UNIT 1

INTRODUCTION TO MACRO ECONOMICS

Macroeconomics is formed with the help of two words i.e. Macro plus Economics. The term
Macro is taken from a Greek word 'Uakpo' which means large and Economies refers to branch
of social science concerned with the production, consumption and distribution of goods and
services. So, macroeconomics is concerned with total production, total consumption and total
distribution at large. Macroeconomics is concerned with economy as a whole.
JM Keynes provides a new direction to the macroeconomics through the development of
general theory in 1936 due to depression in the economy, demand for goods and services starts
declining in the economy. To study the economy as a whole was mandatory because of the
depression happened.

DEFENITION: According to R.G.D. Allen, 'The term Macroeconomics applies to the study
Of relations between broad economics aggregates."

Importance Of Macroeconomics/Scope
1) Helpful in formulation of economic policies
Macroeconomics deals with the economy as a whole. It includes aggregates of all economic
factors. Economic policies of the government are related with the whole economy. The
macroeconomics helps to study the economic factors and formulation or economic policies.
2) Helpful in understanding the functioning of an economy
Macroeconomic study the problems related with behaviour of total output. income,
employment and general price level. It is necessary to have proper and adequate knowledge to
understand the behaviour of the aggregate variables.
3) Useful for determining National Income
The concept of National income is studied under the scope Of macroeconomics, As overall
performance of any nation can only be determined through its national income. For solving the
problems related with overproduction and unemployment it is necessary to prepare data on
national income,among different Sectors Of the economy.
4) Important for Economic growth
Macroeconomics helps in formulation of economic policies, these policies are formed for the
future growth of an economy. These policies form basis for the stable and long run growth of
an economy. There are various theories on unemployment, general prices and national income
in macroeconomics which are helpful to solve the problems related with these issues. Thus,
macroeconomics is helpful for the economic growth.
5) Useful for the development Of Micro economics
Macroeconomic is helpful to understand microeconomics. Without proper understanding of
aggregates of facts, no microeconomics law can be formed.
6) Helpful in Economic planning
Economic planning is formed for balanced economic development and economic solution to
different problems. Economics planning requires special knowledge and skills as future of a
nation is based in its economic planning.
7) Helpful to study Trade cycles

Amritha L J, Faculty of management and commerce, SRM University

Trade cycles indicate the economic fluctuations of the economy. These fluctuations can be
understood and analysed with the help of macroeconomics like inflation, deflation etc
8) Helpful to understand monetary problems
Macroeconomics includes the concept like money, theories Of money, banking and credit
system in a country. Macroeconomics provides the direction to economists to understand these
Concepts and provide remedies to the monetary problems. It help to frame monetary policy
and fiscal policies
9) Useful to analysis Unemployment
Unemployment is a major problem in developing countries. At the time of depression in the
economy it becomes necessary to understand the need and requirement of the labour. TO
understand this concept economists, develop general theory Of employment.

VARIABLES/ASPECTS OF MACRO ECONOMICS

I. Aggregate Demand
Demand refers to that quantity of goods services for which consumer is ready to
pay and have willingness to purchase that goods and services at different price level
over a period of time. But, Aggregate demand refers to the total expenditure
incurred on the purchase of all the finished goods and services in the economy
during the period Of an accounting year. [t can be defined as the total monetary
expenditure incurred on the purchase of goods and services at a specified price level
on a point of time.
II. Aggregate Supply
Supply refers to production of that goods and services which a producer is
willing to sell at different prices during a period of time, when all the other factor

Amritha L J, Faculty of management and commerce, SRM University

 remain constant. Aggregate supply is the total supply or total production of goods
and services ill the economy during all accounting period.
III. Aggregate Consumption
Total consumption of all goods and services in the economy during an
accounting period is known aggregate consumption.
IV. Aggregate Investment
Investment refers to that asset which results into appreciation of income over a period
of time. In economies, it can be defined as expenditure incurred by producers to
purchase raw material so that this can be add to their capital in that year. And aggregate
refers to the total expenditure incurred by all the producers for purchasing raw material
in the economy to add their capital during that year.
IV. Unemployment
Unemployment occurs when a person wants to do job but he is unable to find a job.
Unemployment can be computed on the basis of unemployment rate.
Unemployment Rate = Unemployed People / Labor Force * 100
High rate of unemployment leads to unfavourable indicators of macroeconomics.
High rate of unemployment leads to maximum number of workforce who is not
engaged in any work and job. This represents negative signs for an economy,
V. General Price level
General Price level refers to index of prices of all goods and services in the economy
at the end of a specified period of time.
VI. Exchange Rate
Exchange rate refers to that rate at which Currency of one country is exchange with
the currency Of Other country.

VII. Interest rate

It refers the cost of borrowed money. Interest rate is the rate which interest is
paid by the borrower for use of money to lender.
VIII. Government Spending
Government spending refers to the government consumption, government
investment and transfer payments. Government spending describes the size Of the
public sectors in the economy. This include education sector, health Sector,
transportation, social protection, defence. etc. This spending is based on major two
factors i.e. tax collection and borrowing from public.
IX. GDP & National Income
Gross domestic product is the total monetary value of the final goods and services
produced within national boundaries of a country during an accounting year. GDP
is a macroeconomic indicator of health Of an economy- High GDP represents the
increase in output and this will lead to economic growth. Generally, GDP is also
known as measurement Of national income. National income provides an idea of
purchasing power of people of a country,
X. Inflation

Amritha L J, Faculty of management and commerce, SRM University

 Inflation refers to hike in general price level of goods and services In an economy
over a period of time.
XI. Economic Policies
Economic policies are also defined as the macroeconomic indicators. There are two
major economic policies i.e. monetary policy and fiscal policy. Monetary policy is
the policy which is formed to control money supply in the economy. Fiscal policy
is the policy of government expenditure and revenue. These policies are formed by
monetary authority and government of the country.
XII. Business cycle
Business cycle refers to the upward and downward movements in the gross domestic
product. Business cycle defines the fluctuations in the aggregate productions trade
and activity in an economy.
DIFFERNECE BETWEEN MICRO AND MACRO ECONOMICS
Sr. No. Microeconomics Macroeconomics

1 Microeconomics deals with the Macroeconomics deals with the aggregate of

individual units of an economy. individual units Or the whole economy.

2. It includes individual price, individual It includes general prices, aggregate demands

demand, individual income, etc. National income, etc.

3. Price determination and allocation of Determination of income and unemployment

resources are the major problem studied are the major problem studied under macro
under microeconomics. economics.

4. Two major tools i.e. demand and Supply Two major tools i.e. aggregate demand (AD)
of a particular commodity is used and aggregate supply (AS) of a particular
commodity is used in macroeconomics.

5. Microeconomics solves the Central Macroeconomics solves the Central problem

problem Of what to produce, how of full employment of resources in the
produce and for whom to produce. economy.

6. It is concerned with the equilibrium of a It is concerned with the equilibrium of level of

consumer, a producer and an industry. income and employment in an economy.

7. Microeconomics uses bottom-top Macroeconomics uses top-bottom approach for

approach for analysing the economy. analysing the economy.

Amritha L J, Faculty of management and commerce, SRM University

 8. It assumes that all macroeconomic It assumes that all microeconomic variables
variables like aggregate demand, Like individual demand, individual income,
national income and price are constant. etc. are constant.

9. It is also known as price theory. is also known as income theory or

employment theory.

10. It believes in Laissez-faire economy. It believes in command economy.

11. It is simple to study microeconomics, Jt is complex process to understand

macroeconomic due to inclusion of large
numbers.

FLOW OF INCOME IN THE ECONOMY

1. Two Sector Model of Circular Flow of Income (Household and firm)
2. Three Sector Model of Circular Flow of Income (Household sector, Firm and
Government sector)
3. Four Sector Model of Circular Flow of Income (Household sector, Firm, Government
sector and Rest of the world)

1. Two Sector Model (Household and Firms)

The assumptions include:
(a) Government Expenditure does not exist in the economy
(b) Foreign Trade does not exist in the economy
(c) Taxes do not exist in the economy.
(d) Households saving do not exist in the economy

Amritha L J, Faculty of management and commerce, SRM University

 This model defines that households are the owners of factor of productions
(Land, Labour, Capital, and Entrepreneurship) and they provide these factor of
production to producer. Producer offers factor payments (Rent, Wages, Interest
and Profit) for use of these factors of production called as FACTOR FLOW

Producer produces goods and services and rendered these product to consumer in
exchange with Money. When goods are transferred from producer to consumer, it
is known as REAL FLOW.
EQUILIBRIUM IS Total Income=Total Expenditure ( Y=C )

2. Three Sector Model (Household , Firms and government)

This model involves the government intervention in the economy but still it is
based on closed economy. Closed economy means there is no trade in the economy.

Leakages: Taxes (T) reduce the money available for consumption and
investment.
Injections: Government spending (G) and transfer payments increase the money
flow
EQUILIBRIUM ====== Y=C+G
3. Four Sector Model (Household sector, Firm, Government sector and Rest of the
world)

Amritha L J, Faculty of management and commerce, SRM University

 EQUILIBRIUM IS === Y=C+I+G+(X−M)
Foreign Sector: Represents international trade and financial flows through exports
(goods and services sold abroad) and imports (goods and services bought from other
countries).
Leakages: Savings (S), Taxes (T), Imports (M)
Injections: Investment (I), Government Spending (G), Exports (X)

NATIONAL INCOME- Concepts

National income may be defined as the total Sum of factor incomes earned by normal
residents Of a Country during an accounting year.
National income involves two major terms i.e. Factor income and Normal residents of a
country. Factor income refers to the income earned by households from factor of production
(land. labour. capital, entrepreneurship.
Normal resident of a country may be defined as the resident who normally resides in the
country and his -economic interest lies in that country.
 Concepts or Aggregates of National Income
A. Gross Domestic Product
Gross domestic product (GDP) is the monetary value Of total
sum Of all goods and services produced within domestic territory Of a country in an
accounting period
GDP = Market value Of goods and services produced in the country + incomes
earned in the country by foreigners — incomes received by resident
nationals from abroad

B. Gross Domestic Product at Market price (GDP-MY)

Amritha L J, Faculty of management and commerce, SRM University

 The market value of the output of final goods and services produced in the
domestic territory Of a country during an accounting year
Market Price (MP) = Cost of Production or factor cost + Net Indirect Taxes
Net Indirect Taxes = Indirect Taxes – Subsidy
( GDP at market price is calculated on market price Of goods and services which includes the
indirect taxes like sales tax and excise duty. The grants or subsidy received from government
also reduce the market price.)
C. Gross Domestic Product at Factor Cost
GDPFc refers to total value of goods and services produced during an
accounting year at the cost Of production. GDPFc is dependent on gross
domestic product at market price. So» first of all we have to calculate GDP at
market price then indirect taxes are deduced and subsidies are added into
GDP at market price.
GDPrc= GDPup - Indirect Taxes + subsidies
OR
GDPvc= Factor Income (Rent + Compensation + Interest + Profit) +
Depreciation (due to consumption of fixed capital)
GDP at factor cost may be defined as sum total of factor incomes generated in
an accounting year within the domestic territory of a country.
D. Net Domestic Product
Gross domestic product includes depreciation Charges incurred due to
Consumption of fixed capital. When these charges depreciation are deducted
from GDP, it becomes Net Domestic Product or NDP. It is also known as net
output of a country in an accounting year, It can be calculated as follows:
NDP = GDP — Depreciation
E. Nominal and Real Gross Domestic Product
GDP can be calculated On the basis of two type of prices i.e. current price and fixed
price
When GDP is calculated on current price. it is known as nominal GDP and
When GDP is calculated on fixed price in Some year. it is known as real
GDP

Nominal GDP = Quantity of final goods and services produced during an accounting
year x Current prices prevailing during the accounting year
Base Year
Real GDP = GDP for the current year x
Current Year Index

F. Gross National Product

GNP refers to the gross national product which is total value of goods and
services produced by normal residents and non-residents in the domestic
territory Of a country. Net income from Abroad is the major difference
among GDP and GNP
GNP = GDP + Net factor income from abroad

Amritha L J, Faculty of management and commerce, SRM University

 G. Net National Product
Net National Product is the total value of goods and services
produced in the domestic territory of a country in an accounting year after deducting
depreciation
NNP = GNP — Depreciation

H. Domestic Income
Domestic income is the total factor income generated by producing goods and services in
the domestic territory of a country in an accounting year. This income is generated with
the help of own resources of a country. Domestic income includes rent, wages. interest,
dividend, direct taxes and undistributed profits. Domestic income does not include
the income generated from abroad.
I. Private Income
Private may be defined as the income which is generated by private sector from any
source; which may be productive or other, It also includes retained earnings of the
corporations. According to Central Statistical Organisation, private income is total
factor income from all sources and the current transfers from the government and
the rest Of the world accruing to private sector.
Private Income — Income from Net Domestic Product accruing to the Private
Sector +Net Factor Income from Abroad + Net Transfer Payments from the
Government + Net Current Transfer Payments from Rest Of The World + Interest
On National Debt
J. Personal Income
Personal income refers to the total income received by households from all sources
in the form of current transfer payments and factor incomes in an accounting year.
It includes wages, salaries, fees, commission, bonus, dividends and earnings
from self- employment.Other transfer incomes ,pension, social security
benefits, sickness allowances, etc. are also included in personal income. Personal
income can never be equal to national income because personal income includes
transfer payments also
K. Personal Disposable Income
Personal Disposal Income is that part of income which is obtained after
deducting direct taxes, fines and fees to the government from personal
Income. This income can be used by individual for any purpose which may be
saving or consumption.
Personal Disposable Income= personal Income — Personal Taxes
OR
Personal Disposable Income = Consumption + Saving
L. Per capita income
refers to average income of the people of a country in particular year, It can
be also known as measurement of national income at current prices and
constant prices. Per capita income can be computed as follows
National Income
Per capita income —

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 Population
Per capita income indicates the average availability of goods and services per
individual during an accounting year.

MEASUREMENT OF NATIONAL INCOME

Amritha L J, Faculty of management and commerce, SRM University

Amritha L J, Faculty of management and commerce, SRM University
BUSINESS CYCLE /TRADE CYCLE (Same for Unit 1 and 5)

The business cycle refers to the natural fluctuation of economic activity over time, consisting
of periods of expansion (growth) and contraction (recession) in the economy. It is characterized
by changes in key economic indicators such as GDP (Gross Domestic Product), employment,
production, and inflation.
The features of the business cycle are:
1. Cyclic Nature: The economy moves through alternating periods of expansion and
contraction.
2. Fluctuations in GDP: Economic output increases during expansions and decreases
during recessions.
3. Phases: The cycle includes four phases: expansion, peak, contraction (recession), and
trough.
4. Unemployment: Unemployment tends to fall during expansions and rise during
contractions.
5. Inflation: Inflation may rise during expansions and moderate during recessions.
6. Investment Patterns: Business investment tends to increase during expansions and
decline during recessions.
7. Consumer Confidence: Consumer confidence rises during expansions and falls during
recessions.
8. Duration and Irregularity: The length and intensity of each phase can vary.
9. Impact on Employment: Employment levels fluctuate based on economic growth or
contraction.
10. Government and Monetary Response: Governments and central banks often adjust
policies to smooth out business cycle fluctuations.

PHASES OF BUSINESS CYCLE

A. Expansion
Expansion is the first step Of the business Cycle. Economic indicators such as
employments production, output, wages, sales, competition, and the provision of
goods and services are rising at this point. In this stage, debtors pay their debts on
time, pace or money supply is high. and level of investment is also high. This process
continues till there are favourable economic conditions for growth in the economy. Thus,
all the positive conditions in the economy lead to increase in flow of income,
B. Peak
The economy reaches at a saturation point or at peaks which is the second stage of
business cycle. There is maximum growth at this stage in the economy and economic
indicators such as production, profit, sale and employment cannot rise anymore above
this point. Further, price rates are highest but this increase in prices. gradually decreases
the demand for consumer goods. This point is a turning point in the economic growth
cycle and consumers have to restructure their monthly budgets at this level.
C. Recession
Recession is the third stage which follows peak phase. In this phase, demand for goods
and services starts decline rapidly. But, producers do not immediately notice this decline in
demand and production continues which results into excess supply in the market and hence,
prices tend to decline. Consequently, all positive economic indicators like income,

Amritha L J, Faculty of management and commerce, SRM University

 productions wages, savings, investments, etc. starts falling in the economy and this all will
results into recession.

D. Depression
Recession converts Into depression when there is a general decline in all the economic
activities. It means there is reduction In production of goods and services, employment,
income, demand and prices in the economy. This decline in economic activity tends to
decrease in bank deposits and thus, credit expansion stops and consequently, bank rate
also falls in the economy. Thus, a situation of depression captures an economy.
E. Trough
In the stage of depression, growth rate falls below the normal level of growth and it
became negative. Further, it declines until the factor prices, demand and supply of goods
Land services reach at their lowest point. Eventually, the economy reaches to the next
stage i.e. trough. It is the negative saturation point of an economy. At this stage, there is
complete decrease in national income and expenditure. At this stage. it became
difficult for debtors to pay their debts and fate of interest will increase in the economy.
Further, investors will not invest in the stock market and investment level goes down.
During this period, many weak organizations leave the industry and economy reaches at
a lowest level of shrinking.
F. Recovery
The economy comes to the recovery stage after this point. This is a reversal stage from
the recession to recovery and in this process economy Starts to rebound from the
negative rate Of growth. Demand begin to rise because Of the lowest prices and
therefore supply also begins to respond. The economy starts developing with a positive
attitude towards investment and thus, employment and production will also increase.
Employment starts increasing and lending also shows positive signs due to accumulated
cash balances with the banks. In this phase, producers replace the depreciated capital,
leading to new investment in the process of production. The stage of recovery continues
until the economy reaches to expansion stage

Amritha L J, Faculty of management and commerce, SRM University

 THEORIES OF BUSINES CYCLE
1. Monetary Theories
 Quantity Theory of Money (Milton Friedman): Suggests that changes in the money
supply directly influence economic activity. An increase in money supply leads to
higher demand, creating expansions, while a decrease causes recessions.
 Monetary Explanation (Friedrich Hayek, Ludwig von Mises): This Austrian theory
asserts that business cycles are caused by distortions in the market, such as artificially
low interest rates set by central banks, which lead to over-investment, followed by a
correction (recession).
2. Real Theories
 Real Business Cycle (RBC) Theory (Finn E. Kydland, Edward C. Prescott):
Suggests that fluctuations in the economy are mainly due to real shocks such as
technological changes or supply-side disruptions. For example, a sudden improvement
in technology may spur growth, while a decrease in resources can cause a contraction.
 Classical Theory: Focuses on long-term equilibrium, where the economy is assumed
to operate at full employment, with any business cycle fluctuations attributed to changes
in real factors such as labour, capital, and productivity.
3. Keynesian Theories
 Keynesian Theory (John Maynard Keynes): Argues that fluctuations in aggregate
demand (consumer spending, investment, government spending) drive the business
cycle. Recessions occur when there is insufficient demand, leading to higher
unemployment and decreased production.
 Sticky Prices and Wages: According to Keynes, wages and prices do not adjust
quickly to changes in demand, leading to periods of excess supply (recession) or excess
demand (inflation) in the economy.
4. Investment Theories
 Investment Theory of Business Cycles (John Maynard Keynes): This theory focuses
on the role of business investment in the cycle. Changes in business confidence lead to
varying levels of investment, driving the cycle. Increased investment leads to
expansion, while reduced investment causes contraction.
5. Psychological Theories
 Animal Spirits (George Akerlof, Robert Shiller): Suggests that human emotions,
optimism, and pessimism can drive economic cycles. High business and consumer
confidence lead to investment and expansion, while a loss of confidence leads to
recession.
6. Political Theories
 Political Business Cycle Theory: Proposes that politicians may manipulate economic
policies (such as increasing government spending) to create favourable economic
conditions during elections, leading to artificial booms followed by inevitable
downturns once political goals are achieved.
7. Under consumption Theories
 Under consumption Theory (John A. Hobson): Argues that economic recessions
occur because workers' wages are too low to buy the goods they produce, leading to a
reduction in demand and an economic downturn.

Amritha L J, Faculty of management and commerce, SRM University