MACROECONOMICS

Instructor: Tamali Chakraborty

 Text Book
• Macroeconomics Policy and Practice, Frederic
Mishkin, Second Edition (FM)
Additional references

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 EVALUATION
S.no TEST WEIGHTAGE SYLLABUS EXAM TYPE
1 Quiz-1 10% Cumulative Closed Book
(Calculators
allowed)
2 Mid-term Exam 30% Cumulative Closed Book
(Calculators
allowed)
3 Quiz-2 10% Post-mid-term Closed Book
cumulative (Calculators
allowed)
4 End term exam 40% Full course Closed Book
Cumulative Topics (Calculators
allowed)
5 Group Project 10% Assigned topics
 1. Attending classes is important. Future Classes
build on previous ones
2. Be on time & be non-disruptive. No cross-talk.
GROUND 3. Academic integrity: Do not cheat or plagiarize.
RULES – 4. Q & A between faculty and student is
Personal encouraged (within a time-limit). Any
questions/doubts (as many doubts) must be
Conduct addressed to the instructor.
5. Discussion amongst students is NOT fine, unless
requested.
6. Please raise your hand if you need to speak.
 Basic Principles of Economics
• The basic principles of Economics don’t change with
decades.

• The macroeconomists must apply these techniques to

understand the changing circumstances of various economic
problems such as recession, inflation, unemployment,
poverty, etc.
 Ten Basic Principles of Economics
1. People face trade-offs

2. Opportunity cost

3. Rational people think at the margin

4. People respond to incentive

5. Trade can make everyone better off

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 Ten Basic Principles of Economics
6. Markets are usually a good way to organize economic activity

7. Governments can sometimes improve market outcomes

8. A country’s standard of living depends on its ability to produce goods

and services

9. Prices rise when the Government prints too much money

10. Society faces a short-run trade-off between inflation and

unemployment
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 How will the course proceed ?

1. Predominantly lecture – based

2. Emphasis is on theory, with

practical issues for brief discussion
and extra-class reading.

3. Graphs, Algebra and Calculus will

be our tools of trade.

Source: @Microeconomicsmemes
 Layout of Sessions

Macroeconomics

Module 3:
Economy in the Short-run
Module 1: Metrics & Data Module 2: Micro foundations
Business Cycles
Measuring GDP, Inflation. Consumption, Investment and
Demand and Supply in the
Economy in the long-run Money & Labour market
Short Run

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Preliminaries
• Economic Models to assess Cause and Effect and to understand real
world. It often illustrates the relationship of variables.
• Exogenous (Models take as given) and Endogenous Variables (Models
try to explain)
• Stock and Flow variables
 Micro vs Macroeconomics

Microeconomics Macroeconomics
Study of how individual households Study of the economy as a whole.
and firms make decisions and how they Its goal is to explain the economic changes
interact in markets. that affect many households, firms, and
One market at a time markets at once.
Multiple markets and their interactions.

Microeconomic models are foundations to understand

Macro
Source: Microeconomicmemes.
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 Revisiting (Microeconomic) analysis

• An Economic Model

• Exogenous and Endogenous variables

• Movements along a curve

• Shifts in a curve
A Market Model –
Evaluate Endogenous and Exogenous variables
 A Market model
• Demand:

• Supply:

Qd = Qs

• Endogenous variables: Variables which have to be determined within the model using
some pre-supposed information (output of models). These variables cause
movement along an existing curve.
• Exogenous variables: Information on these variables is taken as given and used to
determine other variable values (input of models). These are called Shift factors, as
they cause the curves to shift left or right.
Ceteris Paribus
• Latin term Ceteris Paribus = all else being equal

• A way of thinking to remove clutter in scientific models and their

predictions

• Assume away everything except two variables (x, y) as fixed /

exogenous.

• Establish a relation between x and y.

 Stocks vs. Flows
A stock is a
quantity measured Flow Stock
at a point in time.
E.g.,
“The U.S. capital stock was $26
trillion on January 1, 2006.”

A flow is a quantity measured per unit of time.

E.g., “U.S. investment was $2.5 trillion during 2006.”

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Stocks vs. Flows - examples

stock flow

a person’s
a person’s wealth
annual saving

Num. of people with Num. of new college

college degrees graduates this year

the govt debt the govt budget deficit

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 What do we study?

• Macroeconomics answers questions such as the following:

• Why is average income high in some countries and low in others?

• Why do prices rise rapidly in some time periods while they are
more stable in others?

• Why do production and employment expand in some years and

contract in others?

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Macroeconomics – What comes to mind?

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 Circular Flow of Economy-
Two Sector Model
• A circular flow is seen between firms and households.

• GDP equals the total amount spent by households in the market for
goods and services.

• It also equals the total wages, rent and profit paid by firms in the
markets for the factors of production.

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 The Circular Flow
Income ($)

Labor

Households Firms

Goods

Expenditure ($)

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 Circular Flow of Economy-
Three Sector Model
• A circular flow is seen between firms, households and Government.

• Taxes act as withdrawals from income flows as they reduce private

disposable income and reduce consumptions and savings.

• Government expenditure is the injection into income flows as they add

to aggregate demand in form of government purchases of factor
services from households and goods and services from business sector.

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 Circular Flow of Economy-
Four Sector Model
• A circular flow is seen between firms, households, Government and
foreign sector.

• Export act as an injection and import act as an withdrawal.

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 Gross Domestic Product

Gross domestic product (GDP) is a measure of the income and

expenditures of an economy.

GDP is the market value of all final goods and services

produced within a country in a given period of time.

https://www.youtube.com/watch?v=mjJmo5mN5yA&ab_channe
l=MarginalRevolutionUniversity

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 GDP
• “GDP is the market value…”
Output is valued at market prices.

• “. . . of all final . . .”
It records only the value of final goods, not
intermediate goods (the value is counted only once).

• “. . . goods and services . . . “

It includes both tangible goods (food, clothing, cars)
and intangible services (haircuts, house cleaning).

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 GDP…
• “. . . produced . . .”
• It includes goods and services produced in the period we’re
considering, not transactions involving goods produced in the past.

• “ . . . within a country . . .”
• It measures the value of production within the geographic confines
of a country.

• “. . . in a given period of time.”

• It measures the value of production that takes place within a
specific interval of time, usually a year or a quarter (three months).

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 Real Versus Nominal GDP
Nominal GDP values the production of goods and services
at current prices.
Real GDP values the production of goods and services at
constant prices.

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 Nominal GDP Vs Real GDP

Goods/Services Base Year Price Base Year Quantity Current Year Price Current Year Quantity
X1 2 40 3 60
X2 8 90 10 150
X3 80 100 90 110
X4 70 120 80 130
 The GDP Deflator
• The GDP deflator is a measure of the price level calculated as the ratio
of nominal to real GDP times 100
• It reflects what is happening to overall level of prices in the economy.
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
• 𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = ∗ 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
Σ𝑃𝑡 𝑄𝑡
• 𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = ∗ 100
Σ𝑃0 𝑄𝑡
• This index is called a Paasche’s Index.

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 Table 2c Calculating the GDP deflator

For year 2013, nominal GDP is €200, and real GDP is €200, so the GDP deflator is
100.

We now need the nominal GDP and the the real GDP for the other two years to
complete our calculations (see table 2a).

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 GDP Measurement Rules
• Adding of Apples and Oranges - Adding monetary values of final
products

• Sale of Used Goods is not included in GDP calculation. If a collector

sells a rare Mickey Mantle card to another collector for $500 is not
included in GDP.
 GDP Measurement Rules…
• Intermediate Goods and Value Added – In GDP
calculation, final product’s market price is included to avoid
double counting. To compute value of all final goods and
services is to sum the value added at each stage of
production.

• Housing Services and other Imputation- Most goods and

services are valued at market prices. Some are not sold at
market place and therefore do not have market price.
• If GDP is to include the value of goods and services, we must
use an estimate of their value. It is called imputed value.
 What Is (Not) Counted in GDP?
• GDP includes all items produced in the economy and sold
legally in markets.

• What Is (Not) Counted in GDP?

• Home Production: GDP excludes most items that are produced
and consumed at home and that never enter the marketplace.
• Intermediate goods: Sales of iron ore to Tata Steel will not count
instead only Steel output sold in retail markets is counted
• Inventory: Amazon adds Books not sold to its Inventory. It is
counted as “Investment”.
• Used goods: OLX reports sales of 10 Used 2-wheelers. It is Not
counted.
• It excludes items produced and sold illicitly, such as illegal drugs.
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GDP Measurement

GDP
Measurement

Expenditure Income Value Added

Method Method Method

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