Macroeconomics Lecture 1

Narsee Monjee Institute of Management Studies University

Macroeconomics Introduction

Dipankar De Mumbai, October 2007

Economic Fundamentals - An Integrated Perspective

Framework Macro economic scenario

ECONOMIC ENVIRONMENT

FIRM’S BUSINESS ACTIVITIES

Policy/ Regulatory scenario

Operating Activities Investment Activities Financing Activities

OWN BUSINESS STRATEGY Corporate Strategy

Business Strategy

Framework Macro economic scenario National Income Accounts •Real Sector •Monetary Sector •Financial Sector Macro Aggregates • Inflation • Interest rate • Exchange rate

ECONOMIC ENVIRONMENT

Policy/ Regulatory scenario Domestic macro policy • Fiscal Policy • Monetary Policy

FIRM’S BUSINESS ACTIVITIES

Industrial policy Trade policy

OWN BUSINESS STRATEGY Corporate Strategy

Business Strategy

Diversification Mergers & Acquisitions International strategies

Vertical integration Cost leadership Product differentiation Tacit collusion

International & Domestic

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?  Three central issues addressed by Macroeconomics are: 1. How do we explain periods of high & persistent

unemployment ? 1. How do we explain periods of inflation ?

1. 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

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The Economist, London – www.economist.com

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Pacific Exchange Rate

Get acquain ted with the website s& 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

Business Cycles – 4 Phases

1 = Peak 3 = Trough

2 = Recession 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

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Phase III: Depression suggests a further rapid decline in economic activity below the normal level till it reaches a ‘bottom’

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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. Output gap Ξ Actual output – Potential output

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These fluctuations in economic activity are called Business cycles

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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

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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

Business Implication of Business Cycles 

Business implication of an overall economic slowdown is harmful for any economy

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Production and sales decline, impacting profits of the companies; in extreme scenario may lead to bankruptcy

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Business cycles follow irregular patterns & predicting when an expansion will end & recession will begin is often difficult

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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