics 287
The Three Problems of Economic
Organization
1. What commodities are produced and in what

quantities?
I.e. Pizzas or shirts etc.
Resources are limited and we have to trade-off and prioritize
Macroeconomics 288
Organization Contd.,
2. How are goods produced?
What Technology to use
• Labor intensive or
• Capital Intensive
Macroeconomics 289
2. How are goods produced?
What Technology to use
• Labor intensive or
• Capital Intensive
Macroeconomics 290
3. For whom are goods produced?
Poor or rich etc.
• If Necessities will be produced more, Prices of necessities
fall and affordability of poor increases
• If Luxuries are Produced more, , Prices of necessities rise and
affordability of poor decreases
Macroeconomics 291
• All these questions are dominantly solved by market
through price mechanism
• Prices are determined by demand and supply forces in
competitive market
• Prices guide the production of goods and services
Macroeconomics 292
References
• Samuelson Pual and Nordhaus W.D “ Economics” 19th
Edition, McGraw Hill
Macroeconomics 293
THANKS
MACROECONOMICS-I
BC-2303
Lecture [19] : Macroeconomic Concerns
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Major Issues Macroeconomics Deals With
Three of the major issues macroeconomics deals with are:
• Unemployment
• Inflation
• Output growth
Macroeconomics 296
1. Unemployment
•Unemployment represents that ratio of labor force which fails to
get employment
• The unemployment rate is a key indicator of the
economy’s health
• The existence of unemployment seems to imply
that the aggregate labor market is not in
equilibrium
• Unemployment has remained a severe problem
specially during depressions and economic crisis like
that of 1936 and 1970s oil crisis

https://www.livescience.com/13710-unemployment-depression-identity-job-search.html
Macroeconomics 297
1. Unemployment Contd.,
Unemployment Problem
• Classical economist believed in full employment i.e. all
resources of economy are fully employed and there is no
possibility of unemployment
• Great depression of 1930 brought a lot of miseries in form
of slump and vast Unemployment
• Keynes in his book in 1936 rejected the full employment
Macroeconomics 298
1. Unemployment Contd.,
• High unemployment is both an economic and a social
Problem
• Unemployment is an economic problem because it represents waste

of a valuable resource.
• Unemployment is a major social problem because it causes enormous

suffering as unemployed workers struggle with reduced incomes
• During periods of high unemployment, economic distress spills over

to affect people’s emotions and family live
Macroeconomics 299
2. Inflation
• Lenin is said to have declared that the best way to destroy

the capitalist system was to debauch the currency. By a
continuing process of inflation, governments can confiscate,
secretly and unobserved, an important part of the wealth of
their citizens.
J. M. Keynes
https://www.dawn.com/news/1500253
Macroeconomics 300
2. Inflation Contd.,
• Inflation occurs when the general level of prices is rising
• Today, we calculate inflation by using price indexes—weighted

averages of the prices of thousands of individual products.
• The consumer price index (CPI) measures the cost of a market

basket of consumer goods and services relative to the cost of
that bundle during a particular base year
• The GDP deflator is the price of all of the different

components of GDP
Macroeconomics 301
• The rate of inflation is the percentage change in the price

level:
• Rate of inflation in year t= 100X P t - P t - 1
Pt-1
Macroeconomics 302
• Hyperinflation is a period of very rapid increases in the
overall price level
• Hyperinflations is a rare phenomenon.
• Deflation is a decrease in the overall price level
• Prolonged periods of deflation can be just as damaging for the
economy as
sustained inflation
Macroeconomics 303
3. Growth of Output
• Growth refers to change in the level
of economic activity from one year to
the other
• Output growth implies poor and less
developed countries want to attain
increase in national income and
per-capita income
http://www.lagostelevision.com/non-oil-sector-boosts-output-as-gdp-growth-rises-to-1-81/
Macroeconomics 304
3. Growth of Output
• The aggregate output is indicator which tells economic

performance
http://www.lagostelevision.com/non-oil-sector-boosts-output-as-gdp-growth-rises-to-1-81/
Macroeconomics 305
References
Macroeconomics 306
THANKS
MACROECONOMICS-I
BC-2303
Lecture [20] : Nature and Scope of Macroeconomics
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Nature and Scope of Macroeconomics
• Macroeconomics is the study of aggregates or averages
covering the entire economy, like total employment,
national income, national output, total investment, total
consumption, total savings, aggregate supply, aggregate
demand, and general price level and wage level etc.
https://treasure.com.pk/pakistans-total-investment-dips-by-78-4-to-1-042bn-in-july-jan-2018/ https://www.thehansindia.com/business/q3-gdp-growth-dips-to-7-yr-low-of-47-608508 https://www.investopedia.com/terms/i/inflation.asp
Macroeconomics 309
•Macroeconomics is also regarded as the theory of income and
employment, or simply income analysis
https://www.investopedia.com/terms/i/inflation.asp
https://www.thehansindia.com/business/q3-gdp-growth-dips-to-7-yr-low-of-47-608508
Macroeconomics 310
Contd.,
• It is concerned with the problems of unemployment,
economic
fluctuations, inflation or deflation, international trade and
economic growth
• It is the study of the causes of unemployment, and the
various determinants of employment
Macroeconomics 311
Contd.,
Understanding Working of Economy
• The study of macroeconomic variables is crucial for

understanding the working of the economy
• Chief economic problems are linked to the behaviour of total

income, output, employment and the general price level in the
economy
Macroeconomics 312
Contd.,
Economic Growth
• An evaluation of resources of country is done on basis of

macroeconomics
• Aggregate increase in Income, output and employment are

planned and policies are made accordingly to have aggregate
economic development
Macroeconomics 313
Contd.,
Fiscal and Monetary Issues
• Budget deficits, unemployment, poverty and other

macroeconomic issues call for a prudent fiscal policy
• Fluctuations in the value of money, prices and exchange rate

have adverse economic impacts. They also call for a prudent
monetary policy or a fiscal policy accompanying monetary
policy
Macroeconomics 314
Contd.,
Business Cycles
• Macroeconomics was born after 1930’s great depression
https://www.mytwintiers.com/news-cat/new-survey-shows-unemployment-rates-taking-a-toll-throughout-the-state/ https://www.24newshd.tv/10-Apr-2020/great-depression-1930s-economic-nightmare-knocks-door-in-2020
https://www.fox61.com/video/news/health/coronavirus/minneapolis-fed-says-unemployment-numbers-could-rival-great-depression/89-e98d03da-e219-45af-985f-d5a0f6b35630
Macroeconomics 315
Contd.,
Business Cycles
• Macroeconomics was born after 1930’s great depression
• Consequently macroeconomics is very lucrative in

understanding and responding accordingly during ups and
downs in economy
https://corporatefinanceinstitute.com/resources/knowledge/economics/business-cycle/
Macroeconomics 316
References
• https://www.slideshare.net/rajvardhan7/basic-concept-of-
macro-economics
Macroeconomics 317
THANKS
MACROECONOMICS-I
BC-2303
Lecture [21] : National Income Accounting
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
National Income Accounting
National Income
• The flow of goods and services in a nation
over a certain period of time (usually one year)
• The total money value of all goods and
services produced by a nation during one year
after deducting the depreciation value of the
machines used in production
Macroeconomics 320
National Income
• The total payments received by the factors of production

through the production of goods and services in a country in a
year
Macroeconomics 321
• Gross Domestic Product (GDP)
Total money value of the all final goods and services produced
within a country in a given time period
• Gross National Product (GNP)
Total market value of all final goods and services produced by

the residents of a country during period of time.
Macroeconomics 322
GDP can be measured at market price and factor cost
• Market price
Current price in the market through the forces of demand and

supply i.e. actual price paid by consumers
• Factor cost
Real price earned by producer or seller
Macroeconomics 323
Net National Product (NNP)
• The market value of the net output of goods and services

produced by nation in a year
• NNP is also referred to as the national income at market prices
National Income at Factor Cost (NI)
• The total of all income payments made to factor of production
• Can be derived from NNP
Macroeconomics 324
Personal Income (PI)
The income that is actually received by individuals and

household in an economy in a year
Deduction made from national income

(i) Corporate income taxes
(ii) Retained earning
(iii) Social security contributions
(iv) Insurance premium
Macroeconomics 325
Disposable Personal Income (DPI)
• Part of the personal income that is left after the payment of

personal direct taxes
https://www.marketing91.com/what-is-disposable-income/
Macroeconomics 326
References
• Mankiw, N. Gregory author. Macroeconomics. New York
:Worth Publishers, 2016.
• https://www.slideshare.net/mazriayuji/national-income-acc
ounting-16449623
Macroeconomics 327
THANKS
MACROECONOMICS
BC-2303
Lecture [22] : National Income Accounting (Part-2)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Circular Flow of National Income
Circular Flow Diagram
• It is simple representation of macroeconomy
• Explains GDP as spending, revenue, payments to factors and

Income
Macroeconomics 330
Households
• Buys and consumes goods and services
• Owner of factors of production
• Sells or rents factors of production to firms and earn income
Macroeconomics 331
Firms
• Buy or hire factors of production and employ them to produce

goods and services
• Sell these goods and services
Macroeconomics 332
Two Sector Economy
Macroeconomics 333
• Two Sector Economy
So
• No role of government here i.e. taxes etc.
• No Financial system i.e. banks etc.
• No foreign sector i.e. trade etc.
Macroeconomics 334
• Therefore GDP is the market value of all the final goods and
services produced within a country during a given time period
• Hence goods are valued at market price
• All goods are measured in same units
• Things without market value are excluded e.g. the act of

cooking food for your own self
Macroeconomics 335
• GDP only includes the final goods
• Final good’s value already contains the value of intermediate

goods used in production process
Macroeconomics 336
Final goods
• The finally produced good ready to be used for end user or

consumer e.g. bread
https://lilluna.com/basic-homemade-bread-recipe/ https://www.pakwheels.com/blog/toyota-corolla-best-car-based-on-resale-value-pakistan/
Macroeconomics 337
Intermediate Goods
• Used as an ingredient in production
of other goods
https://www.slideshare.net/MrRed/gross-domestic-product
Macroeconomics 338
• GDP includes only currently produced goods
• GDP includes tangible and intangible goods
• GDP includes production done only within borders of country

whether by nationals or foreigners
• GDP is measured usually for a year or quarter
Macroeconomics 339
References
• https://www.youtube.com/watch?v=QJ98XpI2fms
Macroeconomics 340
THANKS
MACROECONOMICS-I
BC-2303
Lecture [] : National Income Accounting (Part-3)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Methods of National Income Measurement
There are three approaches for national income measurement
• Expenditure Approach
• Product Approach
• Income Approach
Income= expenditure = product
Macroeconomics 343
1. EXPENDITURE APPROACH
The total spending on all final goods and services (Consumption

goods and services (C) + Gross Investments (I) + Government
Purchases (G) + (Exports (X) - Imports (M))
Personal Consumption (C)
https://www.slideshare.net/rajvardhan7/national-income-accounting-63668398?qid=c2a0cec4-e792-4e68-a256-a8a2c83bbade&v=&b=&from_search=27
Macroeconomics 344
Consumption
Purchase of good and services produced by firms, individuals or

households
Investment
purchase of capital goods by firms for use in production and in

changes in the firm inventories
Macroeconomics 345
Government Spending (G)
• Expenditure incurred by federal, state and local government

for final good and services Net Exports ( X-M)
• Differences between the value of exports and the value of

imports
Macroeconomics 346
2. Output/ Value added/ Product Approach
GDP is calculated using the output approach by summing the

value of sales of goods and adjusting (subtracting) for the
purchase of intermediate goods to produce the goods sold
Macroeconomics 347
3. Income Approach
GDP based on the income approach is calculated by adding up

the factor incomes to the factors of production in the society
Macroeconomics 348
3. Income Approach
Wages and Salaries
Income received by labour from firm for services rendered to

them
Net Interest
Differences between total interest payment received and total

interest payment made by households
Macroeconomics 349
3. Income Approach
Rental Income
Payment for rented inputs
Profit
Corporate profits earned by business corporations or payment of

dividends to shareholders
Macroeconomics 350
GDP Vs. NDP
NDP = GDP - Depreciation
Real Vs. Nominal GDP
Macroeconomics 351
Relation between Expenditure, Output and Income Methods of Measuring GDP
Stages of Sales Receipt Cost of Value added (4) Factor incomes

Production (1) (2) Intermediate (5)
Products (3)
Wheat 24 0 24 r+w+i+p
Flour 33 24 9 r+w+i+p
Dough 60 33 27 r+w+i+p
Bread 90 60 30 r+w+i+p
Macroeconomics 352
Relation between Expenditure, Output and
Income Methods of Measuring GDP Contd.,
The relationship emerges as follows:
1. Total Sales Receipt = Cost of Intermediate Products
2. Total Sales Receipt = Cost of Intermediate Products = Final

expenditure
3. Total Revenue-Cost of Intermediate Products = Value added
4. Final Expenditure = Value added = r+w+i+p
5. Expenditure Method = Output Method = Income Method

Macroeconomics 353
References
ounting-16449623
• https://www.slideshare.net/rajvardhan7/national-income-a
ccounting-63668398?qid=c2a0cec4-e792-4e68-a256-a8a2c8
3bbade&v=&b=&from_search=27
Macroeconomics 354
THANKS
MACROECONOMICS
BC-2303
Lecture [23] : Problems with National Income Measurement (Part-1)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Problems with National Income
Measurement
1. Problem of Non-market Transactions
• Problems of a non-monetized sector is prevalent in various

third world countries like
• The existence of a large number of non-monetized activities in

these countries especially in the agriculture sector makes the
computation of the national income more difficult
Macroeconomics 357
Measurement
1. Problem of Non-market Transactions
• This is due to large quantity of agricultural output in these

countries traded with other goods locally i.e. barter trade, or
consumed
Macroeconomics 358
Measurement
2. Illiteracy
• A large number of small producers in third world countries are

illiterate
• They are unable to keep accounts of their productive activities
• Thus they fail to provide accurate information to the

government for the purpose of calculating national income
Macroeconomics 359
Measurement
3. Problems of expertise
• The lack of professionals such as statisticians , researchers ,

programmers and analysis is a major problems in third world
countries
• The services of these professionals is very important in

estimating national income data accurately with minimum
errors
Macroeconomics 360
Measurement
4. Problems of less sophisticated machinery
• The non-availability of sophisticated machinery such as

advanced computers or programs to compute national income
data
• Data collected on national income regardless of which method

is used , need to be analyzed using sophisticated machinery
Macroeconomics 361
Measurement
5. Problem of double counting
• Another difficulty is double counting which is usually

associated with the product methods
• Double counting implies the possibility of intermediate goods

being included in the national income more than once
Macroeconomics 362
Measurement
6. Problem of false information
• This problem arises in developed as well as developing

countries
• People do not disclose their income or underestimate their

income to avoid paying higher taxes
Macroeconomics 363
Measurement
7. Problems of Multi - Occupations
People have been found to be engaged in a number of economic

activities which are not included in the national income
Macroeconomics 364
References
ounting-16449623
Macroeconomics 365
THANKS
MACROECONOMICS-I
BC-2303
Lecture [24] : Problems with National Income Measurement (Part-2)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Problems with GDP
Are statistics giving us the right “signals” about what to do? The
big question concerns whether GDP provides a good measure of
living standards
(Joseph E. Stiglitz, 2009)
Macroeconomics 368
Problems with GDP
1. GDP is Born of the Manufacturing Age
• It measures “things you can drop on your foot”
• Yet in advanced economies such as the US, up to 80% of

production is in the service industry
https://www.weforum.org/agenda/2018/01/gdp-frog-matchbox-david-pilling-growth-delusion/
Macroeconomics 369
Problems with GDP
1. GDP is Born of the Manufacturing Age
• It is good at quantity, but lousy at quality
• If the food or service improves in your local restaurant, GDP

will not notice
• Ditto, if an airline’s safety record improves
• In fact, GDP might prefer a plane crash - so that it can build a

new plane
Macroeconomics 370
Problems with GDP
2. GDP is Flummoxed by the Internet
• If one buys his own cheap airline ticket, check himself in online
and pick his own aisle seat, his convenience has gone up, but
GDP has gone down
• He is his own travel agent, a job that would once have been
performed by a fully paid-up GDP-producing employee
• Wikipedia provides all human knowledge free of charge, in

GDP terms, it is worth zilch
Macroeconomics 371
Problems with GDP
3. GDP deals in aggregates; GDP per capita in averages
• In an age where a huge cause of social dislocation is inequality,

GDP has nothing to say about distribution
• Averages are misleading
• Medians are better than means
http://economystified.blogspot.com/2014/06/should-i-use-median-or-mean.html
Macroeconomics 372
Problems with GDP
3. GDP deals in aggregates; GDP per capita in averages
• A rise in average GDP could actually be retrograde, if it leaves

99% of people resentful at how the 1% is making good
https://www.weforum.org/agenda/2018/01/gdp-frog-matchbox-david-pilling-growth-delusion/ https://www.linkedin.com/pulse/focus-gdp-fueling-inequality-short-termism-inclusive-cezar-maroti/
Macroeconomics 373
Problems with GDP
4. From GDP’s perspective, bigger is always better
• In the real world, that is not always so
• When the financial sector got bigger and bigger, it ended in

financial crisis
• When the US health service gets bigger and bigger, it means

costs are out of control
Macroeconomics 374
Problems with GDP
5. In general, GDP measures only cash transactions
• Volunteer work, housework or looking after ageing relative

count for nothing
• GDP has skewed priorities
Macroeconomics 375
Problems with GDP
6. Confrontation with False Choices
may also be confronted with false choices, seeing trade-offs

between output and environmental protection that don’t exist
https://www.project-syndicate.org/bigpicture/the-trouble-with-gdp
Macroeconomics 376
Problems with GDP
GDP Represents Just Number measuring Value
Macroeconomics 377
References
• https://www.project-syndicate.org/bigpicture/the-trouble-
with-gdp
• https://www.project-syndicate.org/bigpicture/the-trouble-
with-gdp
Macroeconomics 378
THANKS
MACROECONOMICS-I
BC-2303
Lecture [25] :Role of State in Economic Affairs (Part-1)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Role of State in Economic Affairs
Keynesians
 Role of government in economic affairs
In case of recession, with no demand in market and no

incentive for private investment, state should invest
Any disequilibrium is auto corrected in long run but in long-

run we are dead
Macroeconomics 381
Classical Economists
No role of government in economic affairs
Invisible hand works
Any disequilibrium is auto corrected in long run
Macroeconomics 382
1. Utilization of Resources
It is the basic responsibility of the state to make full utilization

of economic resources for the economic welfare of the people
The state should make proper allocation of resources
Macroeconomics 383
2. Maintenance of Law and Order
The primary duty of the state is to provide safety and security

of life and property to the citizen
If the life of the people is not safe then they can not work
efficiently and peacefully
It should enforce law and order in the country
https://www.marxist.pk/law-order-and-pakistan-economy/
Macroeconomics 384
If society is not satisfied it can not lead to economic progress
https://www.marxist.pk/law-order-and-pakistan-economy/
Macroeconomics 385
3. Case of Monopolies
Higher prices are charged by the monopolists in case of

monopoly
In this exploitation the state may protect the
consumer from the monopolists
https://www.assignmentpoint.com/business/monopoly-market.html
Macroeconomics 386
4. Capital Formation
In a certain sector when private investor is not willing to invest

due to low return then the state must take steps to invest
For instance, public health, libraries and roads should be

constructed by the state if private sector is not forthcoming
During depression when the private sector is not ready to

invest, state should come forward
Macroeconomics 387
5. Protection of Labour
Generally workers bargaining power is very poor as compared

to the employers
The interest of the workers are guarded by regulations of the

state
For Instance, minimum wage law
Macroeconomics 388
References
• Kennedy, Kieran A. “The Role of the State in Economic
Affairs.” Studies: An Irish Quarterly Review, vol. 74, no. 294,
1985, pp. 130–144. JSTOR, www.jstor.org/stable/30090643.
Accessed 13 May 2020.
• https
://studypoints.blogspot.com/2011/05/role-of-modern-state
-in-economic_385.html
Macroeconomics 389
THANKS
MACROECONOMICS-I
BC-2303
Lecture [26] :Role of State in Economic Affairs (Part-2)
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Overview of Last Lecture
• Classical Economists and Keynesian Economists
1. Utilization of Resources
3. Case of Monopolies
4. Capital Formation
5. Protection of Labour
Macroeconomics 392
6. Supply of Currency
The modern state is supplier of currency
7. Income Distribution
Government through its taxation policy and austerity measures,
tries to reduce the inequality of income in the country
Macroeconomics 393
• 8. Economic Planning
To speed up the rate of economic development, it formulates
the development programs
• It fixes the targets and priorities and the proceeds to

complete them
Macroeconomics 394
9. Protection to Domestic Industries
Modern state also protects the domestic industries from the

foreign competition by imposing the various restrictions and
giving incentives to exporters
The domestic industry is encouraged and production expends.
Macroeconomics 395
10. Encouragement of Private Investors
The state also provides various types of incentives like tax

holiday and import of machinery without custom duty to the
private businessman
It encourages the private investment in the country
Macroeconomics 396
11. Provision of Employment

The modern states create the employment opportunities in the
country and adopt various economic policies to reduce the rate
of unemployment
Macroeconomics 397
12. Provision of Defense

state protects citizens from external and internal threats like
foreign invasion and theft etc.
Macroeconomics 398
13. Provision of Security
State provides financial and non financial security
It provides jobs
It provides security to investor from different dangers like

physical damage to installations
Macroeconomics 399
14. Social Welfare Activities
Modern states provide
Free or subsidized education and medical facility
Pensions and funds to sick and unemployed persons
It directly involves itself in the social welfare programs by

opening health clinics, parks and libraries
Macroeconomics 400
References
• Kennedy, Kieran A. “The Role of the State in Economic
Affairs.” Studies: An Irish Quarterly Review, vol. 74, no. 294,
1985, pp. 130–144. JSTOR, www.jstor.org/stable/30090643.
Accessed 13 May 2020.
• https
://studypoints.blogspot.com/2011/05/role-of-modern-state
-in-economic_385.html
Macroeconomics 401
THANKS
MACROECONOMICS
ECO-2303
Lecture [27] :Introduction to Public Finance
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Introduction
Public Finance
“ The task of economic stabilization requires keeping the

economy from straying too far above or below the path of steady
high employment. One way lies inflation, and the other lies
recession. Flexible and vigilant fiscal and monetary policy will
allow us to hold the narrow middle course.”
(US president John F. Kennedy 1962)
Macroeconomics 404
Introduction
• Simply public finance is the study of the role of the

government in the economy
Macroeconomics 405
Introduction
This study involves answering the four questions of public

finance:
1. When should the government intervene in the economy?
2. How might the government intervene?
3. What is the effect of those interventions on economic

outcomes?
4. Why do governments choose to intervene in the way that

they do?
Macroeconomics 406
Introduction
• Public finance is a study of income and expenditure of the

government at the central, state, and local levels
• Government has to perform certain functions in a country such

as to supply certain public or collective goods which
individuals cannot or do not singly perform
• This is the responsibility of the government to provide those

goods for which it needs revenue
Macroeconomics 407
Introduction
• In the narrow sense, public finance is defined only as the

study of income and expenditure of the government
Macroeconomics 408
Introduction
• The broader view is that public finance does not deal only with
the income and expenditure of the government
• It also the sources of income and the way of expenditure of

various government corporations, public companies, and quasi
governmental ventures
Macroeconomics 409
Public Finance Cycle
Formulation of
Accountability
Fiscal Policy
Generation of
Public Revenue from
Borrowings taxes and
Other Sources
Spending of
Funds
Through
National
Budget
Macroeconomics 410
References
• Gruber, Jonathan. Public Finance and Public Policy. New
York, NY :Worth Publishers, 2016.
• https
://www.slideshare.net/gauravhtandon1/public-finance-\813
08560?from_action=save
Macroeconomics 411
THANKS
MACROECONOMICS
BC-2303
Lecture [28] : Constituents of Public Finance
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Constituents of Public Finance
Public finance is composed of
1. Public Expenditure
• Wages and salaries; subsidies and transfers;
• Expenditure on goods and services such as infrastructures like

road, electricity, telecom, and
• Human capital accumulation like health and education; interest

expenditure etc.
Macroeconomics 414
2. Public Revenue
Different sources of government revenue with major focus on

tax revenue
3. Public Debt
Often public revenue falls short of expenditure and government

has to borrow from internal and external sources.
Macroeconomics 415
4. Public financial administration:
As Walter Bagehot remarks, “money cannot manage itself, an

efficient, energetic and scientific management is required to look
after the public expenditure, public revenue and public debt”
Macroeconomics 416
Public financial administration
• What are the authorities, institutions, agencies to look after the

management, control, and scrutinizing work created by
government?
• How do they keep check on the use and misuse of fund?
Answer to these questions relate public financial administration
Macroeconomics 417
5. Economic stabilization
• Exogenous negative shocks such as financial crises, private

economic activity may remain in a recession for a long while
• Even if the market mechanism is perfect in the long run,

unemployment and idle capital equipment are situations that
can occur in the short run
Toshihiro, 2017
Macroeconomics 418
5. Economic stabilization
• Moreover, in reality, price rigidity and pessimism cause the

market mechanism to work badly, thereby encouraging a
serious recession in the long run
• It is then desirable for the government to intervene in the

private economy and alleviate the unwanted outcomes of
negative shocks
Toshihiro, 2017
Macroeconomics 419
6. Dynamic Optimization
• The market economy does not necessarily achieve optimal

growth
• This is because private decisions on consumption, saving, and

investment do not consider the interest of future generations
appropriately
Toshihiro, 2017
Macroeconomics 420
6. Dynamic Optimization
• Growth is not realized from the viewpoint of generational

equity
• Thus, it becomes the government’s responsibility to consider

the interest of future generations
• The dynamic optimization problem of fiscal policy

encompasses fiscal deficits, the burden of debt, and the
productivity of public investment
Toshihiro, 2017
Macroeconomics 421
References
• Ihori, Toshihiro. Principles of Public Finance. Springer Texts in
Business and Economic, 2017.
• https://www.slideshare.net/gauravhtandon1/public-
finance-\81308560?from_action=save
Macroeconomics 422
THANKS
MACROECONOMICS-I
BC-2303
Lecture [29] : Government Budgeting
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Budget
• Derived from Latin word „Bague‟ and French word

„Bougette‟. „Bougette‟ means small leather bag
• Budget provision were initially introduced in the UK
Macroeconomics 425
Government Budget
• In 1733, the then Chancellor of Exchequer Walpole came with

the leather bag in the parliament to present the annual
statement of income and expenditure, and when he opened bag
people used the term he is opening the budget
• Thus, the term budget became popular
Macroeconomics 426
Government Budget Contd.,
• Budget is a financial statement of the government comprising

expenditures and revenues for a year
• It is both economic as well as political document
Macroeconomics 427
Government Budget Contd.,
• It is a mirror to look into development activities undertaken by

the government, which sets a framework for policy formulation
and implementation
• Budget document is a good source of public information on

past activities, current decisions, and future prospects
Macroeconomics 428
Constituents of a Good Budget Document
A good budget document contains
(a) Overall development policy
(b) Size and composition of revenue and expenditure, and policy
(c) Size and composition of external and internal borrowings,

and policy
Macroeconomics 429
Constituents of a Good Budget Document
Contd.,
(d) whether budget is deficit or surplus and how is deficit

covered and surplus disposed of ?
(e) actual of the previous year, revised estimates of the current

year and estimates for the next fiscal year
Macroeconomics 430
Elements Of Budget
1. Close to Reality
Despite being an estimate, it should be based on reality primarily

on the basis of the experience of the previous year
Macroeconomics 431
Elements Of Budget
2. Simple and obvious
Since this is a public document, all who are interested should

easily get the required information after looking on it
Macroeconomics 432
Elements Of Budget
3. Flexibility
• Not only income and expenditure estimates are there but also
the policies and programs of the government
• Thus, should have the quality of flexibility
Macroeconomics 433
Elements Of Budget Contd.,
4. Single fund
A single fund of the government should be established there for

all revenues and expenditures
5. Extensive
Should be in detail about each item of revenue and expenditure
Macroeconomics 434
Elements Of Budget Contd.,
6. Publicity
It is made public and all the stakeholders are free to comment on

this
7. Annularity Prepared for one fiscal year
Macroeconomics 435
References
• https://www.slideshare.net/gauravhtandon1/public-finance
-\81308560?from_action=save
Macroeconomics 436
THANKS
MACROECONOMICS-I
BC-2303
Lecture [30] : Public Expenditures and Principles of Public

Expenditures
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Public Expenditures
• Expenses incurred by the public authorities i.e. central, state

and local self- governments, are called public expenditure
• These expenditures are made for the maintenance of the

governments as well as for the benefit of the society as whole.
https://www.economicsdiscussion.net/india/public-expenditure/public-expenditure-causes-principles-and-importance/17462
Macroeconomics 439
Public Expenditures
• There was a belief in the academic circles in the nineteenth

century that public expenditures were wasteful and must be
kept low as far as practicable
• This thinking died down in the twentieth century, especially

after the Second World War.
Macroeconomics 440
Canons/Principles of Public Expenditures
1. Principle of Maximum Social Advantage
• Public money should be spent for general cause and must

promote social welfare
• It should not be spent for the benefit of a particular group of

society
• Public expenditure should result in increased production,

elimination of inequality and promotion of welfare of all
• Public Expenditures should secure internal peace and also

protection from external aggression
Macroeconomics 441
Contd.,
2. Canon/Principle of Economy
• The authorities are expected to follow utmost economy in

expenditures
• Public money should not be misused and not result in any

wastage
Macroeconomics 442
Contd.,
Whenever money is raised through taxes, public expenditure in

return should bring maximum benefit
• It should not produce unfavorable effect on production
• Canon of economy does not mean niggardliness or miserliness

but the prevention of extravagance and waste of all kinds
Macroeconomics 443
Contd.,
3. Canon of Sanction
• Without the sanction of the public authority, no money should

be spent
• The amount of money must be spent for the purpose for

which it was sanctioned
Macroeconomics 444
Contd.,
This will ensure that:
• Waste and extravagance are avoided,
• There is proper audit done compulsorily,
• There is control and legislative supervision over public

expenditure
• It is seen whether the expenditure has fulfilled the objective.
Public Accounts Committee established by every legislature sees

that these objectives are achieved
Macroeconomics 445
Contd.,
4. Canon of Elasticity
• There should be scope for varying the expenditure according to

need or circumstances
• There should not be any rigidity in public expenditure
Macroeconomics 446
5. Canon of Surplus
• To greater extent, the government expenditure should lead to

increased production, employment and income
• The expenditure should be within the revenue of the State
• Deficit is permitted only for a short duration
• In times of crisis, government is allowed to have deficit

budget
• The deficit must be made good after the normalcy returns

Macroeconomics 447
• Finally, public expenditure should promote economic growth,

stability and social justice
• Public expenditure should be directed to achieve economic

and social objectives of the country
Macroeconomics 448
References
• https://accountlearning.com/public-expenditure-meaning-cl
assification-principles-effects/
• https://www.economicsdiscussion.net/india/public-expendi
ture/public-expenditure-causes-principles-and-importance/
17462
Macroeconomics 449
THANKS
MACROECONOMICS-I
BC-2303
Lecture [31] : Public Expenditures Vs. Private Expenditures
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Public Expenditures Vs. Private
Expenditures
• Public Expenditure are carried out by national and local

government and public sector enterprises
• Private Expenditure is carried out by individuals and

businesses that are not government owned
https://economicsigcse.wordpress.com/international-economic-interdependence/social-costs-and-benefits-chapter-21/public-expenditure-vs-private-expenditure/
Macroeconomics 452
Arguments in Favor of Private
Expenditures
• Individuals are best placed to choose how to spend their money
• The government can only guess
Macroeconomics 453
Arguments in Favor of Private
Expenditures Contd.,
• When the government spends money, it may be wasteful,

delayed or inefficient
• Government spending on one item always involves a

significant opportunity cost
Macroeconomics 454
Arguments in Favor of Public
Expenditures
• The government can provide public goods and merit goods that
the market would not produce in sufficient quantities for
everyone
• There will be no discrimination and it will be fair for all
Macroeconomics 455
Arguments in Favor of Public
Expenditures Contd.,
• Government can provide support to economy by bailout

packages when private sector lacks capacity during crisis
situations like of Corona Virus
Macroeconomics 456
Public and Private Goods
Private Goods
A product that may be purchased in order to be consumed, and

whose consumption by one individual prevents another
individual from consuming it is called a private good
They are almost always exclusively made for profit e.g. a loaf of
bread
Macroeconomics 457
Public and Private Goods
Public Goods
A public good is a product that an individual can consume

without reducing its availability to others and of which no one is
deprived
Examples of public goods include law enforcement, national

defense, sewer systems, public parks, and the air we breathe
As those examples reveal, public goods are almost always

publicly financed
https://www.investopedia.com/terms/p/public-good.asp
Macroeconomics 458
References
• https://economicsigcse.wordpress.com/international-econo
mic-interdependence/social-costs-and-benefits-chapter-21/
public-expenditure-vs-private-expenditure/
Macroeconomics 459
THANKS
DEPARMENT OF COMPUTER SCIENCE & INFORMATION TECHNOLOGY
MACROECONOMICS-I
BC-2303
Lecture [32]: Sources of Public Revenue

BBF-125
Mehreen Zaid Ullah

(Lecturer)
Lecture [16] : Sources of Public Revenue
Date: 2020
Sources of Public Revenue
• Every government, therefore, tries to meet its annual

expenditure from taxes and from sources other than taxation.
• The revenue, of the state can be classified under the

following heads.
• Revenue from private income
• Irregular revenue
• Revenue from state ownership

Revenue from private income
• A government derives revenue from citizens by taxation and

from other non-tax sources such as fees, prices, special
assessments, rates, etc.
https://minutes.co/our-economy-is-based-on-scarcity-and-its-failing-us-heres-why-the-abundance-model-is-what-we-need-next/
Macroeconomics 464
Irregular Revenue
• All items such as gifts, penalties, war indemnities, etc.
Macroeconomics 465
Revenue from state ownership
A government also obtains income from the different assets

which it owns.
government receives money from b
• state buildings,
• crown lands,
• other productive enterprises such as railways, postal

service, canals, etc.
Macroeconomics 466
References
• https://economicsconcepts.com/sources_of_public_revenue.htm
Macroeconomics 467
THANKS
MACROECONOMICS-I
BC-2303
Lecture [33] : Types of Taxes
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Types of Taxes
There are following types of taxes
• Income Tax
• Corporate Tax
• Sales Tax
• Property Tax
• Tariff
• Estate tax
Macroeconomics 470
Tax Definition
• A tax is a compulsory contribution to the public authority to

cover the cost of services rendered by state for the general
benefit of its people. In the words of Plehn:
• "Taxes are generally compulsory contributions of wealth

levied upon persons, natural or corporate to defray the
expense incurred in conferring a common benefit upon the
residents of the state" Macroeconomics 471
Contd.,
By analyzing this definition, we conclude:
• First, a tax is a compulsory payment to the public authority
• Secondly, a tax is to be paid by a person on whom it is levied whether he

derives any benefit from it or not
• Thirdly, a person who pays taxes to the state cannot claim that because
he pays taxes, therefore, a specific service in return should be provided
to him.
Macroeconomics 472
Cont……
In the words of Thomaas:
"A tax is a compulsory contribution made to government

under stated conditions and not a return for a specific service
rendered"
Macroeconomics 473
Corporate Tax
• A corporate tax is a levy placed on a firm's profit by the
government. The money collected from corporate taxes is
used as a nation's source of income.
• Tax rates are applied to generate a legal obligation that the
business owes the government.

Macroeconomics 474
Corporate Tax
Or
• A percentage of corporate profits taken as tax by the
government to fund federal programs
Macroeconomics 475
Sales Tax
• A sales tax is a consumption tax imposed by the
government on the sale of goods and services
• A conventional sales tax is levied at the point of sale,
collected by the retailer, and passed on to the government.
Macroeconomics 476
Sales Tax Contd.,
• A business is liable for sales taxes in a given jurisdiction if
it has a nexus there, which can be a brick-and-mortar
location, an employee, an affiliate, or some other presence,
depending on the laws in that jurisdiction.
Macroeconomics 477
Property tax
• Property tax is a tax paid on property owned by an
individual or other legal entity, such as a corporation
• Most commonly, property tax is a real estate ad-valorem tax,
• It is calculated by a local government where the property is
located and paid by the owner of the property

Macroeconomics 478
Property tax
• The tax is usually based on the value of the owned property,
including land
• However, many jurisdictions also tax tangible personal
property, such as cars and boats.
Macroeconomics 479
Tariff
• On imported goods imposed in the aim of strengthening
internal businesses
• A tariff is a tax imposed by one country on the goods and
services imported from another country.
• Macroeconomics 480
Tariff
• Governments impose tariffs to raise revenue, protect
domestic industries, or exert political leverage over another
country.
• Tariffs often result in unwanted side effects, such as higher
consumer prices.
Macroeconomics 481
Estate tax
• An Estate tax is a levy on estates whose value exceeds an exclusion limit set by
law. Only the amount that exceeds that minimum threshold is subject to tax.
Assessed by the federal government and about a dozen state governments, these
levies are calculated based on the estate's fair market value, rather than what the
deceased originally paid for its assets.
Macroeconomics 482
Estate tax
• The tax is levied by the state in which the deceased person was living at the time
of their death. The rate applied to the fair market value of property in a person's
estate at the time of death
Macroeconomics 483
References
• https://economicsconcepts.com/types_of_taxes.htm
• https://www.investopedia.com/terms/t/taxes.asp
• https://www.investopedia.com/terms/c/corporatetax.asp
• https://www.investopedia.com/terms/s/salestax.asp
• https://www.investopedia.com/terms/p/propertytax.asp
• https://www.investopedia.com/terms/t/tariff.asp
Macroeconomics 484
References
• https://www.investopedia.com/terms/e/estatetax.asp
Macroeconomics 485
THANKS
MACROECONOMICS-I
BC-2303
Lecture [34] : PRINCIPLES OF TAXATION
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Benefit vs. Ability-to-Pay Principles
Economists and political philosophers have proposed two

major principles for organizing a tax system,
1. Benefit Principle
Individuals should be taxed in proportion to the benefit they

receive from government programs
Macroeconomics 488
Cont…
2. Ability-to-pay Principal
The higher the wealth or income, the higher the taxes
• Government raises funds from higher-income people to

increase the incomes and consumption of poorer groups
Macroeconomics 489
Horizontal and Vertical Equity
Horizontal Equity
• Those who are essentially equal should be taxed equally
• If a tax system follows the ability-to-pay approach,

horizontal equity dictates that people who have equal
incomes should pay the same taxes
Macroeconomics 490
Vertical Equity
• Concerns the tax treatment of people with different levels of

income.
Macroeconomics 491
• Horizontal equity is the principle that equals Should be

treated equal
• Vertical equity holds that people in unequal circumstances

should be treated unequally and fairly, but there is no
consensus on exactly how vertical equity should be applied
Macroeconomics 492
Canons of Taxation
• A good tax system is based on some principles
• Adam Smith has formulated four important principles of

taxation
• A few more have been suggested by various other

economists
• These principles which a good tax system should follow are

called canons of taxationMacroeconomics 493
Canons of Taxation
1. Canon of Equality
2. Canon of Certainty
3. Canon of Convenience
4. Canon of Economy
Macroeconomics 494
Canon of Equality
• Persons should be taxed according to their ability to pay

taxes
• Equality does not mean equal amount of tax, but equality in

tax burden
• Canon of equality implies a progressive tax system
Macroeconomics 495
Canon of Certainty
• The tax which each individual is required to pay should be

certain and not arbitrary.
• The time of payment, the manner of payment and the

amount to be paid should be clear to every tax payer
• The application of this principle is beneficial both to the

government as well as to the tax payer
Macroeconomics 496
Canon of Convenience
• The mode and timings of tax payment should be convenient to the

tax payer
• Taxes should be imposed in such a manner and at the time which

is most convenient for the tax payer
• For example, government collects the income tax at the time

when they receive their salaries
• So this principle is also known as ‘the pay as you earn method’

Macroeconomics 497
Canon of Economy
• Every tax has a cost of collection
• The canon of economy implies that the cost of tax collection

should be minimum.
Macroeconomics 498
References
• https://www.slideshare.net/rishabhsharma12327/taxation-42
437243?from_action=save
Macroeconomics 499
THANKS
DEPARMENT OF COMPUTER SCIENCE & INFORMATION TECHNOLOGY
MACROECONOMICS-I
BC-2303
Lecture [35] : Proportional Versus Progressive Taxation
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Proportional Versus Progressive Taxation
• A tax is called proportional, progressive, or regressive

depending on whether it takes from high-income people the
same fraction of income, a larger fraction of income, or a
smaller fraction of income than it takes from low-income
people
• Taxes can be distinguished by the effect they have on the

distribution of income and wealth
Macroeconomics 503
Proportional Taxation
• A tax is called proportional when the rate of taxation remains

constant as the income of the tax payer increases
• In this system all incomes are taxed at a single uniform rate,

irrespective of whether tax payer’s income is high or low
• The tax liability increases in absolute terms, but the proportion of

income taxed remains the same
Macroeconomics 504
Macroeconomics 505
Progressive Taxation
• When the rate of taxation increases as the tax payer’s income

increases, it is called a progressive tax
• In this system, the rate of tax goes on increasing with every

increase in income
• Progressive taxes are still the leading source of federal revenues
Macroeconomics 506
https://apps.irs.gov/app/understandingTaxes/whys/thm03/les05/media/ws_ans_thm03_les05.pdf
Macroeconomics 507
Regressive Taxation
Regressive Taxation
• The rate of taxation decreases as the tax payer’s income

increases
• Lower income is taxed at a higher rate, whereas higher

income is taxed at a lower rate
• However absolute tax liability may increase

Macroeconomics 508
Summary
• In the United States there are progressive income taxes and

regressive Social Security and property taxes
• Excise taxes and user fees are somewhat regressive
• This combination results in taxpayers paying roughly the

same percentage of their incomes in taxes, creating a
proportional system
Macroeconomics 509
References
• https://www.slideshare.net/rishabhsharma12327/taxation-42437243
• Samuelson Pual and Nordhaus W.D “ Economics” 19 th Edition, McGraw Hill
• https://apps.irs.gov/app/understandingTaxes/whys/thm03/les05/media/ws_ans
_thm03_les05.pdf
Macroeconomics 510
THANKS
MACROECONOMICS-I
BC-2303
Lecture [35]: Direct & Indirect Taxes
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Direct & Indirect Taxes
• The taxes are the basic source of revenue for the Government. Revenue raised
from the taxes are utilized for meeting the expense of Government like,
provision of education, infrastructure facilities such as roads, dams etc.
• Tax is the financial charge imposed by the Government on income, commodity

or activity.
• Government imposes two types of taxes namely Direct taxes and Indirect taxes
Macroeconomics 513
Indirect Taxes
•Levied on goods and services and thus only “indirectly” on individuals. OR
•An indirect tax is that tax which is initially paid by one individual, but the burden of which is passed
over to some other individual who ultimately bears it. It is levied on the expenditure of a person.
Examples:
•Excise Duty, Sales Tax, Custom Duties, Value Added Tax(VAT), Proportional tax
Advantage
Easier to collect, since they can be levied at the retail or wholesale level
Macroeconomics 514
Indirect Taxes
•Levied on goods and services and thus only “indirectly” on individuals. OR
•An indirect tax is that tax which is initially paid by one individual, but the burden of which is passed
over to some other individual who ultimately bears it. It is levied on the expenditure of a person.
Examples:
•Excise Duty, Sales Tax, Custom Duties, Value Added Tax(VAT), Proportional tax
Advantage
Easier to collect, since they can be levied at the retail or wholesale level
Macroeconomics 515
Indirect Taxes
The most common example of an indirect tax is import duties. The duty is paid by
the importer of a good at the time it enters the country. If the importer goes on to
resell the good to a consumer, the cost of the duty, in effect, is hidden in the price
that the consumer pays. The consumer is likely to be unaware of this, but he will
nonetheless be indirectly paying the import duty.
Macroeconomics 516
Direct taxes
• Direct taxes are levied directly upon individuals or firms. A direct tax is that tax
whose burden is borne by the same person on whom it is levied. The ultimate
burden of taxation falls on the person on whom the tax is levied. It is based on
the income and property of a person.
Macroeconomics 517
Direct taxes
Examples
Corporation Tax.
Income Tax
Wealth Tax
Gift Tax
Property Tax
Advantage
Easier to tailor to fit personal circumstances, such as size of family, income, age,
and more generally the ability to pay
Macroeconomics 518
Direct taxes
'Direct Tax’ A direct tax cannot be shifted to another individual or entity. The
individual or organization upon which the tax is levied is responsible for the
fulfillment of the tax payment. Indirect taxes, on the other hand, can be shifted
from one taxpayer to another
Macroeconomics 519
Direct taxes
corporate taxes are a good example of direct taxes. If, for example, a manufacturing
company operates with $1 million in revenue, $500,000 in cost of goods sold
(COGS) and $100,000 in total operating costs, its earnings before interest, taxes,
depreciation, and amortization (EBITDA) would be $400,000. If the company has
no debt, depreciation, or amortization, and has a corporate tax rate of 21%, its
direct tax would be $84,000 ($400,000 x 0.21 = $84,000).
Additionally, a person’s income tax is an example of a direct tax. If a person makes

$100,000 in a year and owes $33,000 in taxes, that $33,000 would be a direct tax.
Macroeconomics 520
References
https://www.investopedia.com/terms/i/indirecttax.asp
https://www.investopedia.com/terms/d/directtax.asp
https://www.slideshare.net/Nikki015/direct-tax-53921439
Samuelson Pual and Nordhaus W.D “ Economics” 19th Edition, McGraw Hill
Macroeconomics 521
THANKS
MACROECONOMICS-I
BC-2303
Lecture [36] : Short Term and Long Term Loans
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Short Term Loans
Definition
There are periods when a government is not able to meet its expenditure from the
tax receipts. It then takes recourse to borrowing. The loans which are payable
within a year are termed as short term loans.
Macroeconomics 524
Short Term Loans - Explanation
(i) If at any time, the expenditure of the government exceeds its revenue, then it
takes recourse to short term borrowing.
(ii) If, at any time, the rate of interest in the market is very high and the government
is in need of large amounts of money to finance its various projects, then it raises
loan for a short period only and waits till the prevailing high rate of interest comes
down.
(iii) The commercial banks find a very safe and profitable opportunity to invest
their surplus funds in the government short term loans.
Macroeconomics 525
Short Term Loans - Disadvantages/Drawbacks
(i) If the short term debt is contracted for an unnecessary expenditure, then people
lose faith in the financial stability of the country.
(ii) The commercial banks find treasury bills as the most safest and profitable form
of investment, they divert their resources from trade and industry and invest their
funds in treasury bills. The economic progress of the country is thus badly affected.
(iii) The government being unable to pay loan issues another loan to pay off the
first and this process continues for an indefinite period.
(iv) if at any time some emergency arises, then new loans in large amounts cannot
be easily raised because the government is already under debt.
Macroeconomics 526
Long Term Loans
Definition:
There are periods when a government is not able to meet its expenditure from the
tax receipts. It then takes recourse to borrowing. If the government is in need of
large funds and the short term loans are not suitable and adequate, then it takes
recourse to long term loans.
Macroeconomics 527
Long Term Loans - Advantages
(i) Long term loan provides an opportunity to the state to under-take large projects
like constructions of canals, hydro-electric projects, buildings, highways, hospitals
(ii) Long term loans are also unavoidable for preparing and fighting of a modern war
(iii) The long term loans provide a very good opportunity for the commercial banks
and the insurance companies to invest their surplus funds. As the rate of interest in
long term loan is higher.
Macroeconomics 528
Long Term Loans - Advantages
(iv) Can be repaid by the government by the time which is favorable or convenient to
it. It can also convert these loans at a lower rate of interest later on.
(v) If at any time the rate of interest is low, the government can contract a long-term
loan and with the amount thus raised, some public works programs can be
undertaken at a lesser cost.
Macroeconomics 529
Long Term Loans - Disadvantages
(i) Long term loans are mostly incurred for financing war or for undertaking big
public works program.
(ii) In times of an emergency, the government has to undertake long-term .loans even
though they are at a higher rate of interest.
(iii) If a government embarks upon a big project by having a recourse to long term
borrowing and miscarries it, then the future generation is burdened with a losing
concern.
(iv) If the government has accumulated large capital through long-term loans and no
real assets exists to pay off such debts, then it resorts to excessive taxation.
Macroeconomics 530
References
• https://economicsconcepts.com/long_term_loans.htm
• https://economicsconcepts.com/short_term_loans.htm
Macroeconomics 531
THANKS
MACROECONOMICS
BC-2303
Lecture [37] : Different Forms of State Borrowing
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Methods of State Borrowing
State can raise loans or borrowing in different forms. It may obtain loans from
(i) people within the country
(ii) from other states and specialized international credit institutions
(iii) by issue of inconvertible paper currency.
Macroeconomics 534
Forms of State Borrowing
There is limit of borrowing in each case. If that limit is crossed, the country is
bound to suffer.
(i) Internal Borrowing
(ii) Loans From the Central Bank
(iii) External Loans
Macroeconomics 535
Internal Borrowing
• When a state finds that it is not possible to obtain further money by taxation, it
resorts to borrowing from citizens and financial institutions within the country.
• How much loans the state will obtain depends upon the total physical saving of
the nation and the socio economic conditions prevailing at that time.
Macroeconomics 536
Loans From the Central Bank
• A government can raise loans from the Central Bank of the country. The Central
Bank purchases the government securities, bonds and debentures from the
government and advances loans against them.
• There is no limit to which a state can raise funds by this method. The limit is
reached when money begins to expand in excess of needs of the trade.
• Every state should borrow from central bank within reasonable limits.
Macroeconomics 537
External Loans
• It raised from international money markets, foreign government and from

international agencies like International Monetary Fund.
• The foreign governments do not advance loans without a limit. They minutely
study the budgetary position of the borrowing country, the tax-bearing capacity
of the nation, the per capita income of the people and the purpose for which the
loan is desired.
• If the position of the budget is sound and the taxable capacity of the nation is
high, then a foreign government may advance sizable loan to the borrowing
country. Macroeconomics 538
References
• https://economicsconcepts.com/methods_of_state_borrowing.htm
Macroeconomics 539
THANKS
MACROECONOMICS
BC-2303
Lecture [38] : Methods of Paying Public Debt
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Methods of Paying Public Debt
• If a government wishes to escape from the burden of the debt, then there are two
ways open to it. It may (i) repudiate its debt, (ii) repay them.
• If the public authority decides to repudiate the debt, then it loses the confidence
of the people living in the country and of the foreign governments. The foreign
states may take military action to recover the loan or boycott the repudiating
government.
Macroeconomics 542
The main methods are:
(i) Sinking Funds
(ii) Terminable Annuities
(iii) Utilization of Surplus Budget
(iv) Redemption by the Purchase of Government Stock
(v) Conversion
vi) Capital Levy
(vii) Surplus Balance of Payments
(viii) Writing off loans

Macroeconomics 543
Sinking Fund
• Sinking Fund is created out of the general revenue for paying off the loans every
year.
• The debtor country during the life of debt sets apart a portion of the current
revenue every year.
• When the sum thus accumulated becomes equal to the loan raised, it pays off the
entire debt in one installment.
Macroeconomics 544
(ii) Terminable Annuities:
If a debtor country wishes to repay a permanent debt, it may do so by fixing

installments over a period of years. These installment repayments are known as
annuities.
(iii) Utilization of Surplus Budget:
If during a particular year, the country has surplus budget, it can be utilized in
reducing the burden of the debt. If at all there is any surplus any year, it is generally
so small. It cannot make any significant reduction in the national debt.
Macroeconomics 545
(iv) Redemption by the Purchase of Government Stock:
A Government can also lessen the burden of debt by the purchase of its own stocks
in the market.
(v) Conversion:
Convert a loan bearing a high rate of interest into another with a lower rate of
interest. Conversion as stated by Dalton is not repayment, it is only the exchange of
new debt for old. If a state has contracted a loan when the rate of interest was high,
it can reduce the annual interest payment by conversion operation.
Macroeconomics 546
vi) Capital Levy:
The advocates of capital levy state that it is not possible to reduce the burden of war debt by
means of a sinking fund or surplus revenues or by annuities, etc. The state should levy a
special tax on a accumulated wealth or capital of the people at a progressive rate and with the
money thus raised pay off all the war debts. Dalton in his book 'Public Finance' Writes: "
during the war a law was passed which every man of suitable age and physique was deemed
to be a soldier”
Macroeconomics 547
(vii) Surplus Balance of Payments:
A government can pay off debt by increasing exports and reducing imports. The
surplus balance can be used to lessen the burden of debt.
(viii) Writing off loans:
The government can also request the credited countries to write off loans.
Macroeconomics 548
References
• https://economicsconcepts.com/methods_of_paying_public_debt.htm
Macroeconomics 549
THANKS
MACROECONOMICS-I
BC-2303
Lecture [39] : Fiscal Policy
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
What is Fiscal Policy?
• The use of deliberate changes in government expenditure and or taxes to achieve

certain national economic goals is called Fiscal Policy.
• Fiscal policy thus is the deliberate change in government spending and taxes to
stimulate or slow down the economy
Macroeconomics 552
• . In the words of F.R. Glahe:
"By fiscal policy is meant the regulation of the level of government expenditure
and taxation to achieve full employment without inflation in the economy".
• J. M. Keynes describes fiscal policy as the steering wheel for the aggregate
economy
Macroeconomics 553
Objectives of Fiscal Policy
• The objectives of fiscal policy differ with the state of development in the
country.
• In advanced countries, the goal of fiscal policy may be the maintenance of full
employment without inflation.
• In developing countries, the objectives of fiscal policy may be to achieve

maximum level of employment and reduction in economic inequalities.
Macroeconomics 554
The main goals of fiscal policy are as under:
(i) Removing Deflationary Gap:
According to J. M. Keynes fiscal policy can play a major role in lifting the
economy out of depression and closing the deflationary gap.
(ii) Fiscal Policy in Inflation:
If the economy of a country is faced with inflationary gap, then anti cyclical
fiscal policies should be adopted to bring down the prices and for closing the
inflationary gaps.
Macroeconomics 555
• .
The main fiscal measures to bring down the excess demand in the economy are:
(a)reduction in government expenditure
(b)increase in taxes
(c)creating a budget surplus.
Macroeconomics 556
(iii) Counter Cyclical Fiscal Keynesian Fiscal Policy in the Short Run
Policy:
Another important objective of

fiscal policy is to minimize the
fluctuations in aggregate demand so
that the economy is always at its
target and potential level of income.
The fluctuations in the economy In figure 27.1 (A), it is shown how an increase
in government spending increases the level of
which are associated with the
national income in the short run
business cycles can be smoothed in
Macroeconomics 557
a number of ways.
In figure 27.1 (B), it is shown how an increase in taxes

and reduction in government expenditure leads to a
decrease in national income in the short run.
Macroeconomics 558
(iv) Equilibrium in Balance of Payments:
• The level of national income is also affected by the balance of payments position
of the country.
• If the country has a favorable balance of payments, it will lead to increase in

income. The rise in aggregate demand will shift the demand line upward and will
increase the level of national income.
• The fall in the balance of payments has the opposite effect. The government uses
fiscal policy in such a way that the balance of payments remains in equilibrium
in the short run. Macroeconomics 559
(v) Economic Growth:
• The economists stress that government should encourage investment to

increase the rate of capital formation by using timely proper fiscal measures.
• The government borrowing for financing schemes of development, the increase

in ratio of savings to national income, cut in taxes to increase investment
spending can accelerate the rate of capital for nation in the country and lead to
economic growth.
Macroeconomics 560
References
• https://economicsconcepts.com/What_is_fiscal_policy.htm
Macroeconomics 561
MACROECONOMICS
BC-2303
Lecture [40] : Fiscal Policy
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
• The use of deliberate changes in government expenditure and or taxes to achieve

certain national economic goals is called Fiscal Policy.
• Fiscal policy thus is the deliberate change in government spending and taxes to
stimulate or slow down the economy
Macroeconomics 563
In the words of F.R. Glahe:
"By fiscal policy is meant the regulation of the level of government expenditure
and taxation to achieve full employment without inflation in the economy".
• J. M. Keynes describes fiscal policy as the steering wheel for the aggregate
economy
Macroeconomics 564
• The objectives of fiscal policy differ with the state of development in the
country.
• In advanced countries, the goal of fiscal policy may be the maintenance of full
employment without inflation.
• In developing countries, the objectives of fiscal policy may be to achieve

maximum level of employment and reduction in economic inequalities.
Macroeconomics 565
The main goals of fiscal policy are as under:
(i) Removing Deflationary Gap:
According to J. M. Keynes fiscal policy can play a major role in lifting the
economy out of depression and closing the deflationary gap.
(ii) Fiscal Policy in Inflation:
If the economy of a country is faced with inflationary gap, then anti cyclical
fiscal policies should be adopted to bring down the prices and for closing the
inflationary gaps.
Macroeconomics 566
• .
The main fiscal measures to bring down the excess demand in the economy are:
(a)reduction in government expenditure
(b)increase in taxes
(c)creating a budget surplus
Macroeconomics 567
(iii) Counter Cyclical Fiscal Keynesian Fiscal Policy in the Short Run
Policy:
Another important objective of

fiscal policy is to minimize the
fluctuations in aggregate demand so
that the economy is always at its
target and potential level of income.
The fluctuations in the economy In figure 27.1 (A), it is shown how an increase
in government spending increases the level of
which are associated with the
national income in the short run
business cycles can be smoothed in
Macroeconomics 568
a number of ways.
In figure 27.1 (B), it is shown how an increase in taxes

and reduction in government expenditure leads to a
decrease in national income in the short run.
Macroeconomics 569
(iv) Equilibrium in Balance of Payments:
• The level of national income is also affected by the balance of payments position
of the country.
• If the country has a favorable balance of payments, it will lead to increase in

income. The rise in aggregate demand will shift the demand line upward and will
increase the level of national income.
• The fall in the balance of payments has the opposite effect. The government uses
fiscal policy in such a way that the balance of payments remains in equilibrium
in the short run. Macroeconomics 570
(v) Economic Growth:
• The economists stress that government should encourage investment to

increase the rate of capital formation by using timely proper fiscal measures.
• The government borrowing for financing schemes of development, the increase

in ratio of savings to national income, cut in taxes to increase investment
spending can accelerate the rate of capital for nation in the country and lead to
economic growth.
Macroeconomics 571
References
• https://economicsconcepts.com/What_is_fiscal_policy.htm
Macroeconomics 572
THANKS
MACROECONOMICS
BC-2303
Lecture [41] : Principal Weapons of Fiscal Policy
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Principles/Tools of Fiscal Policy
• The government uses various fiscal principles/tools in order to achieve rapid

economic growth. The main tools of fiscal policy are grouped under two main
heads
(1) Discretionary Fiscal Policy.
(2) Non Discretionary Controls.
Macroeconomics 575
Discretionary Fiscal Policy
• The discretionary fiscal policy has short, as well as long-run objectives.
• The short-run counter cyclical fiscal policy aims at eliminating business

fluctuations and maintaining moderate stability.
• In case of deflationary situation, the long-run program of fiscal policy is to raise

the level of income and employment in the country.
• In case of sustained long-run inflationary gap in the economy, the objective of

fiscal policy is to reduce the average level of purchasing' power. Let us now
examine the short and long run tools of discretionary fiscal policy in more detail.
Macroeconomics 576
Short Run and Long Run Counter Cyclical Fiscal Policy:
The main weapons or stabilizers of short-run and long run discretionary fiscal
policy are:
(i) Precautions or Guide map
(ii) Changes in tax rates
(iii) Varying public works expenditure
(iv) Credit aids
(v) Transfer payments. Macroeconomics 577

(i) Guide maps: In a capitalistic, society, the entrepreneurs are not aware of each
other investment plans. They, therefore, in competition with one another over-
invest capital in a particular industry or industries and thus cause overproduction
and unemployment in the economy, similarly, in depression period, there is no
agency to guide them, If government publishes the total investment plans and
marginal efficiency of capital in various industries, much of the investment can
proceed at a moderate speed and there can be stability to some extent in income,
output and employment.
Macroeconomics 578
(ii) Changes in tax rates: it is an important weapon of fiscal policy for eliminating
the swings of the business cycle. When the government finds that planned
investment is exceeding planned savings and the economy is likely to be threatened
with inflationary gap, it increases the rate of taxes. The higher taxes, other things
remaining the same, reduce the disposable income of the people they are forced to
cut down their expenditure. The economy is, thus, saved from the inflationary
situation.
Macroeconomics 579
(iii) Varying public works expenditure: Another important factor which

influences economic activity is public expenditure. In times of depression, the
government can contribute directly to the income stream by initiating public works
programs and in boom period, it can withdraw funds from the income stream by
curtailing them. This policy have the following limitations:
Macroeconomics 580
(iv) Credit aids: The government can also avert depression by offering long term
credit aids to the needy industrialists for starting or expanding the business. It can
also give financial help to insurance companies and bankers to prevent their
failures.
Macroeconomics 581
(v) Transfer payments: Variation in transfer expenditure programs can also help in
moderating the business cycle. When the business is brisk, the government can
refrain from giving bonuses to the workers and thus can lessen the pressure of too
great spending to some extent. When the economy is in recession, these payments
can be released and more bonuses can be given to stimulate aggregate effective
demand.
Macroeconomics 582
Non Discretionary Control
• Automatic or Built in Stabilizers:
• The automatic fiscal stabilizers are those which contribute to keep economic
system in balance without human control. The main automatic stabilizer is :
• Progressive Income Tax:
• Personal income taxes are the largest source of revenue to the government. The
tax rate, the individuals pay on their rising income is progressive.
Macroeconomics 583
Progressive Income Tax: Cont…
When the disposable income of the people increases in the boom period, the
higher amount of tax reduces disposable income, reduces consumption and
decreases the aggregate demand which help in curbing economic boom and vice
versa. The expansionary and contractionary fiscal policies can be summed up and
brought under two approaches:
• First: Demand Side Fiscal Policy.
• Second: Supply Side Fiscal Policy.
Macroeconomics 584
(i) Demand side policy: It was originated as a direct result of Keynesian belief.
According to Keynes, during recession, the goal is to raise aggregate demand to the
full employment level. This objective may be achieved by (a) an increase in
government spending (G), (b) a decrease in tax revenue (T) brought about by
reduction in tax rates.
During a period of rapid inflation, the goal is to lower aggregate demand to the full
employment level. The fiscal policy will be (a) a decrease in government
expenditure (b) an increase in taxes brought about by rise in the rates.
Macroeconomics 585
(ii) Supply side fiscal policy: It is a new approach to fiscal policy. The modern
economists are of view that fiscal policies can also influence the level of economic
activity through their impact on aggregate supply. When the firms experience, an
increase in resource costs due to a sharp rise in the world price of a major raw
material say oil, the higher costs causes a decrease in aggregate supply creating a
recessionary gap. Therefore, an expansionary fiscal policy in the form of reduced
corporate taxes and pay roll tax can help in closing the recessionary gap.
Conversely, an increase in the corporate tax rate and pay roll tax etc., can help in
closing the inflationary a gap.
Macroeconomics 586
(iii) Unemployment compensation: In advanced countries of the world, people
receive unemployment compensation and other welfare payments when they are
out of job. As soon as they get employment, these payments are stopped. When
national income is increasing, the unemployment fund grows due to two main
reasons: (a) The government receives greater amount of payroll taxes from the
employees and (b) the unemployment compensation decreases.
"During boom years, therefore, the unemployment reserve fund grows and exerts
stabilizing pressure against too great spending. Conversely, during years of slack
employment, the reserve funds are used to pay out income to sustain consumption
and moderate the decline".
Macroeconomics 587
(iv) Farm aid programs: Farm aid programs also stabilize against the wave like
cyclical fluctuations. When the prices of the agricultural products are falling and
the economy is threatened with depression, government purchases the surplus
products of the farmers at the set prices. The income and total spending of the
agriculturists thus remain stabilized and the contraction phase is warded off to some
extent. When the economy is expanding, the government sells these stocks and
absorbs the surplus purchasing power. It, thus, reduces inflationary potential by
increasing the supply of goods and contracting the pressure of too great spending.
Macroeconomics 588
(v) Corporate saving and family savings: The credit of having automatic or built
in stabilizer does not go to the state alone. The corporations and companies and
wise family members withhold part of the dividends of the boom years to pay in the
depression years. Thus holding back some earnings of good years contracts the
purchasing power and releasing of money in poorer years expands the purchasing
power of the people. Similarly, wise persons also try to save something during the
prosperous days in order to spend the savings in the rainy days.
Macroeconomics 589
References
• https://economicsconcepts.com/principle_weapons_of_fiscal_policy.htm
Macroeconomics 590
THANKS
MACROECONOMICS
BC-2303
Lecture [42] : Fiscal policy with reference to Underdeveloped Countries
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
What is Fiscal Policy/Budgetary Policy?
• Fiscal policy also called budgetary policy is a powerful instrument in the hands
of the government to intervene in the economy.
• Fiscal policy relates to a variety of measures which are broadly classified, as:
(a) taxation, (b) public expenditure (c) public

borrowing.
• Fiscal policy is considered an essential method for achieving the objectives of
development both in developed and underdeveloped countries of the world.
Macroeconomics 593
Definitions of Fiscal Policy
• Fiscal policy has been defined in a number of ways. According to Samuelson:
"Fiscal policy we mean the process of shaping taxation and public expenditure in
order to (a) help dampen the swings of the business cycle and (b) to contribute to the
maintenance of a growing high employment economy".
• In the words of Arthur Smithees:
"Fiscal policy under which the government uses its expenditure and revenue
programs to produce desirable effects and to avoid undesirable effects on the national
income, production and employment"?
Macroeconomics 594
Definitions of Fiscal Policy
• Roger defines fiscal policy as:
"Changes in taxes and expenditure which aim at short run goals of full employment
and price level stability".
Macroeconomics 595
Role of Fiscal Policy
• In the developed countries, the role of fiscal policy is to promote fall

employment without Inflation through its spending and taxing powers.
• For LDC's (Less Developed Countries) or backward countries the vicious circle
of low income, low consumption, low savings, low rate of capital formation and
therefore low income has to be broken by a suitable fiscal policy.
• Fiscal policy in developing countries is thus used to achieve objectives which are
different from the advanced countries.
Macroeconomics 596
(i) To mobilize resources for financing development.
(ii) To promote economic growth in the private sector.
(iii) To control inflationary pressure in the economy.
(iv) To promote economic stability with employment opportunities.
(v) To ensure equitable distribution of income and wealth.
Macroeconomics 597
Fiscal Policy Measures/Weapons
• The main fiscal policy measures/tools which are used to achieve the above
objectives are :
(1) RESOURCE MOBILIZATION FOR FINANCING THE

DEVELOPMENT PROGRAMS IN THE PUBLIC SECTOR:
(a) Taxation. An important instrument for fiscal policy. It is widely used to

mobilize the available resources for capital formation in the country.
Macroeconomics 598
• There are two type of taxes which are levied to transfer funds from private to
public use
i) The direct taxes are levied on the income, profits and wealth of the people who
have potential economic surplus.
ii) The indirect taxes such as excise duty, sales tax etc., are imposed mostly on
goods which have higher income elasticity of demand. A rise in tax rates causes
a reduction in aggregate demand for three reasons
(i) it reduces consumption (ii) It reduces investment and (iii) it reduces net
exports. A fall in the tax rates has the opposite effect.
Macroeconomics 599
(b) Tax on farm income.
Agriculture sector is another important source of revenue which can be tapped

for capital formation. Tax should promote equity whether It is from agriculture or
not agriculture.
Macroeconomics 600
(2) PROMOTING DEVELOPMENT IN THE PRIVATE SECTOR:
• In a mixed economy, private sector constitutes an important part of the

economy.. The private sector should make significant contribution to the
development of the economy. The fiscal methods for stimulating private
investment in developing countries are:
(a) Tax on national saving certificates and other approved forms of saving be
exempted from taxation, this will encourage private savings.
(b) The rates of return on voluntary contribution to provident fund, insurance

premium etc., be raised for incentive to save.
Macroeconomics 601
(c) The retained profits of the public companies should be taxed at

preferential rates or exempted from taxation. This move will boost private
investment.
(d) Private investment can also be stimulated by giving tax holidays or relief
from tax for some specified period of time to certain selected industries.
(e) Rebates and liberal depreciation allowances can also be granted to

encourage investment in the private sector.
Macroeconomics 602
(3) RESTRAINING INFLATIONARY PRESSURE IN THE ECONOMY:
• important objectives of fiscal policy is to use taxation as an

instrument for dealing with inflationary or deflationary
situations.
• In developing countries there is a tendency of the general prices
to go up due to expenditure on development projects, pressure of
wages on prices, long gestation period between investment
Macroeconomics 603
expenditure and production etc.
• Fiscal measures are used to counter act the inflationary pressure.
(4) SECURING EQUITABLE DISTRIBUTION OF INCOME AND

WEALTH:
• A wider measure of equality in income and wealth is an integral part of

economic development and social advance.
• The government can reduce the high bracket incomes by imposing progressive
direct taxes.
• For raising the income of the poor above the poverty line and narrowing the gap
between rich and poor, the government can take direct investment on economic
and social overheads. Macroeconomics 604
(5) PROMOTING ECONOMIC STABILITY WITH INCREASED

EMPLOYMENT OPPORTUNITIES:
• The ultimate objective of economic development is to increase conditions of

employment and to provide rising standard of living.
• Principal aim of the fiscal policy in underdeveloped countries is to provide

incentives for promoting saving and investment and thereby high rate of
economic growth.
Macroeconomics 605
References
• https://economicsconcepts.com/fiscal_policy_with_reference_to_underdevelop
ed_countries.htm
Macroeconomics 606
THANKS
MACROECONOMICS
BC-2303
Lecture [42] : Commercial Policy
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
What is Commercial Policy?
• In the words of Haberler:
"By commercial policy or trade policy is meant all

measures regulating the external economic relations of a
country, that is measures taken by a territorial government
which has the power of assisting or hindering the exports or
imports of goods and services".
What is Commercial Policy?
• In modern times, the commercial policy of every country is
generally based on the encouragement of exports and
discouragement of imports.
• The exports are encouraged by giving preferential freight
rates on exports, consular establishments subsidized
merchant marines etc.
• The imports are hindered by erecting the tariff wails,
exchange controls, quota system, buy at home campaign etc.
Macroeconomics 610
Objectives of Modern Commercial Policy:
The main objectives of the modern commercial policy are

• To increase the quantity of trade with foreign nations
• To preserve, the essential raw material for encouraging the
development of domestic industries
• To stimulate the export of particular products with a view to
increasing their scale of production at home
Macroeconomics 611
• To prevent the imports of particular goods for giving protection

to infant industries or developing key industry or saving foreign
exchange, etc.
• To restrict imports for securing diversification of industries.
• To encourage the imports of capital goods for speeding up the

economic development of the country.
Macroeconomics 612
• To restrict the imports of goods with a view to correct the

unfavorable balance of payments
• to assist or prevent the export or import of goods and services for

achieving the desired rate of exchange
• To enter into trade agreements with foreign nations for stabilizing

the foreign trade
Macroeconomics 613
References
• https://economicsconcepts.com/what_is_commercial_policy.htm
• https://economicsconcepts.com/objectives_of_modern_commercial_policy.htm
Macroeconomics 614
THANKS
MACROECONOMICS
BC-2303
Lecture [44] : Instruments of Commercial Policy
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Instruments of Commercial Policy
• The main instruments or tools of commercial policy are :
(1) Tariffs or Custom Duties:
• Tariff's or custom duties may be defined as a schedule of duties authorized

by territorial government to be imposed upon a list of commodities that are
exported.
• Tariffs are generally classified into three classes. (a) Transit duties, (b)
Import duties, (c) Export duties.
Macroeconomics 617
(a) Transit duties are those which are levied upon merchandize passing through the
country and consigned for another country. Transit duties are levied for raising money for
the government.
(b) Import duties are those which are levied on the goods brought . into the country.
Import duties are chiefly levied for revenue or for protection purpose or for both.
Macroeconomics 618
(c) Export duties are those which are imposed on the merchandize sent out of the country
are called export duties. Export duties, like import duties, are also imposed for raising
revenue and to restrict the export of certain raw material with the view to encourage the
development of domestic industries.
Macroeconomics 619
Custom duties may be discriminatory with respect to commodities of countries or it may

be non-discriminatory.
When a country is pursuing a discriminatory tariff policy, it may give:
(a) Preferential treatment by levying lesser custom duties upon the merchandize of
some of the countries. (or);
Macroeconomics 620
(b) Enter into an agreement with other countries for ensuring fair and equal treatment to
the imports or exports of each member country. (or);
(c) Join a common market where the merchandize of member countries are allowed free
entry but the goods of other countries are subjected to tariffs.
Macroeconomics 621
(2) Bounties on Exports:
• In order to promote the export of particular industry or the export of specified

commodities, a government some times gives bounties on exports.
• The bounties or subsidies may be director, indirect.
• When subsidy is paid in cash from the public treasury, the bounty is said to be direct
• When low freight rates are charged on the goods to be exported or they are exempted
from taxes, etc, the bounty or subsidy is said to be indirect.
Macroeconomics 622
(3) Direct Restrictions on Imports:
• The government may totally prohibit the import of certain commodities into the country
with the intent of increasing foreign exchange or for protection of domestic industries
or for discouraging the use of particular commodities because they are injurious to
health.
• The government may regulate the imports by means of quotas. Under quota system,
the maximum amount of a commodity which can be imported during a particular period
is fixed by the government.
Macroeconomics 623
• In recent years, the governments of most of the countries are

employing the import quota system because:
(i) It is very flexible and can be adjusted by the administrative
authorities without resorting to legal action.
(ii) The home producers know in advance the total quantity of
goods to be imported during a particular period, so they can
regulate their output accordingly.
(iii) It arouses less resentment than the custom duties from the
consumers.

Macroeconomics 624
(4) Trade Agreements:
• The government of a country may enter into trade agreements with other countries for
the exchange of goods. The trade agreements may be bilateral or multilateral.
• When two countries make a trade agreement for the exchange of goods, the agreement
is said to be bilateral.
• When more than two countries enter into, trade agreement for ensuring fair and equal
treatment to the imports and exports of the member countries, the agreement is called
multilateral. Efforts were being made by different countries of the world to secure a
general reduction of tariffs.
Macroeconomics 625
• A General Agreement on Trade and Tariff (GATT) of 117

countries of the world was reached at. The main objectives of the
GATT were:
(i) To develop the resources of the world.
(ii) To expand production and exchange of goods.
(iii) To promote economic development.
(iv) To help in raising standard of living.
(v) To achieve full employment without inflation.
Macroeconomics 626
• In 1995, the GATT was replaced by World Trade Organization.
• The WTO is established to oversee the trade agreements among nations and settle trade
disputes.
• The globalization of economy, liberalization of trade among all the nations of the world
is now taking the shape of new world economic order.
• Globalization is the free movement of capital, goods and services based on market
based economy.
Macroeconomics 627
References
• https://economicsconcepts.com/objectives_of_modern_commercial_policy.htm
• https://economicsconcepts.com/instruments_of_commercial_policy.htm
Macroeconomics 628
THANKS
MACROECONOMICS-1
BC-2303
Lecture [45] : Barriers to Foreign Trade
Mehreen Zaid Ullah

(Lecturer)
Date: 2020
Barriers to Foreign/International Trade
• In order to shelter home industries, foreign/international
trade has following barriers:
• Import and export prohibition
• Custom duties or tariff
• Exchange control
• Quotas
• Preferential treatment
• Import monopolies
• Import licenses
Macroeconomics 631
(i) Import and export prohibition.
The government of a country by law may totally ban the import or export of certain
commodities for reasons of health or for promoting the growth of certain industries in the
country.
For instance, when foot and mouth disease attacks cattle, the government totally prohibits
the import of beef from that country.
Macroeconomics 632
(ii) Custom duties or tariff.
• When tariffs are imposed on the import of commodities, they

discourage import and raise their prices to domestic consumers.
• When they are imposed on the export of commodities, they

discourage exports and make the goods available for home
producers
Macroeconomics 633
• (iii) Exchange control
• Exchange control implies the government regulations relating to

buying and selling of foreign exchange
• Under the system of exchange control, all exporters are required to

surrender their claims foreign exchange to the central bank of the
country in exchange for domestic currency at the rate fixed by the
government or market Macroeconomics 634
• (iii) Exchange control
• The government then allots the foreign exchange among the

licensed importers
• Exchange control may be resorted for correcting an adverse

balance of payments or for protecting home industry or for
conserving foreign resources or for maintaining the exchange rate
at a predetermined parity Macroeconomics 635
(iv) Quotas.
• In order to reduce imports, the government of a country may restrict the total imports of
a given commodity to a specified amount or specify the maximum amount of a
commodity which can be imported from each producing country.
• When the total amount of goods to be imported is determined, the government then
issues licenses for their import
• This device of restricting imports is applied as an alternative to custom duties.
Macroeconomics 636
(v) Preferential treatment
• The government of a country may give preferential treatment in the rate of taxes to
some of the countries. For instance, under the Commonwealth Preferential System
exports have had referential treatment in U.K. Over goods from Non-Commonwealth
countries.
• The granting of preferential treatment results in the formation of trade blocks.
• The countries which are not giving preferential treatment impose high tariffs in relation
to the goods of the discriminating countries. The international trade is thus hindered.
Macroeconomics 637
(vi) Import monopolies.
When the government of a country takes responsibility of importing all the commodities
herself, we say the government has import monopolies.
(vii) Import licenses.
Another barrier which restricts the import of goods from abroad is the import license is
the government of a country allows the import of foreign commodities to the licensed
importers, the trade is very much brought under control, This method is adopted for
curtailing imports and for the use of discrimination between goods and countries.
Macroeconomics 638
References
• https://economicsconcepts.com/barriers_to_foreign_trade.htm
Macroeconomics 639
THANKS

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MIRPUR UNIVERSITY OF SCIENCE AND TECHNOLOGY (MUST), MIRPUR

At the end of this course, students will be able to:

Till Mid Term

Topic 2… National Income Accounting

Topic 3…. Money and Interest

Topic 4….Aggregate Demand and Aggregate Supply

Topic:5…. Consumption ,Investment and Savings

After Mid Term

Topic 1… Inflation and Unemployment

Topic 3 …. Business Cycles

After Mid Term

Topic 4… Monetary Policy

Topic 5… Fiscal Policy

Topic 6 …. Presentation Sessions

Mid Term: 30%

Semester Project: [ 0%]

Final Exam: [ 50%]

Point 1…Individual assignment to evaluate different monetary policies of Pakistan.

Point 2…Research articles of different economists work on monetary economics.

Lecture :1 Macroeconomics ,its principles and tools

Macroeconomics is a branch of economics that studies how an overall

Macroeconomics is a branch of economics dealing with the

Macroeconomics is the branch of economics that studies the behavior

1.WHO WILL WORK

5. HOW PEOPLE MAKE DECISIONS ?

Macroeconomic policy aims to provide a stable economic environment

Fiscal policy is the means by which a government adjusts its spending

Monetary policy is the macroeconomic policy laid down by the central

An exchange rate is the value of one nation's currency versus the

DETAILS ARE GIVEN IN LECTURE 14 AND I5 .

Lecture :2 National Income Accounting

National Income of a country is the total market value of all goods

and services produced within a country in a year.

National Income = National Product = National Expenditure

• Two Sectors, between HH and Firms

◦ Four or Five Sectors?

Gross National Product

Normal Residents? Both national and foreigners dwell in a country.

• Value of Final Goods/Consumed by Consumers, C

• Value of New Capital/Investment Goods, consumed by Firms, I

• Value of expenditure by Govt/Govt Consumption, G

• Net Exports, Exports minus Imports

• Net Factor Income, include wages, rents, interest/profits etc

Net Factor Income from Abroad (FI) +

Gross Private Investment (I) +

Net Exports (Xn) +

Govt Expenditure (G) +

THE VALUE OF ALL GOODS AND SERVICES PRODUCES IN AN ECONOMY DURING A

Net Factor Income from Abroad (FI)

Gross Private Investment (I) + Gross Private Investment (I) +

Net Exports (Xn) + Net Exports (Xn) +

Govt Expenditure (G) + Govt Expenditure (G) +

Private Consumption ( C ) Private Consumption ( C )

Lecture :3 National Income Accounting

Subsidy? Cost Price minus Subsidy, Subsidy is paid by Govts to businesses

When NNP is accounted for Indirect Taxes and Subsidies

disposal of normal consumers to spend/consume is a different entry/value.

paid by the recipient.