Introduction to macroeconomics

U N I T- I INTRODUCTION 1 C HAPTER (cid:1) (cid:9) (cid:9)(cid:10) (cid:2)(cid:3)(cid:4)(cid:5)(cid:6)(cid:7)(cid:8)(cid:3)(cid:1)(cid:5)(cid:2) (cid:3)(cid:5) (cid:11)(cid:8)(cid:4)(cid:5)(cid:12)(cid:8)(cid:5)(cid:2)(cid:5)(cid:10)(cid:1)(cid:8)(cid:13) Economic decisions of individual happening in the economy. Perhaps, it households or firms are guided by their is the concern about the rate of rational behaviour in a given market inflation, level of unemployment, decline situation. Here, in our pursuit to study in the agricultural and industrial the logic of consumption or production output, fluctuations in business decision, we limit our analysis to the activities, accumulation of foreign determinants of choice and preferences exchange reserves, capital market of households or firms, respectively. changes, recession in the world Though the study of individual decision economy and so on. units is a necessary aspect of our These are macroeconomic events enquiry into the rationale of their that engage the attention of govern- economic behaviour, it is by no means ments, economists, entrepreneurs and a sufficient condition for a complete even ordinary people, as all of them study. So, there has to be another level receive the impact of these of study in which the enquiry is macroeconomic events. To understand directed to understand the general the forces behind the overall economic economic conditions in the economy. It performance, we need concepts and is this distinction between the exercises theoretical frameworks and empirical to understand and interpret the measurements to assess performance behaviour of individual units on the one in the given reference year. The subject hand and the general state of the of macroeconomics accomplishes economy on the other establishes the this objective. basic difference between the subject Macroeconomic concepts are not matter of microeconomics and often simple and direct; on the contrary, macroeconomics. in microeconomics concepts such as Now, what is macroeconomics all price, profit, cost, quantity, etc. are about? In simple terms it is the study intuitive and easy to understand. So, of the economy as a whole. Everyone is there is nothing difficult in interested in knowing what is comprehending a basket of apples as + INTRODUCTION TO MACROECONOMICS 3 an output and its price. But in happens in India, to take away a part macroeconomics, we have a variety of of the output to prevent prices falling problems in the stage of definition itself. to an unremunerative level for the While it is relatively easy to define and farmers. Therefore, what is a good and measure individual’s income, it is not proper decision at the individual level so in the case of aggregate income and need not be so at the aggregate level. It output. The scope of macroeconomics is to understand this difference that a could be further made clear if we separate study of economic aggregates attempt to distinguish it from is designed in macroeconomics. microeconomics. Given all the aggregates such as total employment, output, income, etc. Microeconomics and it is essential to find the Macroeconomics interrelationship between them. Does an increase in national output mean an In microeconomics we study the increase in employment? Can the value individual household, individual firm of foreign exchange rate be fixed in or small groupings of firms. If we study terms of domestic country’s prices? We one automobile firm or the automobile will obtain meaningful explanations for industry it is microeconomic approach; the working of the economy only if we but when we take up the entire systematically work out the manufacturing sector, we are in the area interrelationships between the of macroeconomics. In this sense, aggregates. Hence, it is said that macroeconomics studies the macroeconomics is also the study of aggregates of an economic system. We relations between economic aggregates. need to make a separate study of these Basically, macroeconomics is concerned economic aggregates because what is with aggregate level of output, income true at the individual level need not be and spending for all goods and services. true at the aggregate level. In contrast, microeconomics deals Just imagine a case wherein a with output of individual firm and with single farmer produces paddy or wheat. the spending by a single household. In terms of individual rationality, this Microeconomics is primarily concerned farmer has to produce as much output with the allocation of resources by a as possible to reach the maximum level single firm or household. of profit. This is perfectly logical insofar Whatever microeconomics takes as as an individual farm is concerned. But, given is what macroeconomics considers what if all the farmers produce as the prime variable, whose size and maximum output in their respective value are to be determined. farms? For the economy as a whole, this Alternatively, what microeconomics would create more problems than takes as variable is considered to be good. There may be excess supply of given in macroeconomics. For instance, paddy or wheat relative to demand. aggregate output of the economy is Government will have to intervene, as it taken as given in microeconomics but + + + 4 INTRODUCTORY MACROECONOMICS in macroeconomics aggregate output is namely households and firms. an important variable. Similarly, Therefore, micro and macroeconomic macroeconomics takes the distribution analyses are not mutually exclusive of output, for example, as given, but in categories. Each of them attempts to microeconomics it is an important focus its attention on one aspect that variable. the other does not. While it is the price Consider our example of a farmer system and resource allocation that given earlier. An individual farmer is occupies the centre stage in hardly conscious of the aggregate microeconomics, the twin areas of output of paddy or wheat. He is income determination and primarily concerned with his own stabilisation and growth of the output in his farm. Similarly, when economy form the core of government decides its policy of macroeconomics. In such a context, procurement, it considers only the state there is an inevitable interlink between of the aggregate output of paddy or these two major branches of economics. wheat and not that of any individual Which branch of economics farmer. The same thing is true of a assumes primacy and receives single manufacturing firm as against maximum attention of economists the aggregate manufacturing output. depends on whether we need a study Although microeconomics and of the ‘part’ or the ‘whole’. Individual macroeconomics areas seem to be rationality in economic behaviour is an rigidly distinct, it is not always so in important area of study insofar as we practice. Both areas of economic are concerned with demand and supply analysis are interdependent. We seek to forces in the market. On the other hand, explain economic behaviour of in the formulation of policies for individual units in the context of the arresting fluctuations in the economy’s state of the economy. performance and for attaining higher That is, a microeconomic decision growth, macro analysis assumes its by an individual unit has to necessarily importance. have a macroeconomic context. The Emergence of Macroeconomics consumption plans of households for instance cannot be independent of the Interest in macroeconomics deepened taxation of personal income and after the emergence of the ‘Keynesian commodities. Similarly, microeconomic Revolution’.1 In the pre-Keynesian variables may exert their influence on economic theory there was no macroeconomic variables. For instance, recognition of ‘economic crises’. This is aggregate savings and investment are because the Classical economics, which usually influenced by or a function of was the ruling doctrine then, did not the pattern of savings at the micro level, provide an explanation for a major 1 John Maynard Keynes published the book General Theory of Employment, Interest and Money (Macmillan: London, 1936) in which he questioned the basis of the then existing macroeconomics of the Classical School. + + + + INTRODUCTION TO MACROECONOMICS 5 setback to the economy. Classical the way for Keynesian theory. This is the economists strongly believed in the starting point of the present day ‘automatic adjustment’ of the markets macroeconomic approach, which is so that the system will always be in applied extensively in policy-making. equilibrium, and that the ‘shocks’ (that There are many variants of Keynesian is, disturbances in markets) are only approach as the subject of temporary. This contention of the macroeconomics evolved since Keynes’ Classical economists was challenged contribution. when the Great Depression occurred in We may now embark upon learning 1929. The system failed to automatically macroeconomics, concentrating on the correct the crisis situation and therefore Keynesian approach to the structure the failure of the Classical doctrine paved and working of the macro economy. EXERCISES 1. What is microeconomics? 2. What do you understand by macroeconomics? 3. Distinguish between micro and macroeconomics. 4. Give examples of macroeconomic variables. + +