Macroeconomics

Introduction

Dipankar DeMumbai, October 2007

Narsee Monjee Institute of Management StudiesUniversity

Economic Fundamentals- An Integrated Perspective

Framework

FIRM’S BUSINESS ACTIVITIES

Operating ActivitiesInvestment ActivitiesFinancing Activities

ECONOMIC ENVIRONMENT

OWN BUSINESS STRATEGY

Macro economic scenario

Policy/ Regulatory scenario

Corporate Strategy

Business Strategy

Framework

FIRM’S BUSINESS ACTIVITIES

ECONOMIC ENVIRONMENT

OWN BUSINESS STRATEGY

Macro economic scenario

Policy/ Regulatory scenario

Corporate Strategy

Business Strategy

International & Domestic

National Income Accounts•Real Sector•Monetary Sector•Financial Sector

Macro Aggregates• Inflation• Interest rate• Exchange rate

DiversificationMergers & AcquisitionsInternational strategies

Vertical integrationCost leadershipProduct differentiationTacit collusion

Domestic macro policy• Fiscal Policy• Monetary Policy

Industrial policy

Trade policy

What is Macroeconomics?

Macroeconomics is the study of aggregates

Macroeconomics is concerned with the behaviour of the economy as a whole – with booms & recessions, economy’s total output of goods & services, the growth of output, the rate of inflation & unemployment, the balance of payments, & exchange rates

Macroeconomics deals with the long-run economic growth and with the short-run fluctuations that constitute the business cycles

Macroeconomics is a policy-oriented part of economics. The subject matter of Macroeconomics includes factors that determine both the level of these variables and how the variables change over time.

Focus of Macroeconomics

Macroeconomics focuses on the economic behaviour & policies that affect

– Consumption & investment

– Trade balance (exports – imports)

– Currency & exchange rates

– Determinants of changes in wages & prices

– Money, interest rates & Monetary policy

– Taxation, union budget, Govt. deficit, govt. debt &

Fiscal policy, etc.

Central Issues in Macroeconomics?

1. How do we explain periods of high & persistent unemployment ?

Three central issues addressed by Macroeconomics are:

2. How do we explain periods of inflation ?

3. What determines economic growth ?

Another important issue: Should the govt. fix exchange rates or should exchange rates be market determined ?

Non exhaustive list of macroeconomic research agenda…

Policymakers & health-checkup…

Macroeconomic policymakers focus on improving the health of the economy

Crucial is the ‘thermometer’ readings of their key goals –– High & sustainable rates of economic growth– Low inflation– Low unemployment

Common economic yardsticks to measure these goals are:– Gross Domestic Product (GDP)– Consumer Price Index (CPI) or Wholesale Price Index

(WPI)– Unemployment rate

Economic Database…

Important & relevant websites

– www.rbi.org.in & various publications

– www.mospi.nic.in

– www.eaindustry.nic.in

– Ministry of Finance, Ministry of Commerce

CMIE Monthly, Economic Survey Official website of the World Bank & IMF

– www.worldbank.org

– www.imf.org

The Economist, London

– www.economist.com

Pacific Exchange Rate

Get acquain

ted with the

websites &

their various publicat

ions

Macroeconomic Fluctuations

Introduction to Business Cycles

Business cycle is the more or less regular pattern of

expansion (recovery) and contraction (recession) in

economic activity around the path of trend growth

Trend line provides an estimate of the path of potential

output, which is the productive capacity of the economy.

The potential output is the output that the economy could

produce at full-employment given the existing

resources. It is determined by fixed capital & technology

At cyclical peak, economic activity is high relative to the

trend. At cyclical trough, economic activity reaches the low

point

Business Cycles

During a recession, output declines significantly and during

an expansion, real GDP grows & along with it employment

of factors of production/ resources in the economy

Thus, output is not always at its trend level, rather

fluctuates around the trend level

Business Cycles – 4 Phases

1 = Peak 2 = Recession 3 = Trough 4= Recovery

Business Cycles – 4 Phases Phase I: Prosperity suggests an increase in the level of

economic activity above the normal level till it reaches a ‘peak’

Phase II: Recession suggests a slow but steady decline in

economic activity towards the normal level

Phase III: Depression suggests a further rapid decline in

economic activity below the normal level till it reaches a

‘bottom’

Phase IV: Revival means a slow recovery in economic activity

& business conditions towards the normal level

Phases IV & I together constitute the upswing of a business cycle,

where as Phases II & III together constitute the downswing of a

business cycle

Business Cycles The percentage deviation of actual GDP (or output) and the

potential output is called output gap. It allows to measure the

size of the cyclical deviations of output from potential output.

These fluctuations in economic activity are called Business

cycles

A negative output gap implies under employment of resources and

a positive output gap means there is over-employment, overtime

for workers more than usual rate of utilization of machinery

Business cycles differ in both its length and severity

In popular usage, the economy is usually considered to be in a recession if real GDP declines for two consecutive quarters

Output gap Ξ Actual output – Potential output

Business Implication of Business Cycles

Business implication of an overall economic slowdown is harmful

for any economy

Production and sales decline, impacting profits of the

companies; in extreme scenario may lead to bankruptcy

Business cycles follow irregular patterns & predicting when an

expansion will end & recession will begin is often difficult

Business cycle exhibits simultaneous upswings in output,

employment, sales, and income, followed by similarly general

downswings. It is the co-movement of the variables that

generates the cycle