BASIC MACROECONOMICS

Module 1: Concepts of Economics

Familiarity of Economic Concepts

1. Traditional economic system

The traditional economic system is based on goods, services, and work, all of which follow certain
established trends. It relies a lot on people, and there is very little division of labor or specialization. In essence,
the traditional economy is very basic and the most ancient of the four types. Thus, the traditional system, unlike
the other three, lacks the potential to generate a surplus. Nevertheless, precisely because of its primitive nature,
the traditional economic system is highly sustainable. In addition, due to its small output, there is very little
wastage compared to the other three systems.

2. Command economic system

In a command system, there is a dominant, centralized authority – usually the government – that controls a
significant portion of the economic structure. Also known as a planned system, the command economic system
is common in communist societies since production decisions are the preserve of the government.

In theory, the command system works very well as long as the central authority exercises control with the
general population’s best interests in mind. However, that rarely seems to be the case. Command economies are
rigid compared to other systems. They react slowly to change because power is centralized. That makes them
vulnerable to economic crises or emergencies, as they cannot quickly adjust to changed conditions.

3. Market economic system

Market economic systems are based on the concept of free markets. In other words, there is very little
government interference. The government exercises little control over resources, and it does not interfere with
important segments of the economy. Instead, regulation comes from the people and the relationship between
supply and demand.

The market economic system is mostly theoretical.

From a theoretical point of view, a market economy facilitates substantial growth. Arguably, growth is highest
under a market economic system.

A market economy’s greatest downside is that it allows private entities to amass a lot of economic power,
particularly those who own resources of great value. The distribution of resources is not equitable because those
who succeed economically control most of them.

4. Mixed system

Mixed systems combine the characteristics of the market and command economic systems. For this reason,
mixed systems are also known as dual systems. Sometimes the term is used to describe a market system under
strict regulatory control.

Mixed systems are the norm globally. Supposedly, a mixed system combines the best features of market and
command systems. However, practically speaking, mixed economies face the challenge of finding the right
balance between free markets and government control. Governments tend to exert much more control than is
necessary.
 The household is the basic consuming unit in the economy. Households are the main sector for the
consumption of an economy.

The performances of the households are categorized into two ways:

(a) It supplies the factor services to the firms in the form of factors of production like land, labour, capital etc.

(b) It purchases all the final goods and services produced by the firms from the markets directly. Hence, they
supply different factor services to the economy and on the other hand they create demand for the final goods and
services from the market.

Role of Households:

The roles and importance of households for building an economy are immense.

Some of the performances are briefly given below:

(i) Act as a producer:

Example: There are several families in India who are the owners of several small production units. These
households act as entrepreneurs or producers of different goods and services. They form the enterprises which
are basically semi-corporate in nature.

(ii) Act as a consumer:

The households are the final consumers of goods and services produced by the firms. They create demand in the
market and according to their tastes and preferences. The firms produced and supplied goods in the market, as
per their demand. Therefore, households determine the production line of a country.

(iii) Act as a tax-payer:

Households are the main sources of the government tax-revenue. They are the main tax-payer. A household pays
income tax, wealth tax, estate duty, gift tax etc. as direct taxes to the state. Similarly, a household pays several
indirect taxes to the government like sales tax, customs duty, VAT etc. also. All these tax revenues are collected
for the welfare and development of the economy.

(iv) Act as a professional:

All types of professional services like doctor, teacher, lawyer, engineer etc. come from households. Their
activities are very much required for the country to enhance economic development. These professional services
increase the living standard of the people,
(v) Act as a saver:

Income left after consumption is saving. Hence households earn money income after giving several services to
the economy. The portion of their income left after the consumption, is saved in the banks or financial
institutions.

Microeconomics and macroeconomics give attention to individual markets. But in microeconomics that
attention is an end in itself; in macroeconomics it is aimed at explaining the movement of major economic
aggregates—the level of total output, the level of employment, and the price level.

In contrast to microeconomics, macroeconomics seeks the “large picture”, showing the operations of the
economy as a whole, rather than its internal diversity. In fact, it regards the economy as producing a single and
unique good. Its purpose is to obtain the least complex vision of the economy’s functioning, but in such a way
that it also, allows the analysis of the level of economic activity.

We can use Engel’s Law to show the close relations between micro and macro concepts and how one can
have profound implications in the other. Ernst Engel analysed Belgian working class families’ consumption
patterns and related their levels of income with their expenditure on food and other goods. He discovered that the
higher the income of the family, the lower the share of food in comparison to other expenses. This analysis
would become the central statement of his law. As Engel already realized, this had huge consequences in the
economic development. Agriculture production, which relies heavily on food consumption, as this is its main
product, will see a decline regarding its share of the aggregate total production, as the share for food decreases in
aggregate terms as the economy grows. From this concept, we can extract that growth of all sectors at the same
rate is impossible, and we also find the close relation between micro and macro concepts.

Scarcity Explained

In his 1932 Essay on the Nature and Significance of Economic Science, British economist Lionel Robbins
defined the discipline in terms of scarcity:

Economics is the science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.

The Concept of Natural Resource Scarcity

Natural resources can fall outside the realm of scarcity for two reasons. Anything available in practically
infinity supply that can be consumed at zero cost or trade-off of other goods is not scarce. Alternatively, if
consumers are indifferent to a resource and do not have any desire to consume it, or are unaware of it or its
potential use entirely, then it is not scarce even if the total amount in existence is clearly limited. However, even
resources take for granted as infinitely abundant, and which are free in dollar terms, can become scarce in some
sense.
 Take air, for example. From an individual's perspective, breathing is completely free. Yet there are a number
of costs associated with the activity. It requires breathable air, which has become increasingly difficult to take for
granted since the industrial revolution. In a number of cities today, poor air quality has been associated with high
rates of disease and death. In order to avoid these costly affairs and assure that citizens can breathe safely,
governments or utilities must invest in methods of power generation that do not create harmful emissions. These
may be more expensive than dirtier methods, but even if they are not, they require massive capital expenditures.
These costs fall on the citizens in one way or another. Breathing freely, in other words, is not free.

Microeconomics and Macroeconomics

The field of economics is typically divided into two broad realms: microeconomics and macroeconomics. It is
important to see the distinctions between these broad areas of study.

Microeconomics is the branch of economics that focuses on the choices made by individual
decision-making units in the economy—typically consumers and firms—and the impacts those choices have on
individual markets.

Micro economics involves

● Supply and demand in individual markets.

● Individual consumer behaviour. e.g. Consumer choice theory
● Individual labour markets – e.g. demand for labour, wage determination.
● Externalities arising from production and consumption. e.g. Externalities

Macroeconomics involves

● Monetary / fiscal policy. e.g. what effect does interest rates have on the whole economy?

Scarcity generally falls under three categories:

● Demand-induced scarcity: This occurs when the demand for a particular product or resource far
exceeds the supply that the economy is able to provide.

● Supply-induced scarcity: This occurs when environmental degradation or other unforeseen factors

cause the supply of a resource to decrease significantly despite the demand being within normal limits.

● Structural scarcity: This occurs when there is unequal access to particular resources among members

of the population.

Why is scarcity important?

Scarcity is one of the most significant factors that influence supply and demand. The scarcity of goods plays a
significant role in affecting competition in any price-based market. Because scarce goods are typically subject to
greater demand, they often command higher prices as well. This is part of the reason why high-end cellphones
and designer clothing are more expensive than their more abundant counterparts. Problems arise when resources
that are essential to the function of society become scarcer over time.
Scarcity affects more than just products or natural resources. Everything usable can be considered resources.
Common examples are oil, coal and precious metals. When these materials become scarce, the ability of
businesses to meet production goals can be affected adversely.

In some cases, even time can be considered a resource. Consequently, time is subject to the rules of scarcity as
well. To illustrate, most people have only eight or nine hours per day to perform their duties at work. If you have
to go on a personal errand, you are taking away from the hours that should be allotted to work. You could,
therefore, end up with a scarcity of time to do the duties that are expected of you by your employers. Scarcity
helps people make more informed choices about how to use the resources that are available. The concept of
scarcity works in business in the following ways:

● Scarcity is essential to the study of economics:** A fundamental aspect of scarcity is the mismatch

between supply and demand. It is the scarcity of goods that requires economists to study the effective

allocation of resources, as well as assess opportunity cost and risk reduction.

● Scarcity enables businesses to ensure continued profitability:** When faced with the scarcity of a

particular product or resource, manufacturers have to make adjustments to ensure continued profitability.

They may switch to alternative packaging materials, for example, or substitute certain ingredients in

their products.

● Scarcity helps provide for the needs of customers: High demand for certain products often results in

their scarcity over time. Companies that want to keep providing their customers with these products may

decide to release a limited run or increase production to meet the demand.

● Scarcity helps you navigate the job market: Employment opportunities and labor can also be

considered finite resources. Depending on the circumstances of a specific job market, job openings or

qualified personnel may be scarce. Job seekers may choose to target certain positions where there is a

scarcity of qualified personnel. Conversely, they may also relocate to another city or country if

employment opportunities are scarce in their chosen field.

Why is scarcity a fundamental aspect of economics?

The effective allocation of resources is a significant aspect of economics. The limited nature of resources relative
to the unlimited bounds of human needs and wants makes the study of scarcity an integral part of economics.

What are some of the most important issues regarding scarcity?

The constant presence of scarcity in most of the world requires asking some pressing questions, including:

● Why is there such a disparity between rich and poor countries?

● Why have some countries experienced more economic growth than others?
 ● Why do some countries develop at a rapid and constant pace while others do not, regardless of previous

economic growth?

● What can we do to reduce poverty and encourage economic growth?

What are the effects of scarcity?

The scarcity of resources may lead to widespread problems such as famine, drought and even war. These
problems occur when essential goods become scarce due to several factors, including the exploitation of natural
resources or poor planning by government economists.

How does scarcity affect decision-making?

Because scarcity involves working with limited resources to satisfy unlimited wants, people are often compelled
to choose from different alternatives. In most cases, they have to give up the expected value of one particular
option in preference to the expected value of the next best option.

Module 2: Opportunity cost and circular flow of economic activity

Module 3: Macroeconomic Measures of Performance

Lesson 1: Indicators of Economic Performance

‘Introduction: Economic indicators

To know how well an economy is performing against these objectives economists employ a
wide range of economic indicators. Economic indicators measure macro-economic variables
that directly or indirectly enable economists to judge whether economic performance has
 improved or deteriorated. Tracking these indicators is especially valuable to policy makers, both
in terms of assessing whether to intervene and whether the intervention has worked or not.

Useful indicators include:

Levels of real national income, spending, and output. National income, output, and spending are
three key variables that indicate whether an economy is growing, or in recession. Like many
other indicators, income, output, and spending can also be measured in per capita (per head)
terms.

Activating Sources of Economic Growth

Prior
Knowledge
One way for an economy to produce more output is to obtain more resources. Even with the
same resources, however, it is possible for an economy to produce more output if workers
become more productive. Productivity is the quantity of goods and services produced from a
typical hour of a worker’s labor. Improvements in productivity allow an economy to produce
more output and thus earn more income. This increased income represents an improved
standard of living. Thus an increased standard of living usually depends on increasing a
country’s productivity. Thus, improved productivity is the key to economic growth.

Increases in productivity fall into three categories:

1. Investment in physical capital – “Build more machines.”

2. Investment in human capital (education and skills) – “Make workers more productive.”

3. Investment in technology – “Build more productive machines.”

Module 4: Circular Model

Lesson 1: Concepts of Circular Flow Model

Analysis Understanding the Circular Flow Model

The basic purpose of the circular flow model is to understand how money moves within an
economy. It breaks the economy down into two primary players: households and corporations. It
separates the markets that these participants operate in as markets for goods and services and the
markets for the factors of production.

The circular flow model starts with the household sector that engages in consumption spending
(C) and the business sector that produces the goods.
Two more sectors are also included in the circular flow of income: the government sector and the
foreign trade sector. The government injects money into the circle through government spending
(G) on programs such as Social Security and the National Park Service. Money also flows into the
circle through exports (X), which bring in cash from foreign buyers.

In addition, businesses that invest (I) money to purchase capital stocks contribute to the flow of
money into the economy.

Outflows of Cash

Just as money is injected into the economy, money is withdrawn or leaked through various means
as well. Taxes (T) imposed by the government reduce the flow of income. Money paid to foreign
companies for imports (M) also constitutes a leakage. Savings (S) by businesses that otherwise
would have been put to use are a decrease in the circular flow of an economy’s income.

A government calculates its gross national income by tracking all of these injections into the
circular flow of income and the withdrawals from it.

Adding Up the Factors

The circular flow of income for a nation is said to be balanced when withdrawals equal injections.
That is:

The level of injections is the sum of government spending (G), exports (X), and investments (I).

The level of leakage or withdrawals is the sum of taxation (T), imports (M), and savings (S).

When G + X + I is greater than T + M + S, the level of national income (GDP) will increase.
When the total leakage is greater than the total injected into the circular flow, national income will
decrease.

Calculating GDP

GDP is calculated as consumer spending plus government spending plus business investment plus
the sum of exports minus imports. It is represented as GDP = C + G + I + (X – M).

If businesses decided to produce less, it would lead to a reduction in household spending and
cause a decrease in GDP. Or, if households decided to spend less, it would lead to a reduction in
business production, also causing a decrease in GDP.

GDP is often an indicator of the financial health of an economy. The standard definition of a
recession is two consecutive quarters of declining GDP. When this happens, governments and
central banks adjust fiscal and monetary policy to boost growth.
 Module 5: Consumer Price Index

Consumer Price Index

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of
consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price
changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to
assess price changes associated with the cost of living. The CPI is one of the most frequently used statistics for
identifying periods of inflation or deflation.

The Consumer Price Index measures the average change in prices over time that consumers pay for a basket of
goods and services.

CPI is the most widely used measure of inflation and, by proxy, of the effectiveness of the government’s
economic policy.

The CPI statistics cover professionals, self-employed, unemployed, people whose incomes are below the federal
poverty threshold, and retired people in the country but excludes non-metro or rural populations, farm families,
armed forces, people who are currently incarcerated, and those in mental hospitals.

CPI-W measures the Consumer Price Index for Urban Wage Earners and Clerical Workers while the CPI-U is the
Consumer Price Index for Urban Consumers.