basic knowledge of Macroeconomics

1. Macroeconomics
Tropic: Assignment on some basic knowledge of Macroeconomics
Supervised By
Dr. Ataur Rahaman
Department of Business Administration
Submitted To:
Department of Business Administration
Northern UniversityBangladesh
Submitted By:
Section- A
Submission Date: 04-04-2014
Sl No Name ID
01 S.M. Al-Shahriar BBA 120304790
02 Md.Foysal BBA 120304830

2. *1.Defination and Emergence of Macroeconomics:
Macroeconomics
Macroeconomics (from the Greek prefix makro- meaning "large" and economics) is a branch of
economics dealing with the performance, structure, behavior, and decision-making of an
economy as a whole, rather than individual markets. This includes national, regional, and global
economies. With microeconomics, macroeconomics is one of the two most general fields in
economics.
Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price
indices to understand how the whole economy functions. Macroeconomists develop models that
explain the relationship between such factors as national income, output, consumption,
unemployment, inflation, savings, investment, international trade and international finance. In
contrast, microeconomics is primarily focused on the actions of individual agents, such as firms
and consumers, and how their behavior determines prices and quantities in specific markets.
While macroeconomics is a broad field of study, there are two areas of research that are
emblematic of the discipline: the attempt to understand the causes and consequences of short-run
fluctuations in national income (the business cycle), and the attempt to understand the
determinants of long-run economic growth (increases in national income). Macroeconomic
models and their forecasts are used by governments to assist in the development and evaluation
of economic policy.
Emergence of macroeconomics:
Macroeconomics, as a separate branch of economics, emerged after the British economist John
Maynard Keynes published his celebrated book, The General Theory of Employment, Interest
and Money in 1936. The dominant thinking in economics before Keynes was that all the laborers
who are ready to work will find employment and all the factories will be working at their full
capacity. This school of thought is known as the classical tradition. However, the Great
Depression of 1929 and the subsequent years saw the output and employment levels in the
countries of Europe and North America fall by huge amounts. It affected other countries of the
world as well. Demand for goods in the market was low, many factories were lying idle, workers
were thrown out of jobs. In USA, from 1929 to 1933, unemployment rate rose from 3 per cent to
25 per cent (unemployment rate may be defined as the number of people who are not working
and are looking for jobs divided by the total number of people who are working or looking for
jobs). Over the same period aggregate output in USA fell by about 33 per cent. These events
made economists think about the functioning of the economy in a new way. The fact that the
economy may have long lasting unemployment had to be theorized about and explained. Keynes’
book was an attempt in this direction. Unlike his predecessors, his approach was to examine the

3. working of the economy in its entirety and examine the interdependence of the different sectors.
The subject of macroeconomics was born.
We must remember that the subject under study has a particular historical context. We shall
examine the working of the economy of a capitalist country in this book. In a capitalist country
production activities are mainly carried out by capitalist enterprises. A typical capitalist
enterprise has one or several entrepreneurs (people who exercise control over major decisions
and bear a large part of the risk associated with the firm/enterprise). They may themselves supply
the capital needed to run the enterprise, or they may borrow the capital. To carry out production
they also need natural resources – a part consumed in the process of production (e.g. raw
materials) and a part fixed (e.g. plots of land). And they need the most important element of
human labor to carry out production. This we shall refer to as labor. After producing output with
the help of these three factors of production, namely capital, land and labor, the entrepreneur
sells the product in the market. The money that is earned is called revenue. Part of the revenue is
paid out as rent for the service rendered by land, part of it is paid to capital as interest and part of
it goes to labor as wages. The rest of the revenue is the earning of the entrepreneurs and it is
called profit. Profits are often used by the producers in the next period to buy new machinery or
to build new factories, so that production can be expanded. These expenses which raise
productive capacity are examples of investment expenditure. In short, a capitalist economy can
be defined as an economy, in which most of the economic activities have the following
characteristics,
(a) There is private ownership of means of production
(b) Production takes place for selling the output in the market
(c) There is sale and purchase of labor services at a price which is called the wage rate (the labor
which is sold and purchased against wages is referred to as wage labor).
If we apply the above mentioned three criteria to the countries of the world we would find that
capitalist countries have come into being only during the last three to four hundred years.
Moreover, strictly speaking, even at present, a handful of countries in North America, Europe
and Asia will qualify as capitalist countries. In many underdeveloped countries production (in
agriculture especially) is carried out by peasant families. Wage labor is seldom used and most of
the labor is performed by the family members themselves. Production is not solely for the
market; a great part of it is consumed by the family. Neither do many peasant farms experience
significant rise in capital stock over time. In many tribal societies the ownership of land does not
exist; the land may belong to the whole tribe. In such societies the analysis that we shall present
in this book will not be applicable. It is, however, true that many developing countries have a
significant presence of production units which are organized according to capitalist principles.
The production units will be called firms in this blog. In a firm the entrepreneur (or
entrepreneurs) is at the helm of affairs. She hires wage labor from the market; she employs the

4. services of capital and land as well. After hiring these inputs she undertakes the task of
production. Her motive for producing goods and services (referred to as output) is to sell them in
the market and earn profits. In the process she undertakes risks and uncertainties. For example,
she may not get a high enough price for the goods she is producing; this may lead to fall in the
profits that she earns. It is to be noted that in a capitalist country the factors of production earn
their incomes through the process of production and sale of the resultant output in the market. In
both the developed and developing countries, apart from the private capitalist sector, there is the
institution of State. The role of the state includes framing laws, enforcing them and delivering
justice. The state, in many instances, undertakes production – apart from imposing taxes and
spending money on building public infrastructure, running schools, colleges, providing health
services etc. These economic functions of the state have to be taken into account when we want
to describe the economy of the country. For convenience we shall use the term government to
denote state.
Apart from the firms and the government, there is another major sector in an economy which is
called the household sector. By a household we mean a single individual who takes decisions
relating to her own consumption, or a group of individuals for whom decisions relating to
consumption are jointly determined.
Households also save and pay taxes. How do they get the money for these activities? We must
remember that the households consist of people. These people work in firms as workers and earn
wages. They are the ones who work in the government departments and earn salaries, or they are
the owners of firms and earn profits. Indeed the market in which the firms sell their products
could not have been functioning without the demand coming from the households. So far we
have described the major players in the domestic economy. But all the countries of the world are
also engaged in external trade. The external sector is the fourth important sector in our study.
Trade with the external sector can be of two kinds,
The domestic country may sell goods to the rest of the world. These are called exports.
The economy may also buy goods from the rest of the world. These are called imports.
Besides exports and imports, the rest of the world affects the domestic economy in other ways as
well. Capital from foreign countries may flow into the domestic country, or the domestic country
may be exporting capital to foreign countries.
Macroeconomics deals with the aggregate economic variables of an economy. It also takes into
account various interlinkages which may exist between the different sectors of an economy. This
is what distinguishes it from microeconomics; which mostly examines the functioning of the
particular sectors of the economy, assuming that the rest of the economy remains the same.
Macroeconomics emerged as a separate subject in the 1930s due to Keynes. The Great
Depression, which dealt a blow to the economies of developed countries, had provided Keynes
with the inspiration for his writings. In this book we shall mostly deal with the working of a

5. capitalist economy. Hence it may not be entirely able to capture the functioning of a developing
country. Macroeconomics sees an economy as a combination of four sectors, namely households,
firms, government and external sector.
*2.Objectives of Macroeconomics:
Macroeconomic objectives
Broadly, the objective of macroeconomic policies is to maximize the level of national income,
providing economic growth to raise the utility and standard of living of participants in the
economy. There are also a number of secondary objectives which are held to lead to the
maximization of income over the long run. While there are variations between the objectives of
different national and international entities, most follow the ones detailed below:
Sustainability - a rate of growth which allows an increase in living standards without undue
structural and environmental difficulties. 'Economic growth' will be studied later on in this book.
Full employment - where those who are able and willing to have a job can get one, given that
there will be a certain amount of frictional, seasonal and structural unemployment (referred to as
the natural rate of unemployment).
Price stability - when prices remain largely stable, and there is not rapid inflation or deflation.
Price stability is not necessarily the same as zero inflation, but instead steady levels of low-
moderate inflation are often regarded as ideal. It is worth noting that prices of some goods and
services often fall as a result of productivity improvements during periods of inflation, as
inflation is only a measure of general price levels. However, inflation is a good measure of 'price
stability'. Zero inflation is often undesirable in an economy. ("Internal Balance" is used to
describe a level of economic activity that results in full employment with no inflation.)
External Balance - equilibrium in the Balance of payments without the use of artificial
constraints. That is, exports roughly equal to imports over the long run.
Equitable distribution of income and wealth - a fair share of the national 'cake', more equitable
than would be in the case of an entirely free market.
Increasing Productivity - more output per unit of labor per hour. Also, since labor is but one of
many inputs to produce goods and services, it could also be described as output per unit of factor
inputs per hour.
Thermal Equilibrium - equilibrium in the Balance of payments without the use of artificial
constraints. That is, exports roughly equal to imports over the long run.

6. *3.Instruments of Macroeconomics:
Macroeconomic policy instruments
Macroeconomic policy instruments refer to macroeconomic quantities that can be directly
controlled by an economic policy maker. Instruments can be divided into two subsets:
a) Monetary policy instruments and
b) Fiscal policy instruments.
Monetary policy is conducted by the Federal Reserve or the central bank of a country or
supranational region (Euro zone). Fiscal policy is conducted by the Executive and Legislative
Branches of the Government and deals with managing a nation’s Budget.
Monetary policy
Monetary policy instruments consists in managing short-term rates (Fed Funds and Discount
rates in the U.S.), and changing reserve requirements for commercial banks. Monetary policy can
be either expansive for the economy (short-term rates low relative to inflation rate) or restrictive
for the economy (short-term rates high relative to inflation rate). Historically, the major objective
of monetary policy had been to manage or curb domestic inflation. More recently, central
bankers have often focused on a second objective: managing economic growth as both inflation
and economic growth are highly interrelated.
Fiscal policy
Fiscal policy consists in managing the national Budget and its financing so as to influence
economic activity. This entails the expansion or contraction of government expenditures related
to specific government programs such as building roads or infrastructure, military expenditures
and social welfare programs. It also includes the raising of taxes to finance government
expenditures and the raising of debt (Treasuries in the U.S.) to bridge the gap (Budget deficit)
between revenues (tax receipts) and expenditures related to the implementation of government
programs. Raising taxes and reducing the Budget Deficit is deemed to be a restrictive fiscal
policy as it would reduce aggregate demand and slow down GDP growth. Lowering taxes and
increasing the Budget Deficit is considered an expansive fiscal policy that would increase
aggregate demand and stimulate the economy.
*4 .Methods and problems of computing national income.

7. Methods of computing national income.
The national income of a country can be measured by three alternative methods: (i) Product
Method (ii) Income Method, and (iii) Expenditure Method.
1. Product Method:
In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final goods
here refer to those goods which are directly consumed and not used in further production
process.

8. Goods which are further used in production process are called intermediate goods. In the value of
final goods, value of intermediate goods is already included therefore we do not count value of
intermediate goods in national income otherwise there will be double counting of value of goods.
To avoid the problem of double counting we can use the value-addition method in which not the
whole value of a commodity but value-addition (i.e. value of final good value of intermediate
good) at each stage of production is calculated and these are summed up to arrive at GDP.
The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at
market price can be converted into by methods discussed earlier.
2. Income Method:
Under this method, national income is measured as a flow of factor incomes. There are generally
four factors of production labor, capital, land and entrepreneurship. Labor gets wages and
salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their
remuneration.
Besides, there are some self-employed persons who employ their own labor and capital such as
doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these
factor incomes is called NDP at factor costs.
3. Expenditure Method:
In this method, national income is measured as a flow of expenditure. GDP is sum-total of
private consumption expenditure. Government consumption expenditure, gross capital formation
(Government and private) and net exports (Export-Import).
Problems of computing national Income:
The main difficulties which are involved in the measurement of national income are following:
In the fewer developing countries, the accurate figures about the various sectors of economy are
not available due to this we are unable to estimate the real national income of the country. There
is a shortage of trained staff which may collect the statistics about the national product. Public is
also not ready to provide the correct figures about the income due to the fear of income tax.
Some people do not keep any proper account about their business income, so their income is not
included in the national income.
According to Kuznets, the measurement of national income is a complicated problem and is
beset with the following difficulties.
(i) Non-availability of statistical material: Some persons like electricians, plumbers, etc., do
some job in their spare time and receive income. The state finds it very difficult to know the

9. exact amount received from such services. This income which, should have been added to: the
national income is not recorded due to lack of full information of statistics material.
(ii) The danger of double counting: While computing the national income, there is always the
danger of double or multiple counting. If care is not taken in estimating the income, the cost of
the commodity is likely to be counted twice or thrice and national income will be overestimated.
(iii) Non-marketed services: In estimating the national income, only those services are included
for which the payment is made. The unpaid services, or non-marketed services are excluded from
the national income.
(iv) Difficulty in assessing the depreciation allowance: The deduction of depreciation
allowances, accidental damages, repair, and replacement charges from the national income is not
an easy task. it requires high degree of judgment to assess the depreciation allowance and other
charges.
(v) Housing: A person lives in a rented house. He pays Rs. 5000 .per month to the landlord. The
income of the landlord is recorded in the national income. Let us suppose that the tenant-
purchases the same house from the landlord. Now the income of the owner occupant has
increased by Rs. 5000. Is it not justifiable to include this income in the national income? Should
or should not this income be recorded in the national income is still a controversial question.
(vi) Transfer earnings: While measuring the national income, it should be seen that transfer
payments should not become a part of national income. The payments made as relief allowance,
pensions, etc. do not contribute towards current production. So they should be excluded from
national income.
(vii)Self-consumed production: In developing countries, a significant part of the output is not
exchanged for money in the market. It is either consumed directly by producers or bartered for
other goods. This unorganized and non-monetized sector makes calculation of national income
difficult.
(viii) Price level changes: National income is measured in money terms. The measuring rod of
money itself does not remain stable. This means that national income can change without any
change in output.
Problems of measurement in under-developed countries:
The national income in under-developed countries like Pakistan cannot be accurately measured
due to the following reasons:

10. 1. Self-consumed-bartered consumption: Some of the transactions of agricultural goods in the
villages are done without the use of money. The statisticians. therefore, cannot measure the exact
amount of the transactions for inclusion in the national income.
2. No systematic accounts maintained: Most of the producers do not keep any record of the sale
of the products in the market. This makes the task of national income still more complicated.
3. No occupational classification: There is no occupational specialization in the under-developed
countries. People receive Income by working in various capacities. One person sometimes works
as carpenter and at another time as mason. The statisticians cannot accurately measure the
income of such persons.
4. Unreliable data: The statisticians themselves do not feel the importance of figures which they
collect. They also do not take many pains for getting the reliable data. The figures of national
Income are, therefore, not up-to-date in the under-developed countries.
*5.concept and measurement of national income accounting gross
Concept of national income gross
A term used in economics to refer to the bookkeeping system that a national government uses to
measure the level of the country's economic activity in a given time period. National income
accounting records the level of activity in accounts such as total revenues earned by domestic
corporations, wages paid to foreign and domestic workers, and the amount spent on sales and
income taxes by corporations and individuals residing in the country.
National income accounting provides economists and statisticians with detailed information that
can be used to track the health of an economy and to forecast future growth and development.
Although national income accounting is not an exact science, it provides useful insight into how
well an economy is functioning, and where monies are being generated and spent. Some of the
metrics calculated by using national income accounting include gross domestic product (GDP),
gross national product (GNP) and gross national income (GNI).
Measure of national income measurement
Gross National Product (GNP)
Of the various measures of national income used in national income analysis, GNP is the most
important and widely used measure of national income. It is the most comprehensive measure of
the nation’s productive activities. The GNP is defined as the value of all final goods and services
produced during a specific period, usually one year, plus incomes earned abroad by the nationals

11. minus incomes earned locally by the foreigners. The GNP so defined is identical to the concept
of gross national income (GNI). Thus, GNP = GNI. The difference between the two is only of
procedural nature. While GNP is estimated on the basis of product-flows, the GNI is estimated
on the basis of money income flows, (i.e., wages, profits, rent, interest, etc.).
Gross Domestic Product (GDP)
The Gross Domestic Product (GDP) is defined as the market value of all final goods and services
produced in the domestic economy during a period of one year, plus income earned locally by
the foreigners minus incomes earned abroad by the nationals. The concept of GDP is similar to
that of GNP with a significant procedural difference. In case of GNP the incomes earned by the
nationals in foreign countries are added and incomes earned locally by the foreigners are
deducted from the market value of domestically produced goods and services. In case of GDP,
the process is reverse – incomes earned locally by foreigners are added and incomes earned
abroad by the nationals are deducted from the total value of domestically produced goods and
services.
Net National Product (NNP)
NNP is defined as GNP less depreciation, i.e., NNP = GNP – Depreciation
Depreciation is that part of total productive assets which is used to replace the capital worn out in
the process of creating GNP. Briefly speaking, in the process of producing goods and services
(including capital goods), a part of total stock of capital is used up.
‘Depreciation’ is the term used to denote the worn out or used up capital. An estimated value of
depreciation is deducted from the GNP to arrive at NNP.
The NNP, as defined above, gives the measure of net output available for consumption and
investment by the society (including consumers, producers and the government).
NNP is the real measure of the national income. NNP = NNI (net national income). In other
words, NNP is the same as the national income at factor cost. It should be noted that NNP is
measured at market prices including direct taxes. Indirect taxes are, however, not a point of
actual cost of production. Therefore, to obtain real national income, indirect taxes are deducted
from the NNP. Thus, NNP–indirect taxes = National Income.
National Income: Some Accounting Relationships
(a) Accounting Identities at Market Price
GNP ≡ GNI (Gross National Income)

12. GDP ≡ GNP less Net Income from Abroad
NNP ≡ GNP less Depreciation
NDP (Net Domestic Product) ≡ NNP less net income from abroad
(b) Some Accounting Identities at Factor Cost
GNP at factor cost ≡ GNP at market price less net indirect taxes
NNP at factor cost ≡ NNP at market price less net indirect taxes
NDP at factor cost ≡ NNP at market price less net income from abroad
NDP at factor cost ≡ NDP at market price less net indirect taxes
NDP at factor cost ≡ GDP at market price less Depreciation