Macroeconomics

Ganesh Kumar N.

Agenda
Course

administration
Scope of macroeconomics
Overview of recent macroeconomic
news/data/events
Observed facts of economies
Long run, short run, medium run models
Business cycles

Course Evaluation
Component

%age

Quizzes

20

Mid Term

35

End Term

35

Class
Participation

10

Scope of Macroeconomics

Macroeconomics is concerned with economy

as a whole

Booms and recessions

Consumption and investment
Rate of inflation, wages
Interest rates
Unemployment
Exports, Imports, Balance of payments
Budget deficits
Monetary policy and Fiscal policy

India: GDP growth

RBI cuts repo rate 4 times by

125 basis points 2015 and 2
time 50 bps in 2016
Date

Revised rate

15 - January- 2015 (0.25%)

04 - March- 2015 (-0.25)
02 - June- 2015 (-0.25)
28 Sept 2015 (-0.50)
05-April- 2016 (-0.25)

7.75

04-Oct.- 2016 (-0.25)

6.25

7.50
7.25
6.75
6.50

Observed facts about economies

Over long periods of time economy grows at

steady rates Long run behaviour of the
economy
In some periods inflation rates are much higher
1970s; Medium run behaviour of the
economy.
In bad year unemployment rate rises short
run behaviour year to year fluctuations
Macroeconomics help us understand the
reasons for these observed facts

Long run: Growth theory

GDP 80-81 prices

Actual Vs. Potential GDP

1950

In growth theory, we focus on

long term growth ignoring short
term fluctuations booms and
recessions.

1960

1970

1980

1990

Aggregate demand & aggregate

supply

Aggregate supply: amount of output an

economy can produce given resources and
technology
Aggregate demand: Total demand for goods
& services (consumption, investment, govt.
purchases, net exports)

Economy with fixed productive

capacity
Why

in some countries prices are stable

for many years while in some prices
double every month?
In the long run output is determined by
supply side (productive capacity)
Price level is determined by demand
relative to the output economy can
supply.

Economy with fixed productive

capacity
Level of output
P
is determined by
productive
capacity

Price level

AS

AD

Y0

Inflation (price
rise) is generally
due to changes in
AD
Output, Y

AS in the long run

AS

Output (Y)

Price level

Time

Output, Y

Short run

Fluctuations in output around the potential output

Flat AS: Any level of output can be produced at a
given price
Underlying assumption is output does not affect
prices in the short run
Fluctuations in output are due to fluctuations in
AD

Short run

Price level

AS

AD

Y0

Output, Y

Medium run

Positively
sloping AS:

Price level

AS

AD

Y0

When AD
demand pushes
output beyond
sustainable level
as per the long
run model, firms
start raising
prices
Output, Y

Business cycles
Inflation,

growth and output are related

through business cycles
It is a regular pattern of expansion
(recovery) and contraction (recession)
in economic activity around the path of
trend growth

Peak

Recession

Recovery
Trough

A recession is a decline in output that persists for more

than two consecutive quarters in a year.

Duration of Cycles and

Recession in USA
Average of all cycles

No. of months of
recession

1854-1919 (16 cycles)

22

1919-1945 (6 cycles)

18

1945-2001 (10 cycles)

10

Great Depression:
August 1929(III)March 1933(I)

43

Mother of all recessions - Great

depression
Between 1929 and 1933 in USA:
The stock market fell by 85%
GNP fell by nearly 30%
Unemployment rose from 3% to 25%
Consumer price index fell by 25%
Investment collapsed.

Inflation and business cycle

Output gap =actual output potential output

Inflation rates are positively related to output gap
During recession inflation comes down
During boom inflation rate picks up

USA: Rate of Inflation in Consumer Prices,

1960-2002