23-09-2015

Macroeconomic Theory and Policy

BM 2015-17
P C Padhan
pcpadhan@xlri.ac.in

No area in Economics is today more vital

and controversial than Macroeconomics.

P A Samuelson.
(Nobel Laurate in Economics, 1970)

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Economics:Origin
Economics is the social science that studies Economic Activities

Economy is concerned with the study of

Production
Consumption
of Goods and Services
Exchange
Originated as a Science of Statecraft. Emergence of Political Economy.
517 BC Fan Lin of China
325 BC Chanakyas Arthasastra
1776 : Adam Smith (Father of Economics) Science of
Wealth

Economics:Meaning
Etymologically the word economics comes from a Greek word
oikos and nomos.

Oikos means home

Nomos means Management.
Economics means management of a household
Economy means one who manages a household

Ex Robison Crusoe Economy

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Economy:Variety

Household/society Economy

Robinsons Economy

State Economy

Country (Indian) Economy

Global Economy

Economics:Problems
BasicEconomicProblem
UnlimitedWants
ScarcityofResources
(AlternativeUses)

ProblemofChoice
(Decision)

CentralEconomicProblem
(5W1H)
Productions
AllocationandUtilization
Distribution

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Economics:Problems
Decision Problem of Economic Agents or an Economy

Individual (Robinson Crusoe)

Household

Society

Firms/Industries

Government

Foreign

Economics:SolutiontoDecisionProblems
A.HowPeople(Household/Firms/Govt)MakeDecisions??
Peoplefacetradeoffs:Nofreelunch.EquityVsEfficiency.
Thecostofsomethingiswhatyougiveuptogetit:OpportunityCosts
RationalpeoplethinkattheMargin:MarginalisticPrinciples
Peoplerespondtoincentives.
B.HowPeople(Household/Firms/Govt)Interact??
Tradecanmakeeveryonebetteroff.Comparativeadvantage
Marketsareusuallyagoodwaytoorganizeeconomicactivity:D&S
Governmentscansometimesimproveeconomicoutcomes:
propertyright,
marketfailure:a)externality,b)marketpower
C.HowTheEconomy(Household/Firms/Govt)asaWholeWorks??
Acountrysstandardoflivingdependsonitsabilitytoproducegoodsandservices:
Productivity,ProductionPossibilityCurve
Pricesrisewhenthegovernmentprintstoomuchmoney:Inflation
Societyfacesashortruntradeoffbetweeninflationandunemployment: Business
Cycle

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Economics:Definition
Scarcity Definition: (The Science of Choice)
Thus Economics is the study of how society manages its scarce
resources.
Lionel Robbins (1932) defines,Economics is the science which
studies the human behavior as a relationship between scarce
means which have alternative uses
Since the economy(society) has scarce resources, which have
alternative uses and society has unlimited wants, its essential
to take wiser decision (choice) to maximize the objective
function.
This makes Economics is a science of choice under uncertainty..

Economics:TheScienceofChoice
Humanbeing
(EconomicAgents)

UnlimitedWants
(Max.Objective
Functions)

Individual/House
holds/Society

Satisfaction

Firms/Industry

Profit

Government(All)

HighGrowthrate,
PriceStability,
FullEmployment,
Welfare

ForeignSector

HighExport&
LowImport

ScareResources
CentralEco
DecisionProblem)
(5W1H)

Production
(MinCost)

MakeChoice
(EcoBehavior)
(DecisionProblem)

OpportunityCosts
Marginalistic
Principle

Tradeoff
Allocation
(consumerpref.)
Production
(MB=MC)
PossibilityFrontier
MarketFailure
Distributions
(Exchange)
Comparativeand
(D=S)
absoluteadvantage

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Economics: The Nature

Microeconomics studies the economic behavior of individual
economic agents.
Households
Firms/Industry

Macroeconomics studies the aggregate

activities/behaviour of all the economic agents.

Households
Firms/Industry
Government
Foreign Sector

Closed Economy

economic

Open Economy

Macroeconomics: Structure
Monetary Policy
Business Cycle( Output, Employment and Prices)
Fiscal Policy
Producer
Production
Short Run

Medium
run

Goods

Economy

Q=F(L,N,K.O)

Distribution
(Exchange) Price

Factor Market

Households
Firms
/Industry

Financial or
Money Market

Government

Long-Run

Services

Allocation
(Consumption)

Z=C+I+G+Nx

Foreign
Country

Goods Market
Consumer

Technology

Monetary Policy

Economic Growth and Stability

Percapita productivity

Fiscal Policy

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Macroeconomics:Summary
Macroeconomics studies the Aggregate Economic behavior of all economic agents who
interacts in various markets (Factor, Product and Financial markets) to maximize their
respective objectives with limited resources and unlimited wants over a period of time.

4 Economic Agents:
Individual/Household/Society
Firms/Industry
Government (local / municipal /
state / center)
Foreign Sector
2 Objects
Goods
Services

3 Objectives
Economic Growth
Price Stability
FullEmployment(Lowunemployment)
2 Policy
Monetary Policy
Fiscal Policy

4 Factors of Production

4 Markets
Factor Market (N,L,K,E)
Product Market (goods and services)
Financial Markets (capital)
Foreign Exchange Market

Land,
Labour
Capital
Entrepreneur/organisation

3 Time Period
Short run: Business Cycle
Medium run: Labour market
Long run: sustainable economic growth

References:
Ch1 and 2 of Principles of
Macroeconomics by N G Mankiw, 6th
edition.
Ch1 of Macroeconomics by D N Dwivedi