Segment: Macroeonomics

Topic: Basic Concepts of Macroeconomics

Basic Concepts of Macroeconomics

Table of Contents

1. Basic Concepts ......................................................................................................................... 5

2. Summary .................................................................................................................................. 9
3. Glossary .................................................................................................................................... 9

2
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

Introduction

In the previous topic, we studied about pricing under imperfect competition. We learnt about
how prices are determined in markets with varying structures. The structure of a market is
influenced by the environment in which it operates. In this topic, we will learn the basic
concepts of macroeconomics.

Macroeconomics is that branch of economics, which deals with the study of aggregative or
average behavior of the entire economy. In macroeconomics, we study the collective
functioning of the whole economy. It deals with the gross aggregates of the economic system
rather than with individual parts of it. It is the study of the entire forest rather than the study
of individual trees. Hence, it is called as “Aggregative Economics.” It splits up the economy into
big lumps for the purpose of convenience of the study and therefore, it is called as “Lumping
Method”. It gives a detailed description about the performance and achievements of different
sectors of the economy like agriculture, industry, export and import, etc. As part of
macroeconomics, we also study how the entire economy reaches the position of equilibrium.
Hence, it is called as “General Equilibrium Analysis”. It explains how the equilibrium level of
national income is determined in an economy and so it is called as “Income Theory”. The scope
of macroeconomics covers the following topics:

• The theory of income and employment with consumption function, saving and investment
function and trade cycles.
• The general theory of price level, which includes inflation and deflation.
• The theory of economic growth, development and planning.
• The theory of macroeconomic distribution, which includes the study of relative shares of
rent, wages, interest and profits in the national income of a country.

In general, as part of macroeconomics, we study aggregate demand, aggregate supply,

aggregate saving and investment, aggregate income and expenditure, unemployment, poverty
problems, etc.

Managerial economics is a part of microeconomics. It is to be noted that a business unit carries

on its business operations in the midst of the society and not in isolation. It has to meet the

3
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

requirements of the members of the society. Hence, knowledge about the macroeconomic
environment is very essential. Macroeconomic concepts, principles, and policies greatly
influence the decision making process of a firm. Changes in the level of incomes of the people,
their purchasing power, consumption habits, general price level, business fluctuations are all
factors that influence the decision making process. Further, government economic policies like
monetary, fiscal, financial, physical, industrial, labour, import and export, foreign capital and
investment, etc would certainly affect the decision-making and forward planning of the firm.
Therefore, macroeconomic background provides a solid basis for the working of a micro unit.

Case Let (Continued from previous topic)

In the previous topic, we saw that Ramesh was asked to explore pricing where firms had market power.
He saw that the traverse rods industry was oligopolistic in nature with a few firms garnering most of the
market share. He was surprised to learn that most buyers of traverse rods were unaware of all the
products, their prices and sellers in the market. He realised that firms were able to identify niche
markets and sell their produce. However, some industry experts mentioned to him that although the
sales of traverse rods was highly influenced by factors such as consumer incomes and construction
activities, those factors themselves were influenced by general economic conditions. He also learnt that
house construction activities and wages were determined by factors such as the investment rates and
consumption rates prevailing in the economy. Ramesh could not understand how overall economic
conditions such as, interest rate regimes influenced demand for the traverse rods that were sold by his
firm. He discussed the same with his superior who encouraged him to recollect macroeconomic
concepts which he had learnt in college.

Learning Objectives

At the end of this topic, you will be able to:

• categorise the concepts of macroeconomics to their impact on business activities
• analyse basic macroeconomic concepts and the mechanisms to manage them.

4
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

1. Basic Concepts
1. Variables
A variable is a symbol or quantity which during a specified time period under consideration,
may assume different values or a set of admissible values. Macroeconomic variables deal with
aggregates like gross national product, national income, consumption function, saving
function, investment function, general price level, total money supply and general level of
employment or unemployment in the country, etc. These variables are further divided into two
parts -
a) Stock variable: A stock variable is a quantity measured at a specific point of time. It may be
referred to as a certain amount or quantity at a specific point of time. For example, we can
say that total money supply in India as on 27-2-2008 is Rs. 80,000 crores. Stock variable has
a time reference. In this case, both time and quantity is specified in clear terms and there is
no ambiguity.
b) Flow variable: A flow variable is a quantity which can be measured in terms of a specific
period of time and not at a point of time. For example, GNP during the period 2004-05 was
Rs. 90,000 crores. It is clear that goods and services worth Rs. 90,000 crores is produced in
India during the period covering 2004-05. Thus, flow variable has a time dimension.
2. Ratio variables
Economic variables are measured in terms of ratio variables. A ratio variable expresses
quantitative relationship between two different variables at a certain time. For example,
average propensity to save expresses the ratio of total savings to total income. Similarly,
average propensity to consume expresses the relationship between total consumption to total
income. Hence,

These two examples come under flow ratio. Liquidity ratio shows relationship between liquid
assets and total assets whereas leverage ratio shows value of debts and total assets. Hence,

These two examples come under stock ratio.

5
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

3. Functional variables
Functional variables explain the functional relationship between different variables under
consideration. They are further divided into two kinds. They are as follows:
a) Dependent variable: A variable is dependent if its value varies as a result of variations in
the value of some other independent variable. In short, value of one variable depends on the
value of another variable or variables.
b) Independent variable: In this case, the value of one variable will influence the value of
another variable. If a change in one variable causes change in another variable, it is called as
independent variable.
For example, consumption function explains the relationship between changes in the level of
consumption as a result of changes in the level of income of consumers. It indicates how
consumption varies as income changes. It is expressed as C = f [Y] where C refers to
consumption and Y implies income of consumers. In this case, consumption is dependent
variable and income is independent variable.
It is to be noted that functional relationship may be related to either two or more variables. In
case of microanalysis, we explain that D = f [P] where demand depends on price of the
commodity concerned only. Similarly, we can explain that economic development, ED = f [C, L,
T …..]. This implies that economic development depends on several factors like capital, labour,
technology, etc.
4. Functions
Functions suggest that the value of something depends on the value of one or more things.
There are uncountable numbers of functional relationships in the real world. D = f [P] or S = f
[P] at the micro level and C = f [Y] or S = f [Y] at the macro level.
5. Constant
A constant is a magnitude or value, the quantity of which does not change.
6. Parameter
A parameter is a quantity which when varied affects the value of another variable.
7. Capital and investment
In the ordinary language, the term capital refers to cash or money held by a person. It is
measured at a point of time, however, in economics, it has a wider meaning. It is defined as all
man-made aids that are used for further production of wealth. It includes all kinds of

6
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

producers’ goods, inventory of materials, machine tools, equipment, instruments, factories,

dams, transport and communications, etc which are used for further production of goods and
services.
The term investment in the ordinary language refers to financial investment. It means
purchase of stocks shares, bonds debentures, etc where there is only transfer of titles or rights
from one person to another. The term investment in economics refers to creation of new
capital assets or additions to the existing stock of productive assets. Creation of income-
earning assets is called as investment in economics. Investment is the change in the capital
stock over a period of time. Hence, the term capital and investment are synonymous.
8. Ex-ante and Ex-post
These are two Latin phrases. It implies before-hand and afterwards. Ex-ante means anything
planned, anticipated, expected or intended. For example, Ex-ante saving is an amount that the
people intend to save out of their income. Ex-post refers to actual or realised value. For
example, Ex-post saving is the exact amount that the people actually save in a particular time
period. These two terms have great significance in macroeconomic forecasts. One has to
compare the expected rate of economic growth in a particular year and the actual achieved
growth rate in that year. If the actual growth rate is more or equal to the expected rate, the
government assumes that the various economic policies are in the right direction. On the other
hand, if the actual growth rate is less than expected, the government has to modify its
economic policies.
9. Equilibrium and disequilibrium
These are the two terms which are frequently used in economic discussions. It is a position
wherein two opposing forces tend to balance each other so that there will be no further
changes. Hence, it is described as a position of rest in general, however, in economics, it has a
different meaning. A state of rest implies that the various quantities used in the economic
system remain constant and with the help of these constant quantities, the economy
continues to churn over. There is movement or activity and this movement is regular, smooth,
certain and constant. The equilibrium position is free from violent fluctuations, frequent
variations and sudden changes. At the point of equilibrium, an economic unit is maximising its
benefits or gains. Hence, it is described as the coziest position of an economic unit. There will
be a tendency always to move towards this equilibrium position.

7
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

Disequilibrium on the other hand is a position wherein the forces operating in the system are
not in balance. There is imbalance in different forces which are working in the system. Hence,
there are disturbances and disorders in the system.
Generally speaking, in microeconomics, we make reference to partial equilibrium analysis and
in macroeconomics; we make reference to general equilibrium analysis. We can explain these
two concepts with the help of two simple examples. When demand for a particular commodity
is equal to its supply in the market, equilibrium price is established at the micro level. Any
imbalance between either demand or supply would create disequilibrium. At macro level, an
economy is said to be in equilibrium when, aggregate demand for goods and services is equal
to aggregate supply and total investment is equal to total savings. If aggregate demand is
either greater than aggregate supply or aggregate supply is greater than aggregate demand, it
would disturb the equilibrium in the economic system.
10. Economic models
An economic model shows the relationship among different economic variables in a precise
manner. Its purpose is to explain causal relations among different variables in the real world,
avoiding all kinds of complexities in order to get a clear picture of how an economy operates. It
is a method of analysis which presents an over-simplification of the real world. It is just a
precise formal statement of one or more economic relationships. It is a quantitative hypothesis
based on certain assumptions framed to achieve a set of objectives. An economic model is
presented in the form of a statement, logical statement of economic theory, geometrical form
or in mathematical or statistical equations. Any economic model cannot give a perfect answer
to any economic problem. It can give only a rough solution because we have to make certain
assumptions which are not to be found in the real world. Hence, it helps in arriving at a
probable conclusion. An economic model is essentially based on some institutional frame
work- a free enterprise economy, a socialist economy, a mixed economy, etc.
A simple demand and supply model is prepared to explain the determination of market price in
a microeconomic model. A macroeconomic model explains relationships between different
macroeconomic variables and their impact on the working of the economy. Harrod-Domar
model of economic growth is one such example.

8
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION
Basic Concepts of Macroeconomics

2. Summary
Here is a quick recap of what we have learnt so far:
• Macroeconomics is that branch of economics, which deals with the study of aggregative or
average behavior of the entire economy.
• Macroeconomic variables deal with aggregates like gross national product, national
income, consumption function, saving function, investment function, general price level,
total money supply and general level of employment or unemployment in the country, etc.
• Economic variables are measured in terms of ratio variables.
• Equilibrium and disequilibrium are the two terms which are frequently used in economic
discussions. It is a position wherein two opposing forces tend to balance each other so that
there will be no further changes.
• An economic model shows the relationship among different economic variables in a
precise manner. Its purpose is to explain causal relations among different variables in the
real world, avoiding all kinds of complexities in order to get a clear picture of how an
economy operates.

3. Glossary
Macroeconomics Branch of economics which deals with the study of aggregative or
average behaviour of the entire economy.

9
©COPYRIGHT 2019, ALL RIGHTS RESERVED. MANIPAL ACADEMY OF HIGHER EDUCATION