Ecn 203 Lecture Note 1 - 221219 - 102648

Course Code: ECN 203- INTRODUCTION TO MACROECONOMICS
Lecture Note 1
Topic: Meaning and Goals of Macroeconomics
Understanding Macroeconomics
Macroeconomics is a branch of economics that studies how an overall economy (the markets,
businesses, consumers, and governments) behave. Macroeconomics examines economy-wide
phenomena such as inflation, price levels, rate of economic growth, national income, gross
domestic product (GDP), and changes in unemployment.
Some of the key questions addressed by macroeconomics include: What causes

unemployment? What causes inflation? What creates or stimulates economic growth?
Macroeconomics attempts to measure how well an economy is performing, understand what
forces drive it, and project how performance can improve. Macroeconomics in its modern
form is often defined as starting with John Maynard Keynes and his theories about market
behaviour and governmental policies in the 1930s; several schools of thought have developed
since then.
As the term implies, macroeconomics is a field of study that analyses an economy through a
wide lens. This includes looking at variables like unemployment, GDP, exchange rate,
consumption, investment and inflation. In addition, macroeconomists develop models
explaining the relationships between these variables.
These models, and the forecasts they produce, are used by government entities to aid in
constructing and evaluating economic, monetary, and fiscal policy. Businesses use the models
to set strategies in domestic and global markets, and investors use them to predict and plan for
movements in various asset classes.
Macroeconomics vs. Microeconomics
Macroeconomics differs from microeconomics, which focuses on smaller factors that affect
choices made by individuals and companies. Factors studied in both microeconomics and
macroeconomics typically influence one another.
A key distinction between micro- and macroeconomics is that macroeconomic aggregates can
sometimes behave in very different ways or even the opposite of similar microeconomic
variables. For example, Keynes referenced the so-called Paradox of Thrift, which argues that
individuals save money to build wealth (micro). However, when everyone tries to increase
their savings at once, it can contribute to a slowdown in the economy and less wealth in the
aggregate (macro). This is because there would be a reduction in spending, affecting business
revenues and lowering worker pay.
Meanwhile, microeconomics looks at economic tendencies, or what can happen when

individuals make certain choices. Individuals are typically classified into subgroups, such as
buyers, sellers, and business owners. These actors interact with each other according to the
laws of supply and demand for resources, using money and interest rates as pricing
mechanisms for coordination.
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Macroeconomic Goals/Objectives
Macroeconomic goals are quite different from Micro Economics because the overall response
of the economy must not match with the individual units. As macroeconomics looks at the
whole, its objectives are aggregative in nature. The macroeconomic policy objectives are the
following: (i) Full employment, (ii) Price stability, (iii) Economic growth, (iv) Balance of
payments equilibrium and exchange rate stability, and (v) Income equality
(i) Full employment: Performance of any government is judged in terms of goals of

achieving full employment and price stability. These two may be called the key
indicators of health of an economy. In other words, modern governments aim at
reducing both unemployment and inflation rates. Unemployment refers to involuntary
idleness of mainly labour force and other productive resources. Unemployment (of
labour) is closely related to the economy‘s aggregate output. Higher the unemployment
rate, greater the divergence between actual aggregate output (GNP/CDP) and potential
output. So, one of the objectives of macroeconomic policy is to ensure full
employment. The objective of full employment became uppermost amongst the
policymakers in the era of Great Depression when unemployment rate in all the
countries except the then socialist country, the USSR, rose to a great height. It may be
noted here that a free enterprise capitalist economy always exhibits full employment.
But, Keynes said that the goal of full employment may be a desirable one but
impossible to achieve. Full employment, thus, does not mean that nobody is
unemployed. Even if 4 or 5 percent of the total population remain unemployed, the
country is said to be fully employed. Full employment, though theoretically
conceivable, is difficult to attain in a market-driven economy. In view of this, full
employment objective is often translated into high employment objective. This goal is
desirable indeed, but how high should it be? One author has given an answer in the
following way; ―The goal for high employment should therefore be not to seek an
unemployment level of zero, but rather a level of above zero consistent with full
employment at which the demand for labour equals the supply of labour. This level is
called the natural rate of unemployment.
(ii) Price stability: The emphasis on attainment of full employment as a macroeconomic
goal has shifted to price stability. By price stability we must not mean an unchanging
price level over time. Not necessarily, price increase is unwelcome, particularly if it is
restricted within a reasonable limit. In other words, price fluctuations of a larger degree
are always unwelcome. However, it is difficult again to define the permissible or
reasonable rate of inflation. But sustained increase in price level as well as a falling
price level produce destabilising effects on the economy. Therefore, one of the
objectives of macroeconomic policy is to ensure (relative) price level stability. This
goal prevents not only economic fluctuations but also helps in the attainment of a
steady growth of an economy.
(iii) Economic growth: Economic growth in a market economy is never steady. These
economies experience ups and downs in their performance. This objective became
uppermost in the period following the World War II (1939-45). Economists call such
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ups and downs in the economic performance as trade cycle/business cycle. In the short
run such fluctuations may exhibit depressions or prosperity (boom). One of the
important benchmarks to measure the performance of an economy is the rate of
increase in output over a period of time. There are three major‘ sources of economic
growth, viz. (i) the growth of the labour force, (ii) capital formation, and (iii)
technological progress. A country seeks to achieve higher economic growth over a long
period so that the standards of 3 living or the quality of life of people, on an average,
improve. It may be noted here that while talking about higher economic growth, we
take into account general, social and environmental factors so that the needs of people
of both present generations and future generations can be met. However, promotion of
higher economic growth is often hampered by short run fluctuations in aggregate
output. In other words, one finds a conflict between the objectives of economic growth
and economic stability (in prices). In view of this conflict, it is said that macroeconomic
policy should promote economic growth with reasonable price stability.
(iv) Balance of payments equilibrium and exchange rate stability: From a macro-
economic point of view, one can show that an international transaction differs from
domestic transaction in terms of (foreign) currency exchange. Over a period of time,
all countries aim at balanced flow of goods, services and assets into and out of the
country. Whenever this happens, total international monetary reserves are viewed as
stable. If a country‘s exports exceed imports, it then experiences a balance of payments
surplus or accumulation of reserves, like gold and foreign currency. When the country
loses reserves, it experiences balance of payments deficit (or imports exceed exports).
However, depletion of reserves reflects the unhealthy performance of an economy and
thus creates various problems. That is why every country aims at building substantial
volume of foreign exchange reserves. Anyway, the accumulation of foreign exchange
reserves is largely conditioned by the exchange rate the rate at which one currency is
exchanged for another currency to carry out international transactions. The foreign
exchange rate should be stable as far as possible. This is what one may call it external
stability in price. External instability in prices hampers the smooth flow of goods and
services between nations. It also erodes the confidence of currency. However,
maintenance of external stability is no longer considered as the macroeconomic policy
objective as well as macroeconomic policy instrument. It is, however, because of
growing inter- connectedness and interdependence between different nations in the
globalised world, the task of fulfilling this macroeconomic policy objective has become
more problematic.
(v) Income redistribution: Macroeconomic policy is also used to attain some social
ends or social welfare. This means that income distribution needs to be more fair and
equitable. In a capitalist market-based society some people get more than others. In
order to ensure social justice, policymakers use macroeconomic policy instruments.
Macroeconomic Policy Instruments

As our macroeconomic goals are not typically confined to ―full employment, price
stability, rapid economic growth, BOP equilibrium and stability in foreign exchange
rate, so our macroeconomic policy instruments include monetary policy, fiscal policy,
income policy in a narrow sense. But, in a broder sense, these instruments should
include policies relating to labour, tariff, agriculture, anti-monopoly and other relevant
ones that influence the macroeconomic goals of a country. Confining our attention in
a restricted way we intend to consider two types of policy instruments the two giants
of the industry monetary (credit) policy and fiscal (budgetary) policy. These two
3
policies are employed toward altering aggregate demand so as to bring about a change
in aggregate output (GNP/GDP) and prices, wages and interest rates, etc., throughout
the economy.
Monetary policy attempts to stabilise aggregate demand in the economy by influencing

the availability or price of money, i.e., the rate of interest, in an economy. Monetary
policy may be defined as a policy employing the central bank‘s control of the supply
of money as an instrument for achieving the macroeconomic goals.
Fiscal policy, on the other hand, aims at influencing aggregate demand by altering tax,
expenditure and debt programme of the government. The credit for using this kind of
fiscal policy in the 1930s goes to J.M. Keynes who discredited the monetary policy as
a means of attaining some of the macroeconomic goals such as the goal of full
employment. As fiscal policy has come into scrutiny in terms of its effectiveness in
achieving the desired macroeconomic objectives, the same is true about the monetary
policy. One can see several rounds of ups and downs in the effectiveness of both these
policy instruments consequent upon criticisms and counter- criticisms in their
theoretical foundations.

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Course Code: ECN 203- INTRODUCTION TO MACROECONOMICS

Topic: Meaning and Goals of Macroeconomics

Some of the key questions addressed by macroeconomics include: What causes

Macroeconomics vs. Microeconomics

Meanwhile, microeconomics looks at economic tendencies, or what can happen when

(i) Full employment: Performance of any government is judged in terms of goals of

Macroeconomic Policy Instruments

Monetary policy attempts to stabilise aggregate demand in the economy by influencing

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