Introduction of

Macroeconomics
 Definition
Macroeconomics is the study of the behavior of the economy as a
whole. It examines the forces that affect fi rms, consumers, and
workers in the aggregate. It contrasts with microeconomics , which
studies individual prices, quantities, and markets.

Two central theme

• The short-term fluctuations in output, employment, financial
conditions, and prices that we call the business cycle
• The longer-term trends in output and living standards known as
economic growth
KEY CONCEPTS OF MACROECONOMICS
• Why do output and employment sometimes fall, and how
can unemployment be reduced?

• What are the sources of price inflation, and how can it be

kept under control?

• How can a nation increase its rate of economic growth?

OBJECTIVES AND INSTRUMENTS OF
MACROECONOMICS
Objectives
• Output: High level and rapid growth of output
• Employment: High level of employment with low involuntary
unemployment
• Stable prices

Instruments
• Monetary policy: Buying and selling bonds, regulating financial
institutions
• Fiscal policy: Government expenditures Taxation
Measuring Economic Success
Output - The ultimate objective of economic activity is to provide the
goods and services that the population desires. The most
comprehensive measure of the total output in an economy is the gross
domestic product (GDP).

GDP is the measure of the market value of all final goods and
services—beer, cars, rock concerts, donkey rides, and so
on—produced in a country during a year.

There are two ways to measure GDP.

Nominal GDP is measured in actual market prices.
Real GDP is calculated in constant or invariant prices
Measuring Economic Success
• Potential GDP represents the maximum sustainable level of output
that the economy can produce.

• The GDP growth rate can be defined as

Measuring Economic Success
• High Employment, Low Unemployment- Of all the macroeconomic
indicators, employment and unemployment are most directly felt by
individuals. People want to be able to get high-paying jobs without
searching or waiting too long, and they want to have job security
and good benefits. In macroeconomic terms, these are the objectives
of high employment, which is the counterpart of low unemployment.
Measuring Economic Success
• Price Stability - The third macroeconomic objective is price stability.
This is defined as a low and stable inflation rate.

• To track prices, government statisticians construct price indexes, or

measures of the overall price level. An important example is the
consumer price index (CPI), which measures the trend in the
average price of goods and services bought by consumers.

• Economists measure price stability by looking at inflation, or the

rate of inflation.
The Tools of Macroeconomic Policy
• Fiscal Policy - Fiscal policy denotes the use of taxes and government
expenditures. Government expenditures come in two distinct forms.
First there are government purchases. These comprise spending on
goods and services—purchases of tanks, construction of roads,
salaries for judges, and so forth. In addition, there are government
transfer payments, which increase the incomes of targeted groups
such as the elderly or the unemployed.

• The other part of fiscal policy, taxation, affects the overall economy
in two ways. To begin with, taxes affect people’s incomes.

• taxes affect the prices of goods and factors of production and

thereby affect incentives and behavior.
The Tools of Macroeconomic Policy
• Monetary Policy - The second major instrument of macroeconomic
policy is monetary policy, which the government conducts through
managing the nation’s money, credit, and banking system.

• Central Bank does so primarily by setting short-run interest-rate

targets and through buying and selling government securities to
attain those targets. Through its operations influences many
financial and economic variables, such as interest rates, stock prices,
housing prices, and foreign exchange rates. These financial variables
affect spending on investment, particularly in housing, business
investment, consumer durables, and exports and imports.
INTERNATIONAL LINKAGES
• The international economy is an intricate web of trading and
financial connections among countries. When the international
economic system runs smoothly, it contributes to rapid economic
growth; when trading systems break down, production and incomes
suffer throughout the world. Countries therefore consider the
impacts of trade policies and international financial policies on their
domestic objectives of high output, high employment, and price
stability
AGGREGATE
SUPPLY AND
DEMAND
Macroeconomic Equilibrium.
 National Income
• National income (NI): National income sums the total amount earned by
residents of a country for their land, labor, capital, and entrepreneurial talent,
whether within the country or abroad. Hence, national income is sometimes
referred to as factor income, because it equals the income received by residents. i.
e., National income = wages + interest + rent + profits or by subtracting indirect
business taxes from net national product.

• Methods of Calculating National Income

• The national income of a country can be measured by three alternative methods:
• (1) Income Method,
• (2) Expenditure Method and
• (3) Value added Method or Production Method.
 Calculation of National Income
1. Income Method
The income method of calculating national income focuses on the production perspective.
Now production of goods and services involves the use of land, labor, capital, and so on. And
if we consider these factors of production, income is generated via rent, wages and salaries,
profits, and interest.

• We can then calculate the national income by adding all these types of income. Another
important source of income is mixed income. Mixed income refers to the income generated by
self-employed professionals and sole proprietors. (Besides, there are some self-employed
persons who employ their own labour and capital such as doctors, advocates etc. Their
income is called mixed income).
• According to the income method:
• National Income = Rent + Wages + Interest + Profit + Mixed Income
 Calculation of National Income
Expenditure Method

Expenditure method arrives at national income by adding up all expenditures made on goods and services during a year.
Income can be spent either on consumer goods or capital goods. Again, expenditure can be made by private individuals
and households or by government and business enterprises. Further, people of foreign countries spend on the goods and
services which a country exports to them. Similarly, people of a country spend on imports of goods and services from
other countries. We add up the following types of expenditure by households, government and by productive enterprise
to obtain national income.
• The expenditure method takes the following elements into consideration:
∙ Purchase of consumer goods and services by residents and households (C)
∙ Business enterprises’ expenditure on capital goods and stocks (I)
∙ Government expenditure on goods and services (G)
∙ Net exports (exports-imports) (NX)
• Hence, according to the expenditure method:
GDP= C + I + G + (X-M)
= C+I+G+NX
Calculation of National Income
Product method or Value-added Method:

In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final
goods here refer to those goods which are directly consumed and not used in further
production process.
Goods which are further used in production process are called intermediate goods. In the
value of final goods, value of intermediate goods is already included therefore we do not
count value of intermediate goods in national income otherwise there will be double counting
of value of goods.
Suppose the quantity of goods and services produced in a year are X1, X2, X3, X4, X5… Xn and
price of those goods and services are P1, P2, P3, P4, P5… Pn, respectively, then the national
income will be:
GDPMP =P1X1+ P2X2+ P3X3+ P4X4+ P5X5+… +Pn Xn
Difficulties in the measurement of national income

1. Lack of statistical data:

In the less developed countries people keep no record of their income and expenditure consequently
there is lack of accurate statistical data and information, which deprive national income from exact
measurement.

2. The danger of double counting:

While computing the national income, there is always the harmful of double counting. If care is not
taken then the national income will be over-estimated.

3. Lack of trained staff:

In the less develop countries including Pakistan. There is lack of statistician and mathematician. The
information regarding different sectors of the economy is usually collected by the untrained workers.
So, a number of errors take place during the collection of data and information, which deprives
national income from excel measurement.

4. Transfer earning:
Transfer earning should not be included in the estimation of national income, because the payments
made as relief allowance, pension etc. do not contribute towards current in the production. But
sometime they are added in the estimation of national income due to lack of knowledge which again
deprive national income from exact measurement.
 Difficulties in the measurement of national income

• 5. non-marketed services:
In estimating the national income only these services are included for which the payment is made. The
without payment services are excluded from national income, which create a problem in the estimation of
national income.

• 6. Self-consumed production:
In the developing countries a significant part of the output is not exchanged for money in the market. It is
either consumed directly by producers or bartered for other goods. This unorganized or non-monetized sector
makes calculation of national income difficult.

7. Different sectors of the economy are usually mixed with one another.
Similarly sometime people are engaging in different sectors of the economy at the sometime e.g., farmers
during off seasons engage themselves in other sectors like industrial, transport and communication etc., and
consequently exact information regarding their income is not possible.

• 8. Environmental Damage:
No nation prepares account related to the depletion of natural resources in terms of mining minerals, the
erosion of soil, the pollution of air, water, and soil and so on.
The Consumption Function
Consumption function- The consumption function shows the
relationship between the level of consumption expenditures and the
level of disposable personal income. This concept, introduced by
Keynes, is based on the hypothesis that there is a stable empirical
relationship between consumption and income.

* At any point on the 45° line, consumption exactly equals income and
the household has zero saving. When the consumption function lies
above the 45° line, the household is dissaving. When the consumption
function lies below the 45° line, the household has positive saving. The
amount of dissaving or saving is always measured by the vertical
distance between the consumption function and the 45° line.
Consumption Function
Saving function
• The saving function shows the relationship between the level of
saving and income.
The Marginal Propensity to Consume: The marginal propensity to
consume is the extra amount that people consume when they receive
an extra dollar of disposable income.

*The slope of the consumption function, which measures the change

in consumption per dollar change in disposable income, is the
marginal propensity to consume.

The Marginal Propensity to Save: The marginal propensity to save is

defined as the fraction of an extra dollar of disposable income that
goes to extra saving.
Math
Brief Review of Definitions
1. The consumption function relates the level of consumption to the
level of disposable income.
2. The saving function relates saving to disposable income. Because
what is saved equals what is not consumed, saving and consumption
schedules are mirror images.
3. The marginal propensity to consume (MPC) is the amount of extra
consumption generated by an extra dollar of disposable income.
Graphically, it is given by the slope of the consumption function.
4. The marginal propensity to save (MPS) is the extra saving generated
by an extra dollar of disposable income. Graphically, this is the slope
of the saving schedule.
5. Because the part of each dollar of disposable income that is not
consumed is necessarily saved, MPS= 1 - MPC .