P1 Basic Issues.pdf MACRO SEM - 2 UNIT 1

Unit 1: Introduction to Macroeconomics
and National Income Accounting
▪ Basic issues studied in macroeconomics;
▪ Measurements of gross domestic product,
income,expenditure, and the circular flow;
▪ real versus nominal GDP;
▪ Price indices;
▪ National incomeaccounting for open economy,
balance of payments accounts, current and
capital accounts.
Time : 10 hours
Readings:
1. Abel, Bernanke and Croushore: Chapter 1 (Sections 1.1
and 1.3), Chapter 2 and 5 (up to Section 5.1 - pp. 165-
176).
2. Instead of Table 5.1 in book use latest Economic Survey
2022-23, Table 5.2 (p. 92-95)

P1: Basic issues studied in
macroeconomics

How do we study Economics?
1. Economics can be divided into the subfields of microeconomics and
macroeconomics:
A. Microeconomics is the study of how households and firms make choices, how
they interact in markets, and how the government attempts to influence their
choices through taxation and subsidies.
B. Macroeconomics is the study of the economy as a whole, including topics
such as inflation, unemployment, and economic growth.

What Macroeconomics is About
✓Macroeconomics is the study of the structure and performance of national
economies and of the policies that governments use to try to affect economic
performance.

Thus, macroeconomics is the study of :
1. The entire economy and not just a single market.
2. Problems that require political solutions at a national level.
3. In this we study long-run trends of economic growth as well as the short-
run stories of cycle-like fluctuations.

Important issues Addressed by Macroeconomists
✓What determines a nation’s long-run economic growth?
✓What causes a nation’s economic activity to fluctuate?
✓What causes unemployment?

Macroeconomists also study
✓What causes prices to rise?
✓How does being a part of a global economic system affect nations’ economies?
✓Can government policies be used to improve economic performance?

Thus, macroeconomics addresses many topical issues
1. Why does the cost of living keep rising?
2. Why are millions of people unemployed, even when the economy is booming?
3. What causes recessions?
4. Can the government do anything to combat recessions? Should it?
5. What is the govt budget deficit? How does it affect the economy?
6. Why do some countries have large trade deficits?
7. Why are some countries so poor?
8. What policies may help them grow out of poverty?

Scope and Importance of Macroeconomics
✓Macroeconomics is of much theoretical and practical importance
✓As we know, underdeveloped economies in particular, are confronted with many
national problems
✓It helps us in understanding the working of economy (behaviour of Total Income,
output, employment & general price level – problems of the economy)
✓Useful in economic policies (helps to understand the regulation and control of
economic policies).

Why learn Macroeconomics?
The macroeconomy affects society’s and individual wellbeing:
Source: Bluestone and Bennett Harrison (The Deindustrialisation
of America)

Macroeconomic Policy
There are usually four main policy objectives of macroeconomic policy:
1. A stable and strong rate of economic growth
2. Low unemployment
3. Stable and low inflation
4. A manageable balance in overseas trade and finance.

Difference between Micro and Macroeconomics
There is a division between microeconomics and macroeconomics, but
they are connected too because the parts affect the whole and the whole
affects the parts.
They differ with respect to:
✓Definition
✓Objectives
✓Basis
✓Assumptions

Difference between Microeconomics and
Macroeconomics

Long-Run Economic Growth
✓There is a definite difference in the average living standards of the people
living in developing countries like Bangladesh relative to those of countries
such as the United States.
✓The problems of inadequate food, shelter, and healthcare experienced by the
poorest citizens of rich nations often represent the average situation for the
people of a developing country.
✓Economic growth refers to the ability of an economy to produce increasing
quantities of goods and services, that is, the expansion of society’s productive
potential.

Why is the difference in economic growth?
✓From a macroeconomic perspective, the difference between rich nations and
developing nations may be summarized by saying that rich nations have at
some point in their history experienced extended periods of rapid economic
growth.
✓But that the poorer nations either have never experienced sustained growth
or have had periods of growth offset by periods of economic decline.

Economic growth and living standards
✓Standard of living = degree to which people have access to goods and services
that make their lives easier
✓Scarcity principle = having more of one good thing means having less of
another (always applies)
✓The current standard of living in the US, Western Europe and Australia is the
result of several centuries of sustained economic growth (steady increase in
the quantity and quality of the goods and service)

The more we can produce, the more we can consume
✓Growth in output over the last century due to rapid growth of the Australian
population, and hence the number of workers available
✓Because of population growth, increases in total output can't be equated with
improvements in standard of living.
✓Although more goods and services are available, the increased population means
more people are sharing those goods and services

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-19
What Macroeconomics Is About
• Macroeconomics: the study of structure and performance of national economies
and government policies that affect economic performance
• Issues addressed by macroeconomists:
– Long-run economic growth
– Business cycles
– Unemployment
– Inflation
– The international economy
– Macroeconomic policy
• Aggregation: from microeconomics to macroeconomics

• Long-run economic growth
– Figure 1.1: Output of United States since 1869

Sources: Federal spending
and receipts for 1869–1929
from Historical Statistics of the
United States, Colonial Times to
1970, p. 1104; GNP 1869–1928
from Christina D. Romer,
“The Prewar Business Cycle
Reconsidered: New Estimates
of Gross National Product,
1869–1908,” Journal of Political
Economy, 97, 1 (February 1989),
pp. 22–23; GNP for 1929
from FRED database, Federal
Reserve Bank of St. Louis,
Research.stlouisfed.org/fred2/
series/GDPA; Federal spending
and receipts as percentage
of output, 1930–2011 from
Historical Tables, Budget of the
U.S. Government, Table 1.2
Figure 1.1 Output of the U.S. economy,
1869-2011

• Long-run economic growth
– Figure 1.1: Output of United States since 1869
– Note decline in output in recessions; increase in output in some
wars
– Two main sources of growth
• Population growth
• Increases in average labor productivity

• Average labor productivity
– Output produced per unit of labor input
– Figure 1.2 shows average labor productivity for United States
since 1900

Sources: Employment in thousands
of workers 14 and older for 1900–
1947 from Historical Statistics of the
1970, pp. 126–127; workers 16 and
older for 1948 onward from FRED
database, Federal Reserve Bank of
St. Louis,
research.stlouisfed.org/fred2/series/
CE16OV. Average labor productivity
is output divided by employment,
where output is from Fig. 1.1.
Figure 1.2 Average labor productivity in the
United States, 1900-2011

• Average labor productivity growth:
– About 2.5% per year from 1949 to 1973
– 1.1% per year from 1973 to 1995
– 1.7% per year from 1995 to 2011

• Business cycles
– Business cycle: Short-run contractions and expansions in
economic activity
– Downward phase is called a recession

• Unemployment
– Unemployment: the number of people who are available for work
and actively seeking work but cannot find jobs
– U.S. experience shown in Fig. 1.3
– Recessions cause unemployment rate to rise

Sources: Civilian unemployment
rate (people aged 14 and older until
1947, aged 16 and older after 1947)
for 1890–1947 from Historical
Statistics of the United States,
Colonial Times to 1970, p. 135; for
1948 onward from FRED database
Federal Reserve Bank of St. Louis,
research.stlouisfed.org/fred2/series/
UNRATE.
Figure 1.3 The U.S. unemployment rate,
1890-2011

• Inflation
– U.S. experience shown in Fig. 1.4

Sources: Consumer price index, 1800–1946 (1967 = 100) from Historical Statistics of the United
States, Colonial Times to 1970, pp. 210–211; 1947 onward (1982–1984 = 100) from FRED
database, Federal Reserve Bank of St. Louis, research.stlouisfed.org/fred2/series/CPIAUCSL. Data
prior to 1971 were rescaled to a base with 1982–1984 = 100.
Figure 1.4 Consumer prices in the United
States, 1800-2011

• Inflation
– Deflation: when prices of most goods and services decline
– Inflation rate: the percentage increase in the level of prices
– Hyperinflation: an extremely high rate of inflation

• The international economy
– Open vs. closed economies
• Open economy: an economy that has extensive trading and financial
relationships with other national economies
• Closed economy: an economy that does not interact economically with the
rest of the world
– Trade imbalances
• U.S. experience shown in Fig. 1.5
• Trade surplus: exports exceed imports
• Trade deficit: imports exceed exports

Sources: Imports and exports of goods
and services: 1869–1959 from
Historical Statistics of the United
States, Colonial Times to 1970, pp.
864–865; 1960 onward from FRED
database, Federal Reserve Bank of St.
Louis,
research.stlouisfed.org/fred2/series/BO
PX and BOPM; nominal output: 1869–
1928 from Christina D. Romer, “The
Prewar Business Cycle Reconsidered:
New Estimates of Gross National
Product, 1869–1908,” Journal of
Political Economy, 97, 1 (February
1989), pp. 22–23; 1929 onward from
FRED database, series GDPA.
Figure 1.5 U.S. exports and imports, 1869-
2011

• Macroeconomic Policy
– Fiscal policy: government spending and taxation
• Effects of changes in federal budget
• U.S. experience in Fig. 1.6
• Relation to trade deficit?
– Monetary policy: growth of money supply; determined by central
bank; the Fed in U.S.

Sources: Federal spending and
receipts for 1869–1929 from
Historical Statistics of the
1970, p. 1104; GNP 1869–1928
from Christina D. Romer, “The
Prewar Business Cycle
Reconsidered: New Estimates of
Gross National Product, 1869–
1908,” Journal of Political
Economy, 97, 1 (February
1989), pp. 22–23; GNP for
1929 from FRED database,
Federal Reserve Bank of St.
Louis,
Research.stlouisfed.org/fred2/s
eries/GDPA; Federal spending
and receipts as percentage of
output, 1930–2011 from
Historical Tables, Budget of the
U.S. Government, Table 1.2.
Figure 1.6 U.S. Federal government spending
and tax collections, 1869-2011

• Aggregation
– Aggregation: summing individual economic variables to obtain
economywide totals
– Distinguishes microeconomics (disaggregated) from
macroeconomics (aggregated)

What Macroeconomists Do
• Macroeconomic forecasting
– Relatively few economists make forecasts
– Forecasting is very difficult
• Macroeconomic analysis
– Private and public sector economists—analyze current conditions
– Does having many economists ensure good macroeconomic
policies? No, since politicians, not economists, make major
decisions

• Macroeconomic research
– Goal: to make general statements about how the economy works
– Theoretical and empirical research are necessary for forecasting and economic
analysis
– Economic theory: a set of ideas about the economy, organized in a logical
framework
– Economic model: a simplified description of some aspect of the economy
– Usefulness of economic theory or models depends on reasonableness of
assumptions, possibility of being applied to real problems, empirically testable
implications, theoretical results consistent with real-world data

• In Touch with Data and Research: Developing and Testing
an Economic Theory
– Step 1: State the research question
– Step 2: Make provisional assumptions
– Step 3: Work out the implications of the theory
– Step 4: Conduct an empirical analysis to compare the implications
of the theory with the data
– Step 5: Evaluate the results of your comparisons

• Data development—very important for making data more
useful

Why Macroeconomists Disagree
• Positive vs. normative analysis
– Positive analysis: examines the economic consequences of a policy
– Normative analysis: determines whether a policy should be used

• Classicals vs. Keynesians
– The classical approach
• The economy works well on its own
• The “invisible hand”: the idea that if there are free markets and individuals
conduct their economic affairs in their own best interests, the overall
economy will work well
• Wages and prices adjust rapidly to get to equilibrium
– Equilibrium: a situation in which the quantities demanded and supplied are equal
– Changes in wages and prices are signals that coordinate people’s actions
• Result: Government should have only a limited role in the economy

– The Keynesian approach
• The Great Depression: Classical theory failed because high unemployment
was persistent
• Keynes: Persistent unemployment occurs because wages and prices adjust
slowly, so markets remain out of equilibrium for long periods
• Conclusion: Government should intervene to restore full employment

– The evolution of the classical-Keynesian debate
• Keynesians dominated from WWII to 1970
• Stagflation led to a classical comeback in the 1970s
• Last 30 years: excellent research with both approaches

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