UNIT-1
Introduction to Macro Economics
Meaning:
The terms Macro is derived from the Greek terms ‘Makros’ meaning large. Macro economics studies the behaviour of the economy as whole. Thus Macro economics study of aggregates covering the whole economy such as national income, employment, aggregates Demand and Supply, Total investment & General Price level.
Definition:
1) According to Boulding, “Marco economics deals not with individual quantity but with aggregate if these quantities not with individual incomes bit with national income not with individual prices but with price levels, not with individual outputs but with the national output.”
2) Gardener Ackley, “It looks at the total size and shape and functioning of the elephant if economic experiences, rather the working or articulation or dimensions if the individual parts. It studies the character of the forest, independent of the trees which compose it”.
3) According Prof.Marshall, “Macro economics views the forest as a whole independent of the individual trees composing it.”
1) Study of aggregates: Macro economics is a study of the aggregates. It is also known as aggregates economics. It studies the economics system as a whole covering all condition of the economy such as total production, total consumption, total saving and total investment. In the words of Prof. McConnell, “Macro economics examines the forest, not the tree.”
2) Lumping method: Macro economics deals with macro quantities and macro variable. Unlike macro economics, it does not split up the economy into small slice but studies in big lumps. Therefore it is called the method of lumping.
3) General Equilibrium: Macroeconomic is based on general equilibrium. Whole economy is called general equilibrium. The technique of general equilibrium is applied to study the determination of the general price level, total employment and output.
4) Vision: It gives the overall view of the whole economy i.e.it give a bird’s eye view of the whole economy.
5) Interdependence: Macro analysis stresses inter relationship between the different Market and sectors in the economy. According to general equilibrium analysis, a change in any one market or sector will have its impact on the other markets or sectors of the economy.
6) Income theory: Macroeconomics is known as income theory. It studies the factors determining national income and employment and the causes of fluctuations in income and employment. According to Edward Shapiro, the major task of Macro economics is the explanation of what determines the economy’s income.
7) Policy-oriented: Macro economics, according to Keynes’ is a policy-oriented science. Macro-economic analysis helps in formulating suitable economic policies to promote economic growth, to generate employment, to control inflation, to pull the economy out of depression etc.
Key Points:-Aggregate, Lumping method, General Equilibrium, Vision, Interdependence, Policy Oriented. |
Scope and Subject Matter of Macro Economics:-
1) Theory of Income and Employment: Macro Economic analysis explains what determines the level of national income and employment and what causes the fluctuations in the level of national income for a long period of time. So Macro economics is known as “Income Theory”. He showed how the equilibrium level of national income and employment was determined by the aggregate demand and aggregate supply. Aggregate demand constitutes consumption demand and investment demand. Both consumption function and investment functions interact to determine income, employment interest and general price level.
2) Theory of General Price– Level and inflation: Macro economics also explain show the general prices level is determined .Keynes has explained that it is total ways that increase in supply of money that brings rise in price. But also explained that just as unemployment and depression were caused due to deficiency of aggregate demand, inflation was due to excessive aggregate demand. The problem of fluctuation is a serious problem faced these days, both by the developed and under developed countries of the world. Theory of price level, studies cause and effect to inflation and depression and suggests policies to tackle these problems.
3) Theory of Economic Growth and Development: The problem of growth is a long run problem. It was Harrod and Domar who extended the Keynesian analysis to the long-run problem of growth with stability. If growth with stability is to be achieved, income or demand must be increase at a rate sufficient enough to ensure full utilization of increase capacity. General growth theory applies to both the developed and under developed economies. Special theories have been developed, which explain the causes of under-development and poverty in under developed countries and also suggests strategies for initiating and accelerating grow thin them.
4) Macro Theory of Distribution: The Macro economic theory also explains the factors determining the relative shares of various social classes, workers and capitalist in the form of total rent, total wages, income, total interest and total profit in the total national income.
Key Points:-Income & Employment, Inflation, Growth and development, Distribution of National Income. |
Importance of Macroeconomics:-
1) Function of the Economic: The study of individual items will not help in understanding the working of an economic system. Only an aggregative approach can make it possible to understand the functioning of complex system.
2) Formulation of Economic policies: Study of macroeconomic is an essential requirement for farming economic policies. Modern government depends upon reliable statistics of aggregate variable as the basis for the formulation of government policies. For e.g.–The data collected on national income, general price level, wage rate ,saving, investment, interest rate is very useful in farming sound economic policies.
3) Dynamic science: Macroeconomics studies and suggests solution to the issue and problems from the dynamic view point. It gives importance to the changes in the economy.
4) Understanding of National income: Macroeconomics studies the computation, use and application of National income data. The national income data enable us to understand & evaluate the performance of economy.
5) International comparison: Macro economics facilitates international comparison by providing information about aggregate demand, national income, consumption and saving for different countries.
6) For understanding Micro-theory: Since Macro economics deals with the group behaviour its study is important in understanding the behaviour of individual units.
Key Points:-Functioning, Formulation of economy, Dynamic, National Income |
There are however, certain limitations of macroeconomic analysis. Mostly, these stem from attempts to yield macroeconomic generalisations from individual experiences.
(1)Fallacy of Composition:
In Macroeconomic analysis the “fallacy of composition” is involved, i.e., aggregate economic behaviour is that the sum of individual activities. But what's true of people isn't necessarily true of the economy as an entire.
For instance, savings are a personal virtue but a public vice. If total savings within the economy increase, they’ll initiate depression unless they're invested. Again, if a personal depositor withdraws his money from the bank there's no danger. But if all depositors do that simultaneously, there’ll be a run on the banks and therefore the banking industry are adversely affected.
(2)To take the Aggregates as Homogeneous:
The main defect in macro analysis is that it regards the aggregates as homogeneous without caring about their internal composition and structure. The average wage in an exceedingly country is that the sum of wages altogether occupations i.e., wages of clerks, typists, teachers, nurses, etc.
But the amount of aggregate employment depends on the relative structure of wages instead of on the typical wage. If, as an example, wages of nurses increase but of typists fall, the typical may remain unchanged. But if the utilization of nurses falls a touch and of typists raises much, aggregate employment would increase.
(3)Aggregate Variables might not be Important Necessarily:
The aggregate variables which form the financial system might not be of much significance. As an example, the value of a country is that the total of all individual incomes. An increase in value doesn't mean that individual incomes have risen.
The increase in value could be the results of the rise with in the incomes of some rich people within the country. Thus an increase within the national income of this kind has little significance from the purpose of view of the community.
Prof. Boulding calls these three difficulties as macroeconomic paradoxes which are true when applied to one individual but which are untrue when applied to the economic system as an entire.
(4)Indiscriminate Use of Macro economics misleading:
An indiscriminate and uncritical use of macro economics in analysing the issues of the important world can often be misleading. As an example, if the policy measures needed to realize and maintain full employment within the economy are applied to structural unemployment in individual firms and industries, they become irrelevant. Similarly, measures aimed toward controlling general prices cannot be applied with much advantage for controlling prices of individual products.
(5)Statistical and Conceptual Difficulties:
The measurement of macroeconomic concepts involves variety of statistical and conceptual difficulties. These problems related the aggregation of microeconomic variables. If individual units are almost similar, aggregation doesn't present much difficulty. But if micro economic variables related are similar individual units, their aggregation into one macroeconomic variable could also be wrong and dangerous.
Microeconomics and macroeconomics—the two major divisions of economics—have different objectives to be pursued.
The key microeconomic goals are the efficient use of resources that are employed and therefore the efficient distribution of output.
These two goals of microeconomics are encapsulated as ‘efficiency’ and ‘equity’.
But macroeconomic goals are quite different because the general response of the economy must not match with the individual units. As macroeconomics looks at the overall economy, its objectives are aggregative in character. In other words, due to different level of aggregation, these two branches of economics focus on different economic objectives.
1. Macroeconomic Policy Objectives:
The macroeconomic policy objectives are the following:
(i) Full employment,
(ii) Price stability,
(iii) Economic growth,
(iv) Balance of payment equilibrium and rate of exchange stability, and
(v) Social objectives.
(i) Full employment:
Performance of any government is judged in terms of goals of achieving full employment and price stability. These two could also be called the key indicators of health of an economy. In other words, modern governments aim at reducing both unemployment and inflation rates.
Unemployment refers to involuntary idleness of mainly labour force and other productive resources. Unemployment (of labour) is closely associated with the economy’s aggregate output. Higher the unemployment rate, greater the divergence between actual aggregate output (and GNP/CDP) and potential output. So, one among the objectives of macroeconomic policy is to make sure full employment.
The objective of full employment became uppermost amongst the policymakers in the era of Great Depression when unemployment rate in all the countries except the then socialist country, the USSR, rose to a great height. It should be noted here that a free enterprise capitalist economy always exhibits full employment.
But, Keynes said that the goal of full employment could also be a desirable one but impossible to attain. Full employment, thus, doesn't mean that no-one is unemployed. Even if 4 or 5 p.c. Of the entire population remain unemployed, the country is claimed to be fully employed. Full employment, though theoretically conceivable, is difficult to achieve in a market-driven economy. In view of this, full employment objective is usually translated into ‘high employment’ objective. This goal is desirable indeed, but ‘how high’ should it be? One author has given a solution in the following way; “The goal for high employment should therefore be to not seek an unemployment level of zero, but rather A level of above zero according to full employment at which the demand for labour equals the availability of labour. This level is named the natural rate of unemployment.”
(ii) Price stability:
No longer is the attainment of full employment taken into account as a macroeconomic goal. The emphasis has shifted to price stability. By price stability we must not mean an unchanging price level over time. Not necessarily, increase is unwelcome, particularly if it's restricted within an affordable limit. In other words, price fluctuations of a higher degree are always unwelcome.
However, it's difficult again to define the permissible or reasonable rate of inflation. But sustained increase in price level also as a falling price level produce destabilising effects on the economy. Therefore, one among the objectives of macroeconomic policy is to ensure (relative) price level stability. This goal prevents not only economic fluctuations but also helps within the attainment of a steady growth of an economy.
(iii) Economic growth:
Economic growth during a market economy isn't steady. These economies experience ups and downs in their performance. This objective became uppermost in the period following the World War II (1939-45). Economists call such ups and downs within the economic performance as trade cycle/business cycle. Within the short run such fluctuations may exhibit depressions or prosperity (boom).
One of the important benchmarks to calculate the performance of an economy is the rate of increase in output over a period of time. There are three major’ sources of economic growth, viz. (i) the growth of the labour force, (ii) capital formation, and (iii) technological progress. a country seeks to attain higher economic growth over a long period so that the standards of living or the quality of life of people, on a mean , improve. It should be noted here that while talking about higher economic growth, we take into account general, social and environmental factors so the wants of people of both present generations and future generations is met.
However, promotion of higher economic growth is usually hampered by short run fluctuations in aggregate output. In other words, one finds a conflict between the objectives of economic growth and economic stability (in prices). In view of this conflict, it's said that macroeconomic policy should promote economic growth with reasonable price stability.
(iv) Balance of payments equilibrium and rate of exchange stability:
From a macro- economic point of view, one can show that a global transaction differs from domestic transaction in terms of (foreign) currency exchange. Over a period of time, all countries aim at balanced flow of products, services and assets into and out of the country. Whenever this happens, total international monetary reserves are viewed as stable.
If a country’s exports exceed imports, it then experiences a balance of payments surplus or accumulation of reserves, like gold and foreign currency. When the country loses reserves, it experiences balance of payments deficit (or imports exceed exports). However, depletion of reserves reflects the unhealthy performance of an economy and thus creates various problems. That’s why every country aims at building substantial volume of exchange reserves.
Anyway, the accumulation of exchange reserves is essentially conditioned by the rate of exchange the rate at which one currency is exchanged for another currency to carry out international transactions. The exchange rate should be stable as far as possible. This is often what one may call it external stability in price.
External instability in prices hampers the smooth flow of products and services between nations. It also erodes the confidence of currency. However, maintenance of external stability is no longer considered because the macroeconomic policy objective also as macroeconomic policy instrument.
It is, however, due to growing inter- connectedness and interdependence between different nations within the globalised world, the task of fulfilling this macroeconomic policy objective has become more problematic.
(v) Social objectives:
The list of objectives that we've referred here is by no means an exhaustive one; one can add more within the list. Even then we've incorporated the major ones.
Macroeconomic policy is additionally used to attain some social ends or social welfare. This suggests that income distribution must be fairer and more equitable. In a capitalist market-based society some people get more than others. So as to make sure social justice, policymakers use macroeconomic policy instruments.
REFERENCES
1. Www.wikipedia.org
2. Www.economicsdiscussion.net
3. Macro economics - manan prakashan