Introduction to Macro Economics -II

Chapter`s Outlines Basic Macro Economic concepts Variables and its types Economic models Building economic model Main Macro Economic Problems

Micro Economics Micro economics deals with a small individual unit of the economy, For example, the price of a particular commodity, consumption pattern of a particular consumer, income of particular individual and Producer etc. 3

Macro economics Macro economics deals with total or aggregate level of output, aggregate level of consumption, aggregate level of investment, aggregate level of employment and general price level in economy. 4

Macro Economic Variables/Indicators Consumption Saving Investment National Income Export and Import Government Expenditures Taxes Transfer Payment Rate of Interest Demand for Labor Supply of Labor etc.

Stock Variable verses Flow Variable Stock Variables Those variables whose values are measured from particular point of time such as weight of a car, water in a tank etc.. Similarly, In macro economics we have lots of stock variables such like supply of money, the deposits in the bank, the amount of wealth possess by a person etc.

Stock Variable verses Flow Variable (Cont..) Flow Variables Are those variables whose values are measured from particular period of time such as speed of a car during ten (10) minutes. In macro economics national income, consumption, saving , investment and rate of interest are all flow variables.

Endogenous and Exogenous Variables Endogenous Variable The variables whose values are determined within the model are known as endogenous variables. For example In two sector economy Y=C+ I Y is endogenous variable. The purpose of this model is to find the value of Y.

Endogenous and Exogenous Variables (Cont..) The variables whose values are given outside the model are exogenous variables. The value of I is given To change in the value of exogenous variable effect the model.

Economic Model An economic model consists of equation and functional relations which explain the operation of an economy or some economic unit. Economic models are used to explain theoretical principles of economics. Furthermore they can be used for the purpose of forecasting. Economic model consists of mathematical equations, diagram and graph.

Types of Economic model Economic models are: Partial Equilibrium Model General Equilibrium Model

Partial Equilibrium Model Partial Equilibrium model is a model where we find the relationship between two variables while keeping the other variables constant. Qd= f (P), [Ps, T, Y,…] Qd= Quantity demanded & P is price while T=taste, Ps=price of substitute good, Y is consumer`s income.

General Equilibrium Model General Equilibrium model is a model which establishes relations between all the variables of the economy. For example if we construct a market model we will observe; The prices of many goods, supply of many goods, demand for many goods etc. such situation will represent a General equilibrium model.

Construction of Economic Model Economic Model has four elements: A behavior or statement regarding certain variables. Assumptions which influence these variables. Hypothesis whereby the variables are connected. Prediction

A: Variables of The Model Whenever a model is to be constructed, the variable of the model are selected. For example in Keynesian consumption function we have two variables such as C, Y where C = f(Y)

B: Assumptions Assumption means where we assume something constant. In Keynesian consumption function we assume that except C and Y all other variables are constant, Such as normal condition prevail in economy, there is no inflation or deflation in economy, no change in distribution of income and no change in taste etc.

C: Hypothesis It expresses the behavior of the variables of model. For example, In law of demand our hypothesis is. “ as a result of increase in price, quantity demand falls”.

D: Prediction Prediction means forecasting where we obtain certain results on the bases of certain facts . For example In Keynesian consumption function there exists a non proportional relationship between consumption and income.

Macroeconomic Concerns Three of the major concerns of macroeconomics are: Unemployment Inflation Output growth

1 Unemployment : Unemployment refers to the situation where the population of a country do not find work to earn their livelihood. OR Unemployment represents that ratio of labor force which fails to get employment. The currently 40% of Afghanistan population is unemployed.

Cont`d The unemployment rate is a key indicator of the economy’s health. The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium.

Problem of Unemployment

Problem of Unemployment Classical economist believed in full employment i.e. all recourses of economy are fully employed and there is no possibility of unemployment. BUT Great depression of 1930 brought a lot of miseries in form of slump and vast unemployment. So Keynes wrote a book in 1936 “General theory” in which he rejected the philosophy of full employment . According to him there is always unemployment in economy while full employment is accidental.

2 Inflation Inflation is an increase in the overall price level. Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations is a rare phenomenon. Deflation is a decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation.

Problem inflation During 1930 the phenomena of unemployment got a lot of attractions. Policy makers presented their ideas to remove unemployment . So Government tried to provide better social and economic service due to which Government expenditures went on increasing.

Problem of inflation (cont) Thus public and private spending greatly pushed the aggregate demand in economy which created Demand pull inflation. While on other hand oil crises declined aggregate supply of oil and caused increase in cost of production which was given the name of cost push inflation. So since then to present time the phenomenon of inflation and unemployment is observed throughout the world.

3 Output and Growth Growth refers to change in the level of economic activity from one year to another year. Growth means that poor and developing countries wish to attain a rise in their national income and per capita income.

Output Aggregate output is the total quantity of goods and services produced in an economy in a given period. The aggregate output is the main measure to see how well an economy is doing.

Problem of growth It is of a great concern for economists that what should be the level of rise in investment that the economy can achieve its desired level of income and employment without inflation and deflation. Such a situation will result the full utilization of resources. Full employment means the maximization of output & employment in presence of existing recourses while growth is attach with increase in output & employment

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