Case Study on Macro-Economics
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Subject: MACRO ECONOMICS
Evolution of macroeconomics SCOPE OF MACROECONOMICS INTEGRATION OF MICRO & MACRO ECONOMICS Separation of micro & macro economics Macroeconomics variables & functions Economic model Macroeconomic problems
Evolution of Macroeconomics:
Till 1930 the Great Depression regarding working of the economy was presented by classical economists like Smith, Ricardo, Say and Marshall. According to the classical economists in the real sector of the economy “Supply creates its own demand” Thus we see the classical economists on the basis of • Flexibility of prices • • • Flexibility of rate of interest Flexibility of wages Constancy of velocity of circulation of money proves that there is always full employment in the economy
J. M Keynes Macroeconomics:
In 1936, Keynes rejected the classical theory of full employment and he also presented his own theory of income and employment. According to the Keynes “The level of income and employment is determined where the aggregate demand is equal to the aggregate output” Keynes identified the inflation and unemployment.
Keynes didn’t consider the role of rate of interest in the determination of national income. So John Hicks presented the concept of “IS Curve”
“In such curve he established the relationship between rate of interest and national income through equality of saving and investment.” He also presented the concept of “LM Curve” In such curve he established the relationship between the rate of interest and national income through equality of demand for money and supply of money. Thus with the help of IS and LM Curves, Hicks presented the stimulation equilibrium in goods and money markets.
In Keynes theory, the concept of AD and AS has been presented without any relation to the level of prices. So Modern Macroeconomics linked AD and AS to the level of prices.
Macroeconomics for Stabilization:
In 1960 the major macroeconomic problem was that of inflation. Thus following theories were presented regarding inflation • • • Demand pull inflation Cost Pull inflation Phillips curve approach to inflation
Scope of Macroeconomics:
The study of macroeconomic theory is important for several reasons. • • It provides us with tools by which we can judge the performance of an economy. The performance of an economy is judged by the Gross National Product (GNP) of the economy. It is generally assumed that the objective of the government in any country is to raise the material well being of the country. Now the question is how to define the material well being of the country. These questions are discussed in welfare economics which forms a part of macroeconomics theory. Macroeconomic theory is also useful to the government for formulating appropriate policies such as monetary policy, fiscal policy, income policy, etc. In many developing countries the objective of the government is to promote economic development. For this the government should know the factors influencing the process of economic development so that these factors can be manipulated. For this reason also the knowledge of macroeconomic theory is essential.
For any business firm the knowledge of macroeconomic theory is required. From the theoretical standpoint also the knowledge of macroeconomic theory is necessary.
Integration of Micro & Macroeconomics:
First of all I would like to differentiate between micro and macroeconomics. Micro means “small”, so it deals with small level. E.g. it deals with economic terms regarding individual, firm, company or industry. So it has narrow perspective. It deals with economic affairs of individual, households. Macro means “large”, so it deals with large level. E.g. it deals with economic affairs of whole country, government, in short words we can say it with whole world. It’s at global level. It shows overall economic affairs of a country. So its dimension is larger than microeconomics. As for as this topic is concerned, according to my point of view, integration of micro and macro economics can’t be occurred. Because both are different from each other. One deals with smaller level and other deals with larger level. They can’t integrate because they are different from each other. But somehow they can affect each other. Now I’ll explain that how integration of micro and macroeconomics can’t be occurred. Microeconomics scale is very small because it deals with economic affairs of individual, household etc. But macroeconomics has very larger dimension because it deals with economic affairs of country, government. And it also includes different economic policies like GDP, employment rate income tax So macroeconomics field is diversified. So integration of micro and macroeconomics can’t be occurred.
Separate Identity of Micro & Macroeconomics:
It’s very easiest to differentiate between micro and macroeconomics because both are different from each other and both have same identity. As a result we can say that both micro and macroeconomics are important. Because first of all if we want to make research, then first of all we would have to observe economic affairs of individual and after that we would be able to study the whole economy of country. So always start from lower level to higher level. So we can’t say that macroeconomics is more important than microeconomics. But both are important.
If we talk about microeconomics, it would lead us to know economic affairs of individual, household. So it has main importance. And if we talk about macroeconomics, it would lead us to know GDP rate. Inflation rate, unemployment rate and other different rates regarding economic affairs. At the end we can conclude that both are different from each other and both have separate identity and they can’t be integrated.
Macroeconomics Variables & functional relationship
There are some many important variables of macroeconomics. Some are given below. • Consumption • Investment • Savings • Money Demand • Supply of money as function of interest
a) Consumption: Consumption depend upon income as follows C = f (Y) • As income grows up, consumption increases • As income decreases, consumption decreases General Form: In general it is represented as C = Co + cY Autonomous Consumption= (Co) Induced Consumption = (c) Average Prospenity to consumption: APC = c/Y Ratio of consumption to national income is called as APC. Marginal Prospenity to consumption: MPC = d c/ dY MPC = +c Slope of consumption is greater than 0 b) Investment: I = f (Y) G.F: I = Io + eY Autonomous Investment = Io Induced Investment = eY Average Prospenity to Investment: API = I/Y
API = Io+Ey/Y Marginal Prospenity to Investment: MPI = Di/Dy MPI = d/dY(Io+Ey) MPI = 0+ edY/Dy MPI = + e Slope of investment function is greater than zero
C) Savings: Savings is given as S = f(Y) G.F: S = -So + dY Average Prospenity to Savings: APS = S/Y APS = -So + SY/Y Marginal Prospenity to Savings: MPS = Ds/Dy MPS = d/dY (-So + sY) MPS = 0 + s Slope of saving function is greater than zero d) Money Demand: Money demand depends upon income MD = f (i) Speculation demand for money: Msd depends upon interest rate
e) Supply of money as function of (i): Ms = f(i) F) Demand for labor is function of real wages: DL = f (W/P)
The economic model is used to explain the theoretical principles of economics. This model consists of equations and functional relations which explain of an economy or some economic unit. The economic model consists of mathematical equations, diagrams and computer programs which make the forecasting’s regarding the behavior of economic variables. According to: Ackly Gardener An economic model consist of set of economic functional relationship and in each function relation there is at least one variable. Mac Dougal An economic model represents an economic reality The economic models are classified into two categories • Microeconomic • Macroeconomic
In microeconomic model study the individual units of economy like consumer, firms and factors of production and study the working of a firm , behavior of customer and determine the prices of goods. In this model we see the consumer’s demand model, the model of consumer behavior, the model of demand, supply and the model of equilibrium.
In macroeconomic model we study the aggregate consumption, aggregate investment, national income and the general price level etc. This model is used study the working of the whole economy and mostly employed in economic paining. Acceding to: Keynesian Models (1936-1969) The Simple Keynesian Model, a vastly oversimplified view of the economy, constructs an equilibrium without referring to the labor market. The point of this exercise is to shows that the economy can be in an equilibrium that is far from full employment. The economic model is divided into two categories 1. Partial equilibrium model 2. General equilibrium model Partial equilibrium model In this model, two or few variables are selected while the rest are kept fixed. Then the functional relationship is estimated between the selected variables of the model. General equilibrium model The general equilibrium model is composed of all the variables of the economy. The general equilibrium model establish the relationship between all the variables of the economy (eg) In the market model we
will observe that the price of goods, the supply of a goods, demand of many goods influence the demand and supply of a goods. This situation will represent a general equilibrium model.
Derivation of economic model
There are two methods to derive the economic model 1. deduction Method 2. induction Method
Deduction Method In this method we derive the specific result from an ordinary reality of life. When we get a conclusion from a routine fact of life this will be a deductive method to derive an economic model. (e.g.) consumption depends upon income and when income increase consumption also increases but not in the same proportion. Induction Method In this method a simple law is derived on the basis of specific fact of life. The fact are selected and the statistical data is collected regarding the selected facts. After analysis that data find the conclusion and on the basis of such special result we form an ordinary law.
Construction of an Economic Model
Variables of the Model
When the model is constructed the variables of the model are selected. The variables which we establish have a functional relationship (eg) the Keynesian Law of consumption, the two variables like C and Y where C= f(Y). C and Y are variables because they both can change.
It is assumed that the normal conditions prevail in the economy, there is no hyper inflation in the economy, there is no change in the distribution of income and there is no change in the tastes of people this shows that we will have to make certain assumptions (eg) Keynesian law of consumption assumes that except C and Y all other variables are constant. Hypothesis The hypothesis expresses the behavior of the variables of the model. In the law of demand we see hypothesis that a result of increase in price, the quantity demanded falls (e.g.) Keynesian consumption function the hypothesis is that along with increase in income, the consumption also increase, the hypothesis of this law suggests the positive relationship between income and consumption.
Prediction On the basis of above elements and facts we can deduce a result, As the case of law of consumption (Keynesian) predicts that there exists a non-proportional relationship between income and consumption.
Unemployment refers to the condition of being unemployed, or to the number or proportion of people in the working population who are unemployed Unemployment, especially involuntarily can cause big problems in our modern world. But how does one measure such an enormous prospect? When measuring unemployment it is first necessary to measure the working population, as not every person is able to work. Looking at the elderly and young children as labor resources would be a waste of time. Therefore the first step to controlling unemployment would be to first measure the size of the scale we are working with. We must also look at current unemployment problems, more specifically the costs of unemployment, what causes unemployment as well as examining the various types of unemployment including voluntary and in-voluntary unemployment. Would 100% employment benefit the economy? Overall we must discuss the consequences unemployment bring and the means by which it may be controlled.
The unemployment rate is a ratio, obtained by dividing the number of unemployed persons by the number of persons in the labor force.
Unemployment as a problem
Several circumstances contribute to the problem of unemployment. For example, the constant changes in the modes of production, which today sees the advancement of automation and technology in many areas, and the rationalization of production management practices aimed at maximizing profit and reducing maximum cost. Many people end up losing their work or they just can’t find it because by age or level of education they are unable to adapt new technologies and sectors. All this has an impact on the quality of life on large sections of the population, which expects income and also feel threatened by often achieved fatigue. Some people argue that in order to enjoy life, it is necessary to consider your aim.
Above all it will be necessary to empower individuals, ensuring that they own the idea of continuing education, caring for their talents, and autonomy in the development of appropriate training. Important education will be a widespread, but more importantly the willingness to learn independently throughout your life.
Each of us needs occupations sufficiently attractive, well-remunerated, to alternate periods of work with periods of study, rely more productive within organizations, workplaces healthy and stimulating. Unemployment benefits are needed to prevent the development of pockets of poverty, give all training opportunities and change, give the people the chance to express their talents.
Inflation is defined as an increase in the average price level in the economy. Thus, if the price of each good or service in the economy were to rise by 5% from one year to the next, we could say without hesitation that the average price level has risen by 5%, and there has been 5% inflation. But, in general, prices do not all rise at the same rate, some rise rapidly, some rise slowly, and some prices even drop. Thus, we express the overall price level by a price index, that is, an average of these different rising and falling prices. But a simple average won't do. Some prices are more important than others. In the economy of the 1990's computers are more important than buggy whips, so it doesn't make sense to add the price of computers to the price of buggy whips and divide by two. Instead we use a weighted average with weights that reflect the importance of the different products in production. Since a lot more computers are produced than buggy-whips, we would give computers a heavier weight. Such a weighted index of prices is known as a "price index.