Part I 1 Introduction Macro Economic 512011

BASIC CONCEPTS OF MACRO ECONOMICS
PART 1: AN INTRODUCTION TO MACRO ECONOMICS
WHAT DO YOU UNDERSTAND BY MACRO ECONOMICS?

Macro Economics: Macro Economics is that branch of economics which studies the aggregate behaviour of economic system. Micro economics deals with the Division of total output among individual units Allocation of scarce resources and pricing of particular product. While macroeconomics studies the gross or total national product, aggregate national income and general price level.

IMPORTANT EXAMPLES: NATIONAL INCOME SAVINGS INVESTMENTS EMPLOYMENT BALANCE OF PAYMENTS: EXPORTS, IMPORTS, TRADE BALANCE EXCHANGE RATE INFLATION BUSINESS CYCLES

CONSTITUENT GROUPS OF ECONOMY: BASICS OF MACRO ECONOMIC ANALYSIS. Households The firms The Government The rest of the World. THEIR INTERACTION WITH EACH OTHER LEADS TO RECEIPT OR PAYMENT OF INCOME.

Purchases of domestically made goods and services by locals
REST OF THE WORLD
Purchases of foreign made goods (services) and services by locals
Purchase of Goods & Services Purchase of Goods & Services

Taxes
FIRMS
(Sell goods & services to Household & Govt. They receive Payments; Firms also pay wages Int and dividends to households Pay taxes to Govt.)
GOVERNMENT
(Collect taxes from households and Firms, Buys goods and services from Firms , pay wages and int. to house Holds; makes transfer payments to Households
HOUSEHOLDS
(Receive income from firms and the Govt.; purchase goods & services from firms; also receive transfer payments, interests, dividends)
Taxes
Wages, Interest, Transfer Payments.
Wages, Interest, Dividends, Profits & Rent
MARKETS
MARKETS IN AN ECONOMY
Economies are generally characterised by the following 3 markets: Goods and Services Market Labour Market Money Market
HOUSEHOLDS
FIRMS
GOVERNMENT
HOUSEHOLDS
Goods & Services Markets
Labour Market
Money Market
Goods and Services Market: Households + Govt. Purchase goods and services from firms in Goods & Serv. Market. Firms also purchase goods and services from each other. Firms supply to the goods and services market. Household supplies labour and firms and Govt. demand them. Rest of the World both buys from and sells to the goods and services market.
Savings from households is sometime termed as a leakage from the income or current purchasing power because it withdraws income or current purchasing power from the system. Firms supply to the goods and services market. Households + Govt. + Firms Demand from this market. Rest of the world both buys from and sells to the Government Goods and Services Markets.
Labour Market: Households Supply Labour Firms and Govt. Demand Labour Rest of the world also demand and supplies Labour . Individual to decide to enter in the labour market and for choosing working hours. In recent times Labour has also become as International market.
Money Market: Households Purchase stocks and bonds from firms. Households Supply funds to Financial/Money Markets. Firms Borrow to build new facilities in the hope of earning more in future. Govt. Borrows by issuing bonds Rest of the World both borrows from and lends to the money market.
Borrowings and lending of households, Government, Firms and Rest of the world is coordinated by Financial Institutions: viz Commercial Banks Development Finance Institutions Non banking finance companies Savings and Loan Associations Insurance Companies (These institutions take deposits from one group and lend them to others)
Rate of Interest plays crucial role in Money Market since on borrowings/loan interest is to be paid. Promissory notes are signed by borrowers to return money to the lender. Firms can raise funds through issue of shares. Share is a financial instrument that gives ownership of a firm to investor and hence right to share profit. Share Price and amount of dividends can increase or fall depending on the performance of the company.
GDP
GDP We will discuss in detail. Here only few observations: GDP is the total market value of a nations output. It is the market value of all final goods and services produced within a given period of time by factors of production located within the country. It is a monetary measure arrived at by finding the sum total of the value of products of quantity produced in any specific year.
GDP
GDP as a measure of the total production of an economy acts as an economic barometer of a nation.
GROSS DOMESTIC PRODUCT (GDP)
GDP
GNP VERSUS GDP: Both measure the total market value of all the final goods and services produced in an economy in one year. The difference between them is only in how the economy is defined. While GNP comprises the total output produced with the resources of a nation regardless of whether these resources are located in that nation or abroad, GDP relates to the value of total output produced within the boundaries of a nation whether by resources of the nation or foreign nations.
GDP
For most nations the difference between GDP and GNP is small.
CALCULATING GDP
GDP Computation can be done in two ways: To add up the amount spent on all final goods during a given period. This is EXPENDITURE CALCULATING GDP. APPROACH TO
The other is to add up the income i.e. wages, rents, interest and profits received by all factors of production in producing final goods. This is the INCOME CALCULATING GDP. APPROACH TO
CALCULATING GDP
These two methods lead to the same value of GDP because every payments (expenditure ) by a buyer is at the same time a receipt (income) for the seller.
CALCULATING GDP
The Expenditure Approach: Corresponding to the four main constituent groups in an economy households, firms, the government and the rest of the world GDP is comprised of these expenditure components:
GDP = Personal Consumption Expenditure (C) + Gross Private Investment (I) + Government Purchases (G) + Net Exports (X)
CALCULATING GDP
PERSONAL CONSUMPTION: Expenditures services. by consumers on goods and
3 main categories of expenses: Durable Goods (viz. automobiles, furniture and appliances lasting relatively longer time) Non Durable Goods (Food, clothing cigarettes used up fairly quickly) and
Payments for services (viz. payments to Doctors, lawyers and educational institutions)
CALCULATING GDP
GROSS DOMESTIC INVESTMENTS (I): Purchase of new capital such as housing, plants and equipment and inventory. Investment can be both by the private sector as well as public sector. Private sector investment is generally categorised into residential and non residential investment. Expenditure on machines, tools, plants etc. is termed as non residential investment.
CALCULATING GDP
Change in Business Inventory is the third category. They are goods produced by the companies with the intention of selling at a later date. Net investment is a measure of the change in the stock of capital during a period. GOVERNMENT PURCHASES (G): It includes newly produced goods and services by central state and local governments.
CALCULATING GDP
It include any goods that the government purchases plus the wages and salaries of all government (It is a payment that the government makes to the employees when it purchases their services as employees).
NET EXPORTS: Net Exports are total exports minus total imports. Net exports can be positive or negative.
GDP = C + I + G + X
CALCULATING GDP
INCOME APPROACH: The income approach to calculating GDP looks at GDP in terms of WHO RECEIVES IT AS INCOME AND NOT WHO PURCHASES IT. GDP = National Income (N) + Depreciation (D) + Indirect Taxes minus Subsidies (T) and Net factor payments to the rest of the world ( F). GDP = N + D+ T + F
CALCULATING GDP
NATIONAL INCOME (N): Total Income earned by factors of production owned by a nations citizens. When output is produced, income is created. The Income that flows to the private sector is called national income. NI = Compensation of employees + Proprietors income+ Corporate profits + net Interest and Rental Income.
CALCULATING GDP
Compensation of employees is the largest of the five items includes wages and salaries paid to households by firms and by the government.
CALCULATING GDP
PROPRIETORS INCOME is the income of unincorporate businesses and CORPORATE PROFITS corporate businesses. are the income of
NET INTEREST is the interest paid by business. RENTAL INCOME a minor item is the income received by property owners in the form of rent.
CALCULATING GDP
Thus NATIONAL INCOME IS THE AGGREGATE FACTOR INCOME THAT ARISES FROM THE CURRENT PRODUCTION OF GOODS AND SERVICES AND SERVICES BY THE NATIONS ECONOMY.
CALCULATING GDP
DEPRECIATION (D): The measure of fall in values of capital assets is called depreciation. Since national income includes corporate profits after the depreciation (i.e. it has been deducted) so depreciation must be added back. INDIRECT TAXES SUBSIDIES (T): Since indirect taxes are counted on the expenditure side, they must also be counted on the income side.
CALCULATING GDP
SUBSIDIES: They are payments made by the Government for which it receives no goods or services in return. These subsidies are subtracted from national Income to get the GDP.
CALCULATING GDP
NET FACTOR PAYMENTS TO THE REST OF THE WORLD: Net factor payments to the rest of the world equal the payments of factor income to the rest of the world minus the receipts of factor income from the rest of the world.
GDP EQUILIBRIUM
For analysis of equilibrium of GDP following assumptions are made: 1. GDP is ultimately determined by Aggr. Demand 2.Investment spending is constant with respect to changes in Income and 3.Consumption increases with the level of Income. EQUILIBRIUM LEVEL OF GDP is determined through the equation of Aggregate demand and Aggregate supply:
GDP EQUILIBRIUM
AGGREGATE DEMAND represents the expenditure that the households and the firms are undertaking on consumption and investment: Aggregate Demand = Consumption Demand + Investment Demand. [ Y = C + I ]
Consumption Demand depends on:

Income and consume. Propensity of community to
GDP EQUILIBRIUM
Investment Demand:
Is a function of the Marginal Efficiency of Capital means expected rate of profit that the firms hope to get from the investment in capital assets and Interest.
AGGREGATE SUPPLY: Total Money value of goods and services produced in the economy i.e.
GDP EQUILIBRIUM
It comprises of Output of final consumer goods and services and the output of capital or investment or producer goods. Aggregate Supply of goods in an economy depends upon the stock of capital, the amount of labour and the state of technology. Aggregate Supply represents GDP since both represent the value of output of final goods and services produced.
DETERMINATION OF GDP (GDP EQUILIBRIUM)

Demand Aggregate Demand [EFFECTIVE DEMAND] = Aggregate Supply Effective Demand
Expenditure =Output 450

C + I (Total Spending)
E
Consumption Function C
in end l Sp Tota
PLOT C; ADD CONSTANT I GET TOTAL SPENDING
t utpu =O
N* Output (income), N
EQUILIBRIUM GDP CALCULATION

Output (Income) 100 120 140 160 180 200 Consumption Savings C S 105 120 135 150 165 180 -5 0 5 10 15 20 Investment I 10 10 10 10 10 10 Aggregate Expdt.(C+I) 115 130 145 160 175 190
GDP EQUILIBRIUM (KEYNESIAN CROSS)

Simplest Model to explain how determines output in the short run. demand
It is a graph with the demand for goods and services represented on the vertical axis, output (income) represented on the horizontal axis and a 450 diagonal line representing a key relationship between demand and output. ASSUMPTIONS: Neither the Govt. nor Foreign Sector exist.
GDP EQUILIBRIUM (KEYNESIAN CROSS)

Only consumers and firms can demand output where consumers demand consumption goods and firms demand invest goods. Consumption and firms each demand a fixed amount of goods. Output = Demand = C + I On the demand output diagram line representing demand (C+ I) is superimposed. E is equilibrium point where output measured on the horizontal axis equals demand by consumers and firms measured on the vertical axis.
GDP EQUILIBRIUM (Kenynesian Cross)

450
Demand
E
E2
E1 C + I
N 2
N*
N 1
Output (income), N
Inflationary Gap
Expenditure =Output C + I + G C+I+G C + I + G
Deflationary Gap
GDP EQUILIBRIUM
Algebraic Analysis: N=C+I Consumption function is defined as under: C = a + bN Hence Y= a + bN + I (1 - b) N = a + 1 N = (a + 1) / (1 - b) N = 1/ (1-b) [ a + 1 ] This indicates Equilibrium Income.
AGGREGATE EXPENDITURE THEORY

The theory explains: 1. How an economys equilibrium real GDP relates to the total spending and 2. How a change in total spending affects the level of real GDP. Assumptions: 1. Closed Economy i.e. the one where there are no international trade transactions 1. Economy is private economy i.e. Govt. Sector does not exists 2. All Savings are personal savings 3. Depreciation and net foreign factor income are zero.

The aggregate expenditure theory implies that the amount of goods and services produced or the level of employment in an economy depends directly on the level of aggregate expenditure. Workers and machinery are idle when there are no markets for the goods and services that they can produce. For better appreciation of theory we need to have deeper understanding of consumption and savings CONSUMPTION AND SAVINGS: N=C+S Savings is done at the cost of additional spending. Savings and investment may not necessarily be equal
GDP EQUILIBRIUM (Kenynesian Cross)

450
Demand
Consumption
E1
N 1
Output (income), N

Consumption Function:
Consumption function is defined as under: C = a + bN C- Consumption Spending of Income a and b are constant. a- Part of consumption that is independent of Income (Necessities i.e. food, clothes etc.) Such Expenses independent of income is also known as Autonomous Consumption bMarginal Propensity to consume. (how much consumption spending change for every rupee change in income)
Consumption Function
Consumpt ion
Consumption Function C=a+bY

Slope=b b <1
Autonomous Consumption
Output (Income)
Shifting/Change in Consumption Function

Consumption
C(Slope b=b )C(Slope b)
Consumption
C(Slope b)
C(Slope b)
Increase in Autonomous Exp. will shift entire consumption function
Increase in MPC without Any change in a will change the consumption function Output (Income)
Output (Income)

Autonomous Consumption can change due to several reasons such as a change in consumer wealth, a change in consumer confidence etc. Marginal propensity to consume can change due to consumers perceptions of changes in their income and changes in tax rates etc.

SAVINGS: When all that is earned is not spent there could be Savings. Excess of Income over Consumption : S = Y-C Savings depends on propensity to save: PC (Prop.to consumer S/N) + PS (Propensity to Save)-1 hence PS = 1- PC Savings = Households Savings + Firms Savings (Deducting dividends from profits) + Government Savings (Public Revenue Public Expenses). Factors affecting Savings: Income; Distribution of Income; rate of interest ; population; consumption pattern; Political Stability
CONSUMPTION SCHEDULE
Consumption
Savings
Consumption
E
C
Dissavings
Break Even Income
Income
SAVING SCHEDULE
Savings
Saving Schedule
Savings
O
Dissavin g
Breakeven Income
Income
N 1

Output Level Consump Savings APC tion C S (Y-C) C/Y APS S/Y MPC MPSdelta s/delta Y
100 120 140 160 180 200
105 120 135 150 165 180
-5 0 5 10 15 20
1.0500 -0.0500 1.0000 0.0000 0.75 0.9643 0.0357 0.75 0.9375 0.0625 0.75 0.9167 0.0833 0.75 0.9000 0.1000 0.75
0.25 0.25 0.25 0.25 0.25

AVERAGE AND MARGINAL PROPENSITIES APC = Consumption /Income = C/N APS = Savings/Income = S/N APC falls with the increase in income ; APS rises as the income increases . The fraction of total income that is consumed, declines as the income rises and the fraction of income that is saved rises as the income increases. APS + APC = 1 MPC= Change in Consumption /Change in Income MPS = Change in Savings/ Change in income MPS + MPC = 1

FACTORS AFFECTING CONSUMPTION/SAVINGS: WEALTH INDEBTNESS TAXATION AND AVERAGE SIZE AND AGE OF HOUSEHOLDS Generally it is observed that the amount of consumption increases with the increase in wealth accumulated by the households. For obvious reasons the amount of saving will decrease in such a case. Wealth means both real as well as financial assets that the households own.
Real and Financial Assets
Real Assets HOUSE CAR TELEVISION FRIDGE COMPUTER
Financial Assets CASH SHARES BONDS BANK DEPOSITS GOVT. SECURITIES
INVESTMENT
INVESTMENT: It is the addition to the total physical stock of capital Buying securities which is commonly referred to as investment is not really investment. It is merely a change in the ownership of assets that already exist. In Economics Investment signifies the new expenditure on addition of capital goods and inventories. Investment raises aggregate demand and in turn increases the level of in income and employment in the economy.
INVESTMENT
Private Investment depends on Marginal Efficiency of Capital (MEC) and the Available Rate of Interest (ARI). Investment will be made only when the MEC is greater than the ARI. Marginal Efficiency of capital is the discounting rate that equates the present value of the cash flows generated by an investment project to the present value of cash outflows that is the cost of that investment project.
INVESTMENT
EQUALITY BETWEEN SAVINGS AND INVESTMENT: By definition in actual sense Savings and Investment are always equal. However they are equal only in equilibrium. An Economy will be in equilibrium when the aggregate level of investment equals the aggregate domestic savings.
S= I S>I S<I
Suppose Savings increases Consumption will decline Inventories with the manufacturers and/or traders will rise This addition to the inventories though not planned will raise the level of investment Thus investment will become equal to savings & vice versa.
INVESTMENT
REAL INTEREST RATE: Nominal interest rate Rate of Inflation The real rate of interest rather than the nominal interest rate is crucial in making investment decisions.
Expected rate of net profit/ Real Int. rate
Investment Demand Curve
Investment
INVESTMENT
Other factors which affect Investment decisions: Acquisition and operating costs for machines Corporate Taxes Technological change Future Expectations.
UNEMPLOYMENT
UNEMPLOYMENT
Why Full Employment? All economies seek to achieve full employment and eliminate unemployment. Employment refers to the condition where large number of able bodied persons of working age who are willing to work can get work at current wage levels. Full Employment may be defined as a situation wherein all those who are willing and able to work at the prevailing wage rate are in fact employed for the work in which they are trained. In the state of full employment, when all existing resources are fully and efficiently employed output will be maximum.
UNEMPLOYMENT
Employment refers to the condition where large number of able bodied persons of working age who are willing to work can get work at current wage levels. When such persons cannot get work it is considered to be a case of unemployment. When persons are only partially employed or are employed in inferior jobs though can do better ones, said to be underemployed.
UNEMPLOYMENT
Unemployment refers to any unused resource whether land, labour or capital. In each case a cost to the economy is involved.
In the production side of the national accounts the cost is the value of commodities that could not be produced . While on the income side of the account the cost is loss of wages and salaries, rent and interest for labour, land and capital respectively. Of all resources, labour is the one on which most attention is concentrated .
UNEMPLOYMENT
Reasons for such concentration: 1.Statistics on unemployed labour serves as a fairly reliable indicator of total unemployment. 2.Costs of human unemployment are usually more obvious and dramatic than the costs of other kinds of unemployment. 3. Labour is usually the sole productive resource that a household has to sell. 4. When labour resources are unemployed there is loss of total future output. 5. Human resources depreciates more quickly than other kinds of resources.
UNEMPLOYMENT
More Specific Meaning of Unemployment: Unemployment refers to the situation where a person is not employed but is available for work and has made specific efforts to find work during the previous four weeks. A person not looking for work, either because he or she does not want a job or has given up looking for a job is classified not in labour force. People not in labour force include full time students, retirees and those staying home to take care of children or elderly parents.
UNEMPLOYMENT
Total labour force in the economy is the number of people employed plus the number of people unemployed that is: Labour Force = Labour Force + Not in labour force Unemployment Rate = Unemployed/ (Employed + Non Employed) The ratio of the labour force to the population 16 years old or over is called the Labour force participation rate Labour Participation Rate = Labour Force /Population.
TYPES OF UNEMPLOYMENT
TYPES OF UNEMPLOYMENT: Frictional Unemployment: It is unemployment occurs during normal working of an economy. that
It is not possible for every worker to be employed every single working day of his life. Some will voluntary switching jobs, others will have been fired and are seeking reemployment Some would be temporarily laid off from their jobs due to other factors. Frictional correctly implies that the labour market is not perfect or instantaneous that is it is not without friction in matching worker and the job.
FACTORS: People change jobs , move across the nation, get laid off from their job, takes time for search of jobs. As jobs become more and more complex and the number of required skills increases matching skills and jobs becomes more complex and the frictional unemployment rate may rise Seasonal Unemployment: When a particular productive activity is seasonal in nature and the persons employed in it, become unemployed during the slack season the type of unemployment is called seasonal unemployment. Frictional Unemployment is inevitable and sometimes desirable.
STRUCTURAL UNEMPLOYMENT: Unemployment due to changes in industrial structure, structure of consumer and in technology altering the structure of total demand for labour. Demand for skills alters; some skills becomes obsolete and some jobs need new skills. Reluctance of worker to move to new locations also lead to unemployment. Such workers are potentially employable but firm in their area is willing to pay the salaries they demand for the skills that they possessed.
Although the unemployment that arises from such structural shifts could also be classified as frictional, it is usually called Structural Unemployment . The distinction between frictionally unemployed and structural unemployment is hazy. However, the main difference is that frictionally unemployed workers have saleable skills, whereas the structurally unemployed workers are not readily re employable without retraining, additional education and possibly geographic relocation. Frictional unemployment is used to denote short run job/ skill matching problems that last a few weeks.
Structural unemployment on the other hand denotes long run adjustment problems that tend to last for years. Cyclical Unemployment: The increase in unemployment that occurs during economic recessions and depressions is called cyclical unemployment. During recession the effective demand decreases. As a result in owners to survive in the businesses reduce their production. Some factors of production thus become unemployed causing the cyclical or Keynesian unemployment.
Level of unemployment may be linked directly to the level of total spending. When spending decreases business firms must cut back on production and consequently they are unable to buy as many resources including labour as offered for sale. A recession causes a decline in real GDP or real output. Cyclical Unemployment rises during periods when real GDP or economy grows at a slower than normal rate and decreases when economy improved . As the overall demand for goods and services decreases, employment falls and unemployment increases. For this reason the cyclical unemployment at times is also called deficient unemployment.
COSTS OF UNEMPLOYMENT: Economic losses to both society and individuals. Excess unemployment means that the economy is no longer producing at its potential. Social loss translates into reduced income and lower employment for individuals. When unemployment increases more workers are fired or laid off from their existing jobs and individuals seeking employment find fewer opportunities available. To families with fixed obligations such as mortgage payments the loss in income can bring immediate hardships.
The costs of unemployment are not simply financial. A persons status and position are largely associated with the type of job the person holds. Losing a job can impose severe psychological costs. Some studies have found that increased crime, divorce and suicide rates are associated with increased unemployment. EMPLOYMENT STRATEGIES: Growth oriented Strategies Wage goods strategy Labour intensive technology strategy and Rural public work strategy of employment.
BUSINESS CYCLE
BUSINESS CYCLE
GROWTH CYCLES: Change is a universal phenomenon and business are no exception. Whenever they are affected by the external environment which itself is highly volatile they cannot remain constant for all times. No nation can have a steady economic growth in the long run.
BUSINESS CYCLE
The economic growth will intermittently be interrupted by periods of economic instability. Conventional Business Cycle analysis has been useful in the Industrially Developed countries which have generally experienced short expansionary and contractionary phase in the level of economic activities resulting in low average growth rate. Developing and emerging market economies experience continuous expansion or contraction in the level of economic activities.
BUSINESS CYCLE
Trend component of the series selected for depicting the fluctuations turn out to be so significant that it becomes difficult to visually discern the cyclical component even after accounting for seasonality.
In such economies certain indicators of economic activities increases so rapidly that it appears that there are no recessions that the economy is witnessing a continuous expansion over a very long period of time.
BUSINESS CYCLE
A closer analysis using slightly different tools reveals that cyclicity does exist even in these cases though they are not apparent. A growth cycle is a plot of the deviations of the actual growth rate of the economy from its long run trend rate of growth or the full employment output
PHASES OF GROWTH CYCLES

A Business cycle consists of a period of economic expansion followed by a period of economic contraction. PHASES OF BUSINESS CYCLE: 1. Expansion Peak 2. Contraction (Recession) Trough (Phases: Recovery, Expansion, Slowdown and Recession)

A recession is roughly a period in which real GDP declines for at least two consecutive quarters. An expansion is just reverse. When recession becomes severe it is known as depression. Investment spending, Consumption and share prices are all pro-cyclical. Unemployment is counter cyclical.

RECOVERY: Usually cycle picks up from trough. Rate of growth remains lower than what is possible at the full employment level of output. Mild Increase in prices Inflation rate increases as the economy approaches the trend line or full employment line. Mild increase in the inflation rate below the full employment level of output is known as
reflation

EXPASION: Economy expands at the rate of growth which is higher than the rate of growth at full employment level of output. Rapidly increasing inflation rate. Economy crosses the full employment level of output Level of output, the wages and other prices start rising at a rapid rate

SLOW DOWN Economy operates above the full employment level of output but the rate of growth decelerates and remains less than the peak growth rate achieved by the economy. Slowdown is associated with the slowdown in the rate of increase in the price level i.e. price level increase in this phase but at a declining rate. The decline in the rate of growth of overall price level and inflation rate above the full employment level of output is known as Disinflation

RECESSION: In this phase there is a contraction in economic activities. The actual growth rate is lower than the growth rate at the full employment level. Prices start declining in absolute term and the economy achieves negative growth rate in prices. Absolute decline in prices below the full employment level of output is known as Deflation.

DEPRESSION: The country faces a depression when the recession is widely felt in the economy i.e. not only there is overall recession in the economy but most of the sectors of the economy are going through the recessionary phase and recessionary phases is prolonged for a very long period of time. High Unemployment . Government is not able to stimulate economy by various policy changes. the

Price level declines in sharply in absolute terms. These phases can be broadly clubbed under two broad categories: High growth phase and Low growth phase. The high growth phase consists of recovery and expansion in growth rates whereas low growth phase corresponds to slowdown and recession in the growth rates.

USEFULNESS: Growth cycles have been found useful in understanding the relationship between output, inflation and unemployment. However trend estimation is an important step in determination of cycles through deviations. Growth cycles depend on an distinction between trend and cycle. arbitrary
In certain cases the same shock affects both long run growth and business cycle fluctuations which make segregation of the cyclical component from the trend component difficult.
MONEY DEMAND AND SUPPLY
MONEY AND MONEY SUPPLY

MONEY: Money is anything that is generally accepted as a medium of exchange. People take it for granted that they can walk into any store, restaurant or boutique and buy whatever they want as long as they have enough currency notes in their pocket. 3 crucial functions of Money: A.MEDIUM OF EXCHANGE Money is exchanged for goods and services when people buy things and goods or services are exchanged for money when people sell things.

No one ever has to trade goods for other goods directly. B. STORE OF VALUE Money also serves as a store of value that is an asset that can be used to transport purchasing power from one time period to another. Money is advantageous to other medium like Gold, Silver, Diamond, antique paintings etc. in which value could be stored. 1. It comes in convenient denomination 2. Can easily be exchanged for goods at all times. Disadvantage: The value of money falls in inflationary conditions hence it needs to be converted into some valuable assets.

C. A UNIT OF ACCOUNT:
monetary units)
(All prices are quoted in
Money also serves as a unit of account, a consistent way of quoting prices.
All prices are quoted in monetary units. Thus MONEY MAY BE DEFINED AS ANYTHING THAT IS GENERALLY ACCEPTABLE AS A MEANS OF EXCHANGE AND AT THE SAME TIME CAN BE USED AS A MEASURE OF STORE OF VALUE. The Government declares its paper money to be legal tender and must be accepted in settlement of debts. It does this by fiat and hence the term fiat money.

MONEY SUPPLY:
Total Stock of Money available to society for use in connection with the economic activity of the nation at a point of time. It comprises of two elements namely : A. Currency with public (households, firms and institutions other than banks and the Government). Currency with the public is the sum total of the currency notes in circulation issued by the RBI, no. of rupee notes and coins in circulations and small coins in circulation The Cash Reserves with banks must remain with them and hence have to be deducted from the above sum. B. Demand deposits with the public.

The demand deposits with the public are the bank deposits held by the public. Bank deposits are either demand deposits or time deposits. While demand deposits can be withdrawn by the public by drawing cheques on them, time deposits mature only after fixed period and are money that people hold as a store of value. MEASURING MONEY SUPPLY: Money Supply M1 :Narrow Measure of Money Supply M1 = C +DD + OD [where C= Currency notes and coins with the public; DD= Demand Deposits with all commercial and cooperative banks; OD= Other deposits with the Central Bank]

M1 is also known as transactions money. This is the money that can be directly used for transactions, that is, to buy things. Further, M1 is stock measure, that is, it is measured at a point in time. It is the total amount of currency notes and coins outside of banks and the total amount in demand deposits on a specific day. Since the money included in M1 can easily be used as a medium of exchange it is the most liquid measure of money supply.

Money Supply M2:
Broader Concept of Money M2 = M1 + SD Where SD= Savings Deposits with post office savings banks. SB with post offices are in between demand deposits with banks and time deposits with banks, with regard to liquidity.

Money Supply M3:
M3 is broad concept of money supply. It includes time deposits with banks in addition to the money supply M1: M3 = M1 + TD Where TD is time deposits with all commercial and cooperative banks. This measure uses time deposits because although time deposits cannot be withdrawn through drawing cheques on them but loans from banks can easily be obtained against such deposits. Further, they can be withdrawn any time by foregoing some interest earned on them.

Of late M3 has become a popular measures of money supply.
MONEY SUPPLY M4:

This measure includes deposits with post office savings organisation besides M3. It is however excludes contributions made by public to the National Savings Certificates. Whatever may be the measure, Money Supply is determined by four factors: 1. 2. 3. 4. Bank Credit to Government Bank Credit to Private Sector Changes in net foreign exchange assets and Governments currency liabilities to public.
THE BANKING SYSTEM

Most of the money today is bank money of one type or another. Banks and other financial intermediaries borrow from individuals or firms having excess funds and lend to those who need funds. Banks and bank like institutions are called financial intermediaries because they mediate or act as a link between people who have funds to lend and those who need to borrow. Commercial banks, developmental finance institutions, non banking finance companies, savings and loan associations, life insurance companies and pension funds are various categories of financial intermediaries.
THE BANKING SYSTEM

ACCOUNTING IN BANKS: For a bank assets include the bank building, its furniture, its holdings of government securities, cash in the vaults, bonds, stocks and so on. Most important among assets are loans. A borrower gives the bank an IOU a promise to repay a certain sum of money on or by a certain date. This promise is an assets of the bank because it is worth something. The bank could and sometimes does sell the IOU to another bank for cash.
THE BANKING SYSTEM

Other bank assets include cash on hand and deposits with the central bank. A firms liabilities are its debts or the amount it owes to any one, A banks liabilities are the promises to pay or IOUs that it has issued. A banks most important liabilities are its deposits. Deposits are debts owed to the depositors because when money is deposited in account we in essence making a loan to the bank. Excess Reserves Reserves. = Actual Reserves Required
THE BANKING SYSTEM

If banks give loans up to the point where they can no longer do so because of the reserve requirement restriction, it means that banks give loans up to the point where their excess reserves are zero. The basic rule of accounting says that if we add up a firms assets and then subtract the total amount it owes to all those who have lent it funds the difference is the firms net worth. Net worth represents the value of the firm to its stockholders or owners. Cash Reserve Ratios and Statutory Liquidity Ratios are the two types of reserves ratios .
THE BANKING SYSTEM
MONEY CREATION: Banks usually can not give loans upto the point where they want to do because of the reserve requirement restrictions. A banks required amount of reserves is equal to the required reserves ratio to the total deposits in the bank. The difference between a banks actual reserves and its required reserves is excess reserves.

Whatever may be the measure used Money Supply is determined by four factors namely: 1. 2. 3. 4. Bank Credit to Government Bank credit to private sector Changes in Net foreign exchange assets and Govts currency liabilities to public.
Because a wide variety of financial instruments bear some resemblance to money, it has been advocated to include almost all of them as part of the money supply. In recent years for example credit cards have come to be used extensively in exchange . One of the very broad definitions of money includes the amount of available credit cards as part of the money supply.
CENTRAL BANK AND MONEY SUPPLY

3 Tools are available to the Central Bank for controlling the money supply a. Changing the required reserve ratio b. Changing the discount rate and c. Engaging in open market operations. REQUIRED RESERVE RATIO: The required reserve ratio establishes a link between the reserves of the commercial banks and the deposits (money) that commercial banks are allowed to create. Reserve requirement effectively determines how much money is available with the bank to lend.
Since money supply is equal to the sum of deposits inside banks and the currency in circulation outside banks, reserves provide the leverage that the Central Bank needs to control the money supply.

Reserves are of 2 types: 1. Cash Reserve Requirements ( CRR) and 2. Statutory Liquidity Ratio ( SLR) CRR is the percentage of total deposits of a bank that it has to keep with the Central Bank in the form of cash. Statutory Liquidity Requirement (SLR) refers to the portion of the total deposits of a bank it is required to keep with itself in the form of specified liquid assets that is cash plus approved government securities. Decreases in the required reserve ratio allow the banks to have more deposits with the existing volume of reserves. As banks create more deposits by making loans, the supply of money increases. And vice versa

Central bank generally makes less use of the changes in the reserve requirement to control the money supply. Since CRR earns no interest the higher the reserve requirement the more the penalty imposed on those banks holding reserves. This affects the performance of the banks. It is also true that changing the reserve requirement ratio is a crude tool. Because of lags in banks reporting to the Central bank on their reserve and deposit position a change in the requirement today does not affect banks for about two weeks.

Discount Rate: Interest rate banks pay to the central borrowing money is known as discount rate. banks to
When banks increase their borrowing , the money supply increases. Through discounting rates Central Bank can influence bank borrowing . The higher the discount rate, higher is the cost of borrowing and the less borrowing banks will want to do . Central Banks use the discount rate to control the money supply.
It does change the discount rate from time to time to keep it in line with other interest rates viz. it raises the discount rate and discourages banks from borrowing from it thus restricting the growth of reserves and ultimately deposits.

OPEN MARKET OPERATIONS: Most significant tool. It refers to buying and selling of government securities by the Central Bank When sells some of holdings of government securities to the general public Central banks holding of such securities will decrease . Purchasers of securities pay for these securities by writing cheques drawn on their banks and payable to the Central Bank. Thus the money supply would contract . Money supply could be increased by buying government securities from people who own them .
Each day the open market desk at Central bank buys or sells government securities usually to large security dealers who ct as intermediaries between the central bank and the private markets.

An open market purchase of securities by the Central Bank results in an increase in reserves and an increase in the supply of money by an amount equal to the money multiplier times the change in reserves. Similarly an open market sale of securities by the Central Bank results in a decrease in reserves and a decrease in the supply of money by an amount equal to the money multiplier times the change in reserves. Open market operations are the Central Banks preferred means of controlling the money supply for several reasons: Central Bank needs to change the money supply by just a small amount, it can buy or sell a small volume of government securities.
SUPPLY CURVE FOR MONEY

Open market operations are extremely flexible. If the Central Bank decides to reverse the course it can easily switch from buying securities to selling . Finally open market operations have a fairly predictable effect on the supply of money. A Vertical money supply curve signifies that the Central Bank sets the money supply independent of the interest rate. Interest rate does not affect the RBIs decision on how much money to supply.
SUPPLY CURVE FOR MONEY

Sm Interest Rate r
Money M
DEMAND CURVE FOR MONEY

Interest rate and the level of National Income influence how much money households and firms wish to hold. Demand depends on how much of the financial assets the household or the firm wants to hold in the form of money that does not earn interest versus how much it wants to hold in interest bearing securities such as bonds . Motives behind demand for money: Transaction Motive: The decision to hold money involves a trade off between the liquidity of money and the interest income offered by other kinds of assets.
Holding Money without interest is useful for daily transactions by households.

The precautionary motive: Households and firms may hold money more than what they require for their current transactions considering uncertainty of future receipts and expenditure as a precaution. It varies with income and is inversely related to the interest rate. The Speculative Motive. There are several theories to explain why the quantity of money households desire to hold may rise when interest rates fall and fall when interest rates rise. One involves household expectation and the relationship of interest rates to bond values.

When market interest rates fall , bond values rise and when market interest rates rise bond values fall. Desire to hold money balances instead bonds: If market interest rates are higher than normal they may expected to come down in the future. If and when interest rates fall , the bonds that were bought when they were high will increase in value. When Interest rates are high, the opportunity cost of holding cash balances is high and there is speculation motive for holding bonds in lieu of cash, a speculation that interest rates will fall in the future.

TOTAL DEMAND FOR MONEY: The total quantity of money demanded in the economy is the sum of the demand for demand deposits and cash by households and firms. Firms as well as households can hold their assets in interest earning form. For manage their assets just a households do keeping some in their chequeable accounts and some in bonds. A higher interest rate raises the opportunity cost of money for firms as well as households and thus reduces the demand for money.

Interest Rate r
Dm
Money M
EQUILIBRIUM INTEREST RATE

Money supply curve is a vertical line since it is independent of interest rates in the economy. For the objective central bank uses its 3 tools (Reserve Ratio, discount rate and opern market operations) At r* the quantity of money in circulation that is the money supply equal to the quantity of money demanded. At r1 the quantity of money demanded is Dm1 and the quantity of money supplied exceeds quantity of money demanded . This means there is more money in circulation than households and firms want to hold

Firms and households therefore will attempt to reduce their money holdings by buying bonds. When demand for bonds Is high, those looking to borrow money by selling bonds will find that they can do so at a lower interest rate. If the interest rate is initially high enough to create an excess supply of money the interest rate will immediately fall , discouraging people from moving out of money and into bonds. At r 2 quantity of money demanded (Dm 2 ) exceeds the supply of money currency in circulation.

The households and firms do not have enough money on hand to facilitate ordinary transaction. They will try to adjust their holdings by shifting assets out of bonds and into their bank accounts. At the same time the continuous flow of new bonds being issued must also be absorbed. The government and corporations can sell bonds in an environment where people are adjusting their asset holdings to shift out of bonds only by offering a high interest rate to the people for money , the interest rate will immediately rise discouraging people from moving out of bonds and into money.
MONEY SUPPLY AND INTEREST RATES

Central bank can affect the interest rates. It can reduce the interest rates by expanding the money supply ( Sm) . To expand money the Central Bank can reduce the reserve requirement, cut the discount rate or buy government securities in the open market. All these practices expand the quantity of reserves in the system. Banks can grant more loans and the money supply expands the initial money supply curve and shifts it to the right from Sm 0 to Sm 1 .

At r0 there is an excess supply of money .This immediately put pressure on the interest rates as households and firms try to buy bonds with their money to earn that high interest rate. As this happen the interest rate falls and it will continue to fall until it reaches the new equilibrium interest rate, r1. At this point Sm 1 = Dm and the market is in equilibrium.

If central bank wanted to drive the interest rate up , it would contract the money supply. It could do so by increasing the reserve requirement by raising discount rate or by selling government securities in the open market. The result would be lower reserves and a lower supply of money. Also Sm0 will shift to Sm r 0 to r 1.
1
. lowers the interest rate from
MONEY DEMAND AND INTEREST RATES

The equilibrium interest rates can also be affected by shift in money demand. The demand for money depends on both the interest rate and the volume of transactions. We use the level of aggregate output (income) as a rough measure of the volume of transactions. The relationship between money demand and aggregate output (income), N is positive that is increases in N means a higher level of real economic activity and vice versa. More is being produced, income is higher and there are more transactions in the economy.
Consequently the demand for money on the part of firms and households in aggregate is higher. Thus an increase in N shifts the money demand curve to right.

The result is an increase in the equilibrium level of interest rate from r0 to r1. Money Demand Curve also shifts when the price level changes. If the price level rises, the money demand curve shifts to the right because people need more money to engage in their day to day transactions.

Interest Rate r Sm
r1 r* r2 E
Dm
D m1
D m2
D m3
Money M
INCREASE IN MONEY SUPPLY & INTEREST RATE

Interest Rate r
r0 r1
E0 E1 Dm
s m0
s m1
Money M
INCREASE IN MONEY SUPPLY & INTEREST RATE
FISCAL AND MONETARY POLICIES
FISCAL POLICY
Fiscal Policy is a tool , in the hands of a government to influence the level of GDP in the short run using taxes and government spending. It is about bringing changes in taxes and spending so as to affect the demand for goods and services and hence the output in the short run. Total Spending of the Government : Total Spending = C + I+ G where C- Autonomous consumption I- Investment G- Government Purchases. Any increase in the government purchase increases the total spending and hence the shift in line presenting C+ I+ G upwards
FISCAL POLICY
Multiplier for Government spending = 1/ (1- MPC) An increase in the government spending raises GDP ( Income). The increase in income generates further increase in demand as consumers increase their spending The government programs affect the disposable personal income of the households. The consumption spending depends on income after taxes and transfers or N T where T are the net taxes.
FISCAL POLICY
Multiplier for Government spending = 1/ (1- MPC) An increase in the government spending raises GDP ( Income). The increase in income generates further increase in demand as consumers increase their spending The government programs affect the disposable personal income of the households. The consumption spending depends on income after taxes and transfers or N T where T are the net taxes.
FISCAL POLICY
The consumption faction with taxes is C= C0 + b (N T) As the level of taxes increases , the demand line will shift downward by b ( the increase in taxes) and the equilibrium income will fall from N0 to N2 Demand line does not shift by the same amount with taxes as it does with government spending, the formula for tax multiplier is slightly different:
Tax Multiplier = - b /(1-b)
FISCAL POLICY
The tax multiplier is negative because increases in taxes decrease disposable income and lead to a reduction in consumption spending. The multiplier for Government spending is larger than the multiplier for taxes. Equal increases both in taxes expenditure will increase GDP and government
The multiplier for equal increases in government spending and taxes is also known as the balanced budget multiplier because equal changes in government spending and taxes will not unbalance the budget. When the govt. increases its cuts its spending or cut taxes to stimulate the economy it will increase the governments budget deficit.
FISCAL POLICY
Fiscal policy is a very important tool of macroeconomic policy to stabilise the economy i.e. to overcome recession and to control inflation. EXPANSIONARY FISCAL POLICY: Any Expansionary fiscal policy is an increase in government spending (G) or a reduction in net taxes (T) aimed at increasing aggregate output (income) (N) . Government purchases and net taxes are the tow tools of a government fiscal policy. Government can stimulate the economy i.e. it can increase aggregate output (income) either by increasing government purchases or by reducing net taxes.
FISCAL POLICY
An increase in expenditure causes firms inventories to be smaller than planned, unplanned inventory reductions stimulates production and firms increase output.
FISCAL POLICY
However because added output means added income , some of which is subsequently spent consumption spending also increases . Again inventories will be smaller than planned and output will rise even further . The final equilibrium level of output is higher by a multiple of the initial increase in government purchases. Effects of an expansionary fiscal policy: G or T N Dm r I
FISCAL POLICY
CONTRACTIONARY FISCAL POLICY: Any government policy that is aimed at reducing aggregate output ( Income) is said to be contractionary. It is used for controlling inflation because a decrease in aggregate spending will bring down the rising prices. A contractionary fiscal policy is a decrease in government spending (G) or an increase in net taxes (T) aimed at decreasing aggregate output (income) (N) . G or T N Dm r I
------ finer aspects to be mentioned
MONETARY POLICY
Monetary policy: It is a tool that incorporates the actions that the Central Bank takes to influence the level of GDP. Central Bank can influence the level of output in the short run through open market operations, changes in reserve requirements or changes in the discount rate. These tools can be used to form a suitable monetary policy in the times of both recession as well as inflation. The aggregate demand can be raised in recession period by adopting an expansionary or easy monetary policy while it can be reduced to control inflation through a contractionary or tight monetary policy.
MONETARY POLICY
EXPANSIONARY MONETARY POLICY: An expansionary monetary policy is an increase in the money supply aimed at increasing aggregate output (income) N. Using an expansionary monetary policy when the central bank decides to increase the supply of money, the increase in the quantity of money supplied pushes down the interest rate. Lower Interest rate causes planned investment spending to rise. The increased planned investment spending means higher planned aggregate expenditure which in turn means increased output as firms react to unplanned decreases in inventories.
MONETARY POLICY
This increase in output (income) leads to an increase in the demand for money and the money demand curve shifts to the right. This means that interest rate decreases less than it would have if the demand for money had not increased. The entire sequence of events depicting the effects of an expansionary monetary policy can be summed us as follows: M
s
r I N
MONETARY POLICY
CONTRACTIONARY MONETARY POLICY: Contractionary monetary policy leads to a decrease in the money supply aimed at decreasing the aggregate output ( income) . Using such policy when Central bank decreases the money supply through either open market sale of government securities, increasing the required reserve ratio or increasing the discount rate, the interest rate in the economy also rises. Since the level of planned investment spending is a negative function of the interest the higher the interest rate the lower the planned investment.
MONETARY POLICY
The lower planned investment means a lower planned aggregate expenditure and hence a lower equilibrium level of output (income) . The lower equilibrium income results in a decrease in the demand for money which means that the increase in the interest rate will be less than it would be if we did not take the goods market into account. Ms r I N
AGGR.DEMAND & AGGR. SUPPLY FOR MONETARY AND FISCAL POLICIES

The effects of aggregate supply/aggr. Demand (AS/AD) framework can be effectively used to consider the effects of monetary and fiscal policy. The effects however will be different in short run and long run. SHORT RUN IMPACTS: While an expansionary policy shifts the AD curve to the right, a contractionary policy shifts it to the left. The impact of policy change will depend on where along the short run AS curve the economy is at the time of the change.
If the economy is initially on the flat portion of the AS curve, (PointA) then an expansionary policy which shifts the AD curve to the right results in a small price increase relative to the output increase.

The increase in in equilibrium output ( from N o to N1 ) is much greater than the increase in equilibrium price level ( from P0 to P1) . This is the case in which an expansionary policy works well. There is an increase in output with little increase in the price level. If the economy is initially on the steep portion of the AS curve , then expansionary policy results in a small increase in equilibrium output ( from N0 to N1) and a large increase in the equilibrium price level ( from P0 to P1)

In this case an expansionary policy does not work wellgher price level with little increase in output. Igt results in a much h The multiplier effect is therefore close to zerio. Output initially close to capacity and any attempt to increase it further leads mostly to the higher price level.

Thus it is important to know where the economy is before a policy change is put into effect. The economy is producing on the nearly flat part of the AS curve if most firms are producing well below capacity. When this is the case, firms will respond to an increase in demand by increasing output much more than they increase prices. If the economy is producing on the steep part of the AS curve, firms are close to capacity and will respond to an increase in demand by increasing prices much more than they increase output.
LONG RUN EFFECTS: In the long run since the AS curve is vertical so neither monetary policy nor fiscal policy has any affect on aggregate output in the long run.

The monetary and fiscal policies shift the AD curve . If the long run AS curve is vertical output always comes back to N0 . In this case policy affects only the price level. The multiplier effect of a change in government spending on aggregate output in the long run is zero. Similarly the tax multiplier is also zero.
STABILISATION POLICY
The Government can use either fiscal policy or monetary policy to alter the level of GDP. If the Current level of GDP is below full employment or potential output the government can use expansionary policies such as tax cuts, increased spending or increase in money supply to raise the level of GDP and reduce unemployment. If the current rate of GDP exceeds full employment or potential output the rate of inflation will increase. To avoid this the government can use contractionary policies to reduce the level of GDP back to full employment or potential output.
STABLISATION POLICIES ARE A SET OF ACTIONS THAT REDUCE THE LEVEL OF GDP BACK TO FULL POTENTIAL OUTPUT. In practical difficult to stabilise the level of aggregate output because of lags or delays in stabilisation policy. Lags arise because decision makers are often slow to recognise and respond to changes in the economy and monetary/fiscal policies take time to operate:.
LAGS: Poorly timed policies can magnify economy fluctuations If GDP was currently below full employment but would return to full employment on its own within one year and that stabilisation policies took a full year to become effective. If policy makers tried to expand the economy today , their actions would not take effect until a year from now. BUT ONE YEAR FROM NOW IF STABILISATION POLICIES WERE ENACTED THE ECONOMY WOULD BE STIMULATED UNNECESSARILY AND OUTPUT WOULD EXCEED FULL EMPLOYMENT.
LAGS
INSIDE LAGS: They occur for two basic reasons: 1. It takes time to identify and recognise a problem ( Data may indicate confusing picture some economic indicators may look fine , others may appear worrisome. So how to diagnose the problem. It often takes from several months to a year before it is clear that there is a serious problem with the economy. Further for inside lags once a problem has been diagnosed it still takes time before any action can be taken.
LAGS
OUTSIDE LAGS: Both Monetary and fiscal policies are subject to outside lags, the time it takes for policy to be effective. Central Bank can increase the money supply to rapidly lower the interest rate but firms must change their investment plans before monetary policy can be effective. In case of Fiscal Policy, if taxes are cut, individuals and businesses must change their spending plans to take advantage of cut; it will take some time before any affects of the tax cuts will be felt in the economy.
POLICY MIX
POLICY MIX: Policy Mix refers to the combination of monetary and fiscal policies in use at a given time. Monetary and Fiscal simultaneously. policy both should be used
For Example: both government purchases and money supply can be increased at the same time. While the increase in government purchases raises both N and r , and increase in money supply raises N but lowers r. Hence if the govt wanted to increase N without changing r it could do so by increased supply by the appropriate amounts.
POLICY MIX
asing both govt. purchases and m A Policy mix that consists of a decrease in govt spending and an increase in money supply would favour investment spending over government spending. This is because both the increased money supply and the fall in government purchases would cause the interest rate to fall which would lead to an increase in planned investment. The opposite is true for a mix that consists of an expansionary fiscal policy and a contractionary monetary policy. Tight money and expanded government spending would drive the interest rate up and planned investment down.
MONEY DEMAND AND INTEREST RATE

Interest Rate r Sm
r1 r0
E1 E0
D m1 D m0
D m1
D m2
Money M
FISCAL POLICY EFFECT

Demand C+I+G1
E
C+I+G0
in end l Sp Tota
t utpu =O


C+I+G0
E
C+I+G2
in end l Sp Tota
t utpu =O


C+I+G0
E
C+I+G2
in end l Sp Tota
t utpu =O
CROWDING OUT EFFECT

Planned aggregate Expdt. Effective Demand 2 C + I 0 + G 0 (for r = r 0 )
3C+I
+ G 1 (for r = r 1 )
1 C + I 0 + G o (for r = r 0 )
t utpu =O
in end l Sp Tota
N*
Aggr. Output (Income) N
EXPANSIONARY MONETARY POLICY

Planned aggregate Expdt. C+I1+G+X
E I
C+I0+G+X
in end l Sp Tota
t utpu =O
N*
Aggr. Output (Income) N
EXPANSIONARY MONETARY POLICY

INTEREST RATE, r INTEREST RATE, r
Dm
MONEY
I0
I1
INVESTMENT
EXPANSIONARY MONETARY POLICY (AS/AD FRAMEWORK)

Price Level, P
Price Level, P
AS AS
P1 Po A
P1 Po B
AD 1 AD 0
AD 1 AD 0
No
N1
Aggr.Output (Income),N
No
N1 I1
EXPANSIONARY MONETARY POLICY (AD & AS)

Price Level, P
LAS
AS 1
AS 0
P2 P1 Po AD 0 No N1
AD 1
TYPES OF PRICE INDICES
INFLATION
TYPES OF PRICE INDEX: CONSUMER PRICE INDEX: movements in the consumer prices or retail prices are captured in CPI. This measures the cost of living in a given country.
CPI is the most relevant price index for the consumers as it measures the cost of the basket of only those goods and services which are directly purchased by them in a given period of time relative to the cost of the same basket of goods and services in same specified period known as the base year.

Identification of the basket of goods: The basket usually covers the items of consumption in day to day life such as food, clothing, housing, fuel, transport, education, medicine, electricity, telephone, entertainment. Determination of the weights for each of the commodity covered in the consumption basket. This involves identifying the share of expenditure on each item in the basket in the total expenditure on the basket of commodities.
Regular monitoring of the prices: Prices of the products covered in the consumption basket need to be collected on a regular basis through household surveys. Determination of base year: The year set as the base year has to be a normal year.

PRODUCER PRICE INDEX (PPI): The index is manufacturers. most relevant to the
PPI is designed to measure prices at an early stage of the distribution system or first significant commercial transaction. It is used by the producers for the financial and profitability analysis of their production units.

CPI is based on retail prices, whereas PPI is estimated on the basis of producers prices which exclude taxes, trade margins and transportation costs. Thus the ratio between the CPI and the PPI indicagtes the extent of distribution cost falling on the consumers. It also differs from CPI in terms of coverage and composition as PPI includes raw materials and semi finishbed goods.
PPI serves as one of the leading indicator of business cycle that is closely watched by the policy makers, business managers and even the investors in share and forex markets.

Wholesale Price Index (WPI): Technically very close to the PPI, the WPI measures the movements in the wholesale prices, i.e. the prices charged by the wholesalers once they have crossed the production stage reflecting the second commercial transactions. Besides the prices of raw materials semi finished and final goods the prices of imported tangible goods are also considered in the wholesale price index if they are transacted at the whole sale levels in the country.
However it excludes the prices of exported commodities.
In many countries the distrinction is not made between PPI and WPI and PPI is treated as WPI. Many of the countries which have been compiling WPI and PPI from WPI because PPI is considered to be a better measure of inflation as price changes at primary and intermediate stages can be tracked before it gets built into the finished good stage.

GDP DEFLATOR: The price which reveals the cost of purchasing the items included in GDP during the period relative to the cost of purchasing those same items during a base year is termed as GDP deflator or implict price index. GDP Deflators = Nominal GDP /Real GDP = GDP at current prices in the current year/GDP at constant price in the current year. GDP measures the output produced in the domestic territory, GDP deflator ignores the prices of imported goods.
The base year chosen is assigned the value 100 Hence GDP deflator takes on value greater than 100, it indicates the prices have risen

The ratio of nominal GDP to real GDP is termed as a deflator because one can divide ( or deflate) nominal GDP by this ratio to correct for the effect of inflation on GDP, i.e. Real GDP = Nominal GDP /GDP Deflator Thus the GDP deflator can be used to measure real GDP i.e. GDP in rupees of constant purchasing power.

GDP deflator is also known as the implicit price index because GDP deflator implies a price index not estimated directly but implicityly emerging in the process of estimating real and norminal GDP. GDP deflator is athe most comprhensive measure encompassing the entire spectrum of economic activities taking place in the economy.
TYPES OF INFLATION
Types of Inflation: On the basis of rate of inflation: 4 Categories: Creeping or mild Inflation: Rise in prices very low or snails pace , around 2-3 % per annum. It creates conducive environment for economic growth. Firms are encouraged to invest. Since it creates conducive environment for business and increases employment opportunities in general it is preferred over deflation or zero rate of inflation.
TYPES OF INFLATION
Walking Inflation: A sustained price increase from 3 to 7% is termed as walking inflation. In this scenario along with the prices of the commodities the wages and the prices of other cost components start rising. There is a lag between the increase in the prices of the commodities and its impact on the cost component and hence even walking inflation keeps the profitability the profitability at higher level and motivates the producers to produce more and as such is not feared by policy makers and the producers.
TYPES OF INFLATION
If not controlled at this stage inflation may turn into running inflation or even hyper inflation. Running Inflation: Sustained price from 10 to 20% per anbnum is known as running inflation. Inflation above two digit level encourages speculation.
TYPES OF INFLATION
Alongwith the prices of final commodities the cost of production in such a scenario increases substantially and firms start losing gtheir competitiveness domestically as well as internationally.
TYPES OF INFLATION
The risk in business activities and the cases of business failure increases. Overall intewrest rate appreciates whereas there is a build up of pressure for depreciation of the domestic currency. It is a clear indication of a problem that requires urgent attention and formulation of strong fiscal monetary or even direct control measures.
TYPES OF INFLATION
Hyperinflation: Running inflation if not controlled turns into hyper inflation which is also known as galloping or jumping inflation. Price rise at extremelyt rapid rate of 20-30% and above. Money ceases to be useful as a medium of exchange and a store of value.
TYPES OF INFLATION
People switch to barter or adopt some otgher countrys currency as the medium of exchange orf store of value Monetary inflation. authority loose control over the
Large uncertainty hovers around the horiizons and speculative activities take over.
TYPES OF INFLATION
Producers do not know what price to charge for their products and in general expecting higher prices for their products in the coming period withdraw the already produced goods from the market and hoard those in anticipation of higher prices in the coming period. Resources which are limited get div erted from the productive activities to speculative activities.
TYPES OF INFLATION
Households become inflation conscious and spend money at a much faster rate raising the velocity of circulation. Savings decline and the available saving is diverted in assets which protect their purchasing power such as real estate and gold. Govt. fails to raise resources borrowing i.e. non inflationary sources and hence have to resort to defincit financing which is again inflationary.
TYPES OF INFLATION
As there is pressure on borrowings the rate of interest increases. Domestic products lose their competitiveness in the interernational market and worsen the balance of payment which leads to depreciation of domestic currency, loss in the investors confidence in the domestic economy and flight of capital from the country. Hyperinflation thus can have devastating impact on real output and employment ; can jeopardise the macro economic stability and therefore is dreaded by all i.e. households, producers and the government.
TYPES OF INFLATION
On the basis of degree of control: Open Inflation: Continuous rise in price without any interruption and control from the government or any othjer authority is known as open inflation. Suppressed Inflation: In certain economies prices, though conditions exist for rise in the price level are not allowed to rise through the use of government policies like price controls and rationing.
TYPES OF INFLATION
This istuation is known as suppressed inflation as there are potential of prices flaring up on decontrol and removal of price ceilings.
TYPES OF INFLATION
Suppressed inflation creates many administrative p0roblems as the hierarchy of price controllers, supply officers, rationing officers and their assistance need to be determined and the rules and the prices at which rationing need to be carried out need to be determined in the system of price controls. Rationing of goods breeds black marketing and corruption. Suppressed inflation often diverts demand towards uncontrolled or unrationed goods and thus shifts resources towards unproductive or undesirable channels.
TYPES OF INFLATION
It also results in postponement of present demand to future period and thbus builds up inflationary pressure in the coming period. On the basis of coverage: Headline Inflation: Headline Inflation in most of the countries is estimated on the basis of overall CPI which covers all the commodities in the consumption basket of a typical consumer.
TYPES OF INFLATION
Core Inflation: The shocks in price sensitigtive commodities may flair up inflation rate in certain periods. The impact of these changes is temporary and does not reflect the normal inflation envrionment. Hence core inflation is defined as the overall Cpi less the prices of sensititv e commodities espececiallyu the food and enrgy prices.
TYPES OF INFLATION
On the basis of Nature: The prices may increase either because of demand or due to increase in the Cost. They are known as Demand Pull and Cost Push inflation. Demand pull Inflation: An crease in demand with the supply remaining the same or a reduced supply for the same demand level will cause the prices to increase.
TYPES OF INFLATION
The business sector cannot respond to this excess demand by increasing the real output because all available resources are already fu lly employed. The essence of such an inflation is too much money chasing too few goods
TYPES OF INFLATION
P
PRICE LEVEL
P AS
PRICE LEVEL
AS
P1 A P0
A AD1 AD0
P1 B P0
B AD1 AD0
NO
N1
N0
N1
AGGR. OUTPUT(INCOME) N
TYPES OF INFLATION
COST PUSH INFLATION: Price may rise even when there is no increase in aggregate demand. This could hold good when if the cost of goods and services increase. Whenever due to any reason the price of any one or more factors of production increases the resultant cost of goods and services will rise.
TYPES OF INFLATION
On the basis of coverage: Headline Inflation: Headline Inflation in most of the countries is estimated on the basis of overall CPI which covers all the commodities in the consumption basket of a typical consumer. Two most common sources of cost push inflation are 1. Increase in nominal wages and 2. Increase in the prices of non wage inputs such as raw material and energy.
CHECKING INFLATION
Inflation in developing country like India is normally a miz of demand pull and cost push inflation.
CHECKING INFLATION
When due to demand pull inflation the general price level rises workers demand a rise in their wagves to offset the rising cost of living Increase in cost of production Cost push inflation economy witnesses a persistent rise in the general price level under gthe combined impact of demand pull factors such as rise in budgetary deficit, increase in investment expenditue or expansion of money supply and the cost push factors like the hike in administtered prices of essential commodities increase in indirect taxes or rise in prices of facgtors of production.
CHECKING INFLATION
Inflation is highly undesirable happening in any economy. It badly affects the standard of living of the people. Hampers social inequalities. justice by increasing
Adversely affects overall growth of the nation. Measures: Monetary Fiscal Non Monetary
CHECKING INFLATION
A high inflation rate prevailing simultaneously with a high unemployment rate creates stagflation.
CHECKING INFLATION
Inflation and Natural rate of Unemployment: .
CHECKING INFLATION
Non Accelerating inflation rate of unemployment ( NAIRU):
+
PP -
NAIRU
UNEMPLOYMENT RATE
TYPES OF INFLATION
P
PRICE LEVEL
P AS1 AS0 A
PRICE LEVEL
AS1
AS0
P1 A P0 AD P1
P2 B P0
B AD1 B AD0
N1
NO
N0
N1
BALANCE OF PAYMENTS
Record of a nations transactions in goods, services and assets with rest of the world is called its Balance of Payments. It is thus an indicator of the international economic position of the nation. The consideration that nation receives is in the currency of the foreign nation (Foreign Exchange). A nation earns foreign exchange when it sells products, services or assets to another nation. It spends foreign exchange when its citizens buy things whose prices are quoted in other currencies. Thus balance of payments records a countrys sources (supply) and uses (demand) of foreign exchange.
BALANCE OF PAYMENTS
BALANCE OF PAYMENTS
BALANCE OF PAYMENTS
CURRENT ACCOUNT:
The current account comprises of the nations trade in goods. This category includes exports and imports of goods. While the exports earn foreign exchange for the nation and are a credit item on the current account, the imports use up foreign exchange and are a debit item. Services are another important constituent of the current account. Most nations buy services from an sell services to other nations. The difference between a nations exports of goods and services and its imports of goods and services is its balance of trade.
BALANCE OF PAYMENTS
If exports of goods and services are less than imports of goods and services a nation is said to have a trade deficit. A trade surplus on the other hand occurs when the exports of goods and services of a nation are more than their imports. Investment income is the third item in the current account income. The citizens of a nation hold foreign assets (stock, bonds and real assets like buildings and factories). Dividends, interest , rent and profits paid to such asset holders are a source of foreign exchange. When foreigners earn dividends interest and profits on assets held in nation foreign exchange is used up.
BALANCE OF PAYMENTS
Fourth item is Net Transfer Payments: The net refers to the difference between payments from the nation to foreigners and payments from foreigners to the nation. Thus by adding Net exports of goods, Net export of services, Net investment income and transfer payments, we get the balance on current account. When balance is negative a nation has spent more on foreign goods and services, investment income payments and transfers than it has earned through the sales of its goods and services to the rest of the world, investment income received and transfers. If a nation has spent more on foreign goods , services, investment income payments and transfers than it has earned, its net wealth position vis--vis the rest of the world must decrease.
BALANCE OF PAYMENTS
THE CAPITAL ACCOUNT:
For each transaction recorded in the current account an offsetting transaction is recorded in the capital account. [Consider the purchase of a Japanese car by an Indian citizen. Say that the yen/rupee exchange rate is 0.40 and the yen price of the car is 2.5 million yen which is Rs.1,00,000. The Indian citizen takes Rs.1,00,000 exchange it for 2.5 million yen which is Rs. 1,00,000. The Indian citizen takes Rs. 1,00,000 exchange it for 2.5 million yen and then buys the car. In this case , Indian imports increase by Rs. 1,00,000 in current account and foreign assets in India increases by Rs.1,00,000 in Capital account. The net wealth position of India vis-vis the rest of the world decreases by Rs. 1,00,000 in the capital account.
BALANCE OF PAYMENTS
The nation must pay for the imports and whatever it pays with, is an increase in foreign assets in the nation. Conversely an increase in a nations exports results in an increase in the nations assets abroad because foreigners must pay for such exports. A nations assets abroad are divided holdings and government holdings. into private
Foreign assets in a nation are divided into foreign private and foreign government assets. The sum of these is the balance on capital account.
BALANCE OF PAYMENTS
If there were no errors of measurement in the data collection the balance of capital account would be equal to the negative of the balance of current account since for each transaction in the current account there is an offsetting transaction in the capital account. Another way of looking at the balance on capital account is that it is the change in the net wealth position of the nation vis--vis the rest of the world. If the balance on capital account is positive this means that the change in foreign assets in the nation is greater than the change in the nations assets abroad, which is a decrease in the net wealth position of the nation.
BALANCE OF PAYMENTS
If a nation has positive net wealth position vis--vis the rest of the world, it can be said to be creditor nation. Conversely, if it has negative net wealth position it is a debtor nation. For a nations economy to be sound its balance of payments should be in equilibrium. This happens when after excluding the accommodating items there is neither deficit nor surplus in the balance of payments. Accommodating items are the short term capital movements in the capital account such as borrowings from the IMF/Central banks of other nations, drawing from SDR and change in the foreign exchange reserves with the Central bank.
BALANCE OF PAYMENTS
Although all nations strive to keep their balance of payments in equilibrium mismatch between a nations exports and imports generally cause disequilibrium. The equilibrium can be restored through trade policy measures, deflation, devaluation of national currency and exchange control by the government.
EXCHANGE RATES
Exchange rate is the rate at which one currency can be exchanged for another. What started as a fixed exchange rate system, finally gave way to the floating or market determined exchange rates in the early seventies. While governments is most nations still intervene to ensure that exchange rate movements are orderly, the exchange rate today by and large is determined by unregulated forces of supply and demand. Exchange rates play a crucial role is determining the performance of any economy.
EXCHANGE RATES
Exchange rate
EXCHANGE RATES
They determine the price of imported goods relative to domestic goods and can have significant effects on the level of imports, exports and movement of capital between nations.
EXCHANGE RATES
PRICE OF DOLLAR (Rs./$)
Holders of the rupees who need dollars to pay for their consumption will supply rupees in the foreign exchange market. S
INDIAN COUNTERPARTS
Demand for rupees comes from those who have dollars with them But want to exchange them for rupees for some expdt that has to be paid for in rupees every day D $*
US IMPORTERS ;US CITIZENS TRAVELLING INDIA;US FIRMS BUILDING A PLANT IN INDIA OR US CITIZENS BUYING AN INDIAN STOCK OR BOND
QUANTITY OF DOLLAR
EXCHANGE RATES
EFFECT OF EXCHANGE RATES ON THE ECONOMY: Any change in the exchange rates changes the levels of imports and exports of the nation. Changes in exports and imports can in turn affect the level of real GDP and the price level. A Depreciation of a nations currency can serve as a stimulus to the economy. When a nations currency depreciates, its import prices rise and its export prices in foreign currencies fall. When the local currency is cheap, local products are more competitive than the products produced in the rest of the world and foreign made goods look expensive to the nations citizens.
EXCHANGE RATES
If foreign buyers increase their spending in local goods and domestic buyers substitute local goods for imports, aggregate expenditure on domestic output will rise, inventories will fall and real GDP will increase. Impact of currency depreciation on balance of trade is not uni-directional. When currency starts depreciating the balance of trade is likely to worsen for the first few quarters after which the balance of trade may improve. The effect of exchange rate on a nations balance of trade is called the J Curve Effect.
EXCHANGE RATES
Initially a depreciation of a nations currency may worsen its balance of trade. Initially the negative effect on the price of imports may dominate the positive effects of the increase in exports and a decrease in imports. BALANCE OF TRADE = Pe X Qe Pi X Q i Where Pi = Price of Imports; Pe = Prices of e= Quantity of Exports The quantity of exports increases and the quantity of imports decreases. Both have a positive effect on the balance of trade , lowering the trade deficit or raising the trade surplus.
EXCHANGE RATES
The price of exports in local currency is not likely to change very much, at least not initially while the price of imports increases. An increase in the price of imports in the local currency this has a negative effect on the balance of trade. The net effect of currency depreciation on the balance of trade could go either way. Negative impact of trade balance dominates initially. The impact of depreciation on the price of imports is generally felt quickly, while it takes time for exports and imports quantities to respond to price changes.
EXCHANGE RATES
In short turn the value of imports increases more than the value of exports and hence the balance of trade worsens.
EXCHANGE RATES
While initial effect is likely to be negative but after exports and imports have had time to respond , the net effect turns positive. The more elastic the demand for exports and imports is the larger the eventual improvement in the balance of trade. The depreciation of a nations currency tends to increase its price level. This so happens because of 1. Nations currency is less expensive its products are more competitive on world markets so exports rise.
EXCHANGE RATES
Domestic buyers tend to substitute domestic products for the now more expensive imports. Thus planned aggregate expenditure on domestically produced goods and service rises and the aggregate demand curve shifts to the right. The result is higher prices and higher output or both. Depreciation makes imported more expensive.
EXCHANGE RATES
If economy is close to capacity the result is likely to be higher prices. Second depreciation expensive. makes imported inputs more
If costs increase, the aggregate supply curve shifts to the left. If aggregate demand remains unchanged the result is an increase in the price level.
EXCHANGE RATES
MONETARY POLICY WITH FLEXIBLE EXCHANGE RATES: When Economy is below full employment and Central Bank decides to expand the money supply. The Central Bank expands the volume of reserves in the system perhaps through open market purchases of government securities . This results in a decrease in the interest rate. The lower interest rate stimulates planned investment spending and consumption spending.
EXCHANGE RATES
This added spending causes inventories to be lower than planned and the aggregate output ( income) to rise with the following two effects : The lower interest rate has an impact on the foreign exchange market. A lower interest rate means a lower demand for domestic securities by foreigners so the demand for a local currency drops. The domestic investment managers will be more likely to buy foreign securities which are now paying relatively higher interest rates and hence the supply of local currency rises.
EXCHANGE RATES
Both events will down the value of the local currency. To invest abroad , they will need to sell the local currency and buy foreign currency of the nation where they intend to invest. This will affect the exchange rate, the rate at which one currency trades for another currency. As investors sell their local currency to buy foreign currency the exchange rate which is the value of the local currency from the perspective of the domestic investor will fall. A fall in the exchange rate or a decrease in the value of a currency is called depreciation.
EXCHANGE RATES
Thus lower interest rates will cause the local currency to depreciate which means that it declines the in value. The lower value of the local currency makes the local goods cheaper to foreigners. Foreign residents will want to by more of local goods as they become less expensive to foreign residents. So the nation will export more to the foreign nations. However lower value of local currency will make it more expensive for the nations residents to buy foreign goods.
EXCHANGE RATES
The increase in net exports increases the demand for the nations goods and increases GDP in the short run As investors sell their local currency to buy foreign currency the exchange rate which is the value of the local currency from the perspective of the domestic investor will fall. A fall in the exchange rate or a decrease in the value of a currency is called depreciation. Thus lower interest rates will cause the local currency to depreciate which means that it declines the in value.
.
EXCHANGE RATES
The lower value of the local currency makes the local goods cheaper to foreigners. Foreign residents will want to by more of local goods as they become less expensive to foreign residents. So the nation will export more to the foreign nations. However lower value of local currency will make it more expensive for the nations residents to buy foreign goods. So as the exchange rate falls, imports become more expensive . The nation will exports more goods and import fewer goods . The increase in net exports increases the demand for the nations goods and increases GDP in the short run.
EXCHANGE RATES
A cheaper local currency is a good thing if the goal of the monetary expansion is to stimulate the economy because a cheaper local currency means more exports and less imports.
If consumers substitute local goods for imports both the added exports and the decrease in imports means more spending on local products so the multiplier actually increases.
EXCHANGE RATES
INFLATION: Tight monetary policy works through a higher interest rate. If the Central Bank raises interest rates , investors from around the world will want to invest in the nation. As they buy the local currency the exchange rate will increase and the local currency will increase in value. An increase in value of a currency is called appreciation. The appreciation of the local currency will make Indian goods more expensive to foreigners and imports cheaper for the residents of the nation.
EXCHANGE RATES
An increase in the interest rates will cause the exports to decrease and imports to increase thereby decreasing the net exports.
The decrease in net exports will decrease the demand for local goods and lead to a fall in output in the short run. To summaries an increase in interest rates will reduce both investment spending and net exports. A decrease in interest will increase investment spending and net exports. Monetary policy is even more powerful in an open economy than in a closed economy.
EXCHANGE RATES
FISCAL POLICY WITH FLEXIBLE EXCHANGE RATES: The openness of the economy and flexible exchange rates do not always work to the advantage of policy makers. Consider a policy of cutting taxes to stimulate the economy. Spending by households rises but not all this added spending is on domestic products. Some of it may leak out of the domestic economy reducing the multiplier.
EXCHANGE RATES
As income rises the amount of money people desire to hold for transactions and not the demand for local currency in the foreign exchange market.
EXCHANGE RATES
Unless the Central Bank is fully accommodating the interest rate will rise. A higher interest rate tends to attract foreign demand for domestic securities. This tends to drive the price of the local currency up which further blunts the effectiveness of the tax cut. If the value of the local currency rises, exports are less competitive in the world market and the quantity of exports will decline; so does the demand for money.
EXCHANGE RATES
Similarly a strong local currency makes imported goods look cheaper and domestic citizens spend more on foreign goods and less on domestic goods again reducing the multiplier.
Spend more on foreign goods and less on domestic goods again reducing the multiplier . Apart from this without a fully accommodating Central bank 3 factors work to reduce the multiplier namely a higher interest rate from the increase in money demand may crowd out private investment and consumption some of the increase in income from the expansion will be spent on imports and a higher interest rate may cause the local currency to appreciate discouraging exports and further encouraging imports.
GLOBALISATION BEING SEPARATELY DEALT

Part I 1 Introduction Macro Economic 512011

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Part I 1 Introduction Macro Economic 512011

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BASIC CONCEPTS OF MACRO ECONOMICS

PART 1: AN INTRODUCTION TO MACRO ECONOMICS

WHAT DO YOU UNDERSTAND BY MACRO ECONOMICS?

BASIC CONCEPTS OF MACRO ECONOMICS

BASIC CONCEPTS OF MACRO ECONOMICS

BASIC CONCEPTS OF MACRO ECONOMICS

BASIC CONCEPTS OF MACRO ECONOMICS

REST OF THE WORLD

Purchases of foreign made goods (services) and services by locals

Purchase of Goods & Services Purchase of Goods & Services

Wages, Interest, Transfer Payments.

Wages, Interest, Dividends, Profits & Rent

Goods & Services Markets

GROSS DOMESTIC PRODUCT (GDP)

Consumption Demand depends on:

DETERMINATION OF GDP (GDP EQUILIBRIUM)

Expenditure =Output 450

EQUILIBRIUM GDP CALCULATION

GDP EQUILIBRIUM (KEYNESIAN CROSS)

GDP EQUILIBRIUM (KEYNESIAN CROSS)

GDP EQUILIBRIUM (Kenynesian Cross)

Expenditure =Output C + I + G C+I+G C + I + G

AGGREGATE EXPENDITURE THEORY

AGGREGATE EXPENDITURE THEORY

GDP EQUILIBRIUM (Kenynesian Cross)

AGGREGATE EXPENDITURE THEORY

Consumption Function C=a+bY

Shifting/Change in Consumption Function

Increase in Autonomous Exp. will shift entire consumption function

AGGREGATE EXPENDITURE THEORY

AGGREGATE EXPENDITURE THEORY

Break Even Income

AGGREGATE EXPENDITURE THEORY

100 120 140 160 180 200

105 120 135 150 165 180

0.25 0.25 0.25 0.25 0.25

AGGREGATE EXPENDITURE THEORY

AGGREGATE EXPENDITURE THEORY

Real and Financial Assets

Real Assets HOUSE CAR TELEVISION FRIDGE COMPUTER

Financial Assets CASH SHARES BONDS BANK DEPOSITS GOVT. SECURITIES

Investment Demand Curve

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

PHASES OF GROWTH CYCLES

MONEY DEMAND AND SUPPLY

MONEY AND MONEY SUPPLY

MONEY AND MONEY SUPPLY

MONEY AND MONEY SUPPLY

(All prices are quoted in

Money also serves as a unit of account, a consistent way of quoting prices.

MONEY AND MONEY SUPPLY

MONEY AND MONEY SUPPLY

MONEY AND MONEY SUPPLY

MONEY AND MONEY SUPPLY