Introduction To Macroeconomics

The term “macroeconomics” was first introduced by the economist Ragnar Frisch in 1933. Derived from the Greek word “makros,” meaning broad or large, macroeconomics examines the performance and behavior of an economy as a whole. It focuses on aggregate variables such as national income, total employment, overall output, total savings, total consumption, total investment, per capita income, aggregate demand, aggregate supply, general price level, and inflation.

Macroeconomics emerged as a distinct field following the publication of John Maynard Keynes’ seminal work, “The General Theory of Employment, Interest, and Money” in 1936.

K.E. Boulding defines macroeconomics as dealing with aggregates rather than individual quantities: “Macroeconomics deals not with individual quantities but with an aggregate of these quantities, not with individual income but with national income, not with individual prices but with price level, not with individual output but with national output.” P.A. Samuelson describes it as “the study of the behavior of the economy as a whole. It examines the overall level of national output, employment, prices, and foreign trade.”

Scope of Macroeconomics

1. Theory of National Income:

• Macroeconomics examines various concepts of national income, its components, methods of measurement, and the challenges involved in its measurement.

2. Theory of Employment:

• This area addresses issues related to employment and unemployment, analyzing causes, consequences, and types of unemployment. It also explores factors determining the level of employment such as effective demand, aggregate demand, aggregate supply, aggregate consumption, and aggregate investment.

3. Theory of Money:

• This theory studies the demand and supply of money, including the role of financial institutions and the impact on employment.

4. Theory of General Price Level:

• Macroeconomics investigates the determination and changes in the price level, addressing issues of inflation and deflation.

5. Theory of Economic Growth:

• This field examines theories of economic growth, focusing on both developed and developing countries, and includes the study of monetary and fiscal policies.

6. Theory of International Trade:

• Macroeconomics analyzes trade between countries, including theories of international trade, gains and losses from trade, tariffs, and protectionism.

Economic Systems

1. Closed Economy:

• A closed economy does not participate in international trade. It is self-sufficient or underdeveloped. According to P.A. Samuelson and W.D. Nordhaus, “An economy that does not engage in international trade of goods and capital with other countries is a closed economy.”
• Features:
  • No economic relationship with the rest of the world.
  • No imports or exports.
  • No borrowing or lending internationally.
  • Citizens do not work abroad, and foreigners are not allowed to work domestically.
  • GDP equals GNP.
• Types:
  • Two-Sector Economy: Consists only of the household and business sectors, with GDP being the sum of consumption (C) and investment (I): GDP = C + I.
  • Three-Sector Economy: Includes household, business, and government sectors, with GDP being the sum of consumption (C), investment (I), and government expenditure (G): GDP = C + I + G.

2. Open Economy:

• An open economy engages in international trade. It involves exports and imports of goods and services and is also known as a four-sector economy, including the household, business, government, and foreign sectors. Gross National Product (GNP) is the sum of consumption (C), investment (I), government expenditure (G), and net exports (X – M): GNP = C + I + G + (X – M).
• Features:
  • Economic relations with the rest of the world.
  • Trade relations with other countries.
  • Borrowing and lending internationally.
  • Participation in foreign aid.
  • Mobility of labor across borders.
  • GDP and GNP differ.

Macroeconomic Variables

1. Aggregate Demand and Aggregate Supply:

• Aggregate demand represents the total quantity of goods and services demanded at each price level. Aggregate supply represents the total quantity of goods and services firms are willing to produce and sell at each price level.

1. Gross Domestic Product (GDP):

• GDP is the market value of all final goods and services produced within a country in a year, measured in both nominal and real terms.

1. Per Capita Income (PCI):

• PCI is the national income divided by the total population, usually expressed in US dollars: PCI = NI / Total Population.

1. Economic Growth Rate:

• The economic growth rate measures the increase in real GDP over time, reflecting an economy’s productivity.

1. Price Level:

• The average price of goods and services consumed. Inflation denotes a rise in the price level, while deflation denotes a fall.

1. Employment and Unemployment:

• The unemployment rate measures the percentage of the active workforce that is jobless despite willingness to work.

1. Balance of Trade and Balance of Payments:

• The balance of trade is the difference between a country’s imports and exports. The balance of payments records all financial transactions made between a country and the rest of the world.

1. Demand for and Supply of Money:

• The demand for money refers to the desire to hold financial assets in the form of cash or bank deposits. The money supply is the total amount of monetary assets available in an economy.

1. Trade Cycle or Business Cycle:

• The trade cycle describes the regular fluctuations in economic activity, including phases of depression, recovery, prosperity, and recession.

1. Government Budget:
   • The government budget is a financial statement detailing government income and expenditure over a fiscal year.
2. Consumption, Saving, and Investment:
   • Consumption is the portion of national income spent on goods and services. Saving is the portion not spent on consumption, and investment is spending on goods used for further production.

Differences between open and closed economy