Chapter I - Fundamentals of Macroeconomics

ADDIS ABABA UNIVERSITY
School of Economics
Macroeconomics Theory
By Minda Tesga and Hulunayen Y.; Lecturer, School of Economics, Addis Ababa University
BA in Economics AAU, Masters in Economic Science, MSc. In Economics, Economic Policy
AAU..
May 2023
For detail read the main reference textbooks
Addis Ababa, ETHIOPIA

1
Chapter One: The State Of Macroeconomics
Part I:
Basic concepts of Macroeconomics
2
1.1 Definition of Economics
Economics can be defined in different way

1. Economics is a social study of production, distribution, and
consumption of wealth or output.
 It emphasizes three major economic activities
 output must be produced (production);
 the product must be distributed to potential consumers
(distribution); and
 consumers must choose from the available goods for
consumption (consumption).
2. Economics is a study of choice
 Economic agents (producers and consumers of goods
and services) make choice because of scarcity,
constraints or limitations of resources.
Cont…
3. Economics is the study of decision
making:
a. What to produce:
 which product is profitable for producers in terms of revenue or profit
(commodity X, Y or Z).
b. How to produce:
 what production method or technique to use and about what inputs to use.
c. For whom to produce:
 identify our potential customers, whether farmers or students.
d. Where to produce:
 It view the location of our production unit or distribution center depends on
the location of our potential customers.
e. When to produce:
 determine the season of high demand for your product.
Cont…
4. Economics is the study of wise and efficient use
of limited resources.
It is a science which tries to reconcile unlimited human
wants and limited economic resources to meet this
wants.
It is a science which tries to find out the method of

optimal or proper use of scarce economic resources.
It tries to identify the way that helps economic agents

(human beings) produce maximum output or benefit
from limited resources i.e. money, natural resources,
human resources, etc.
1.2 Branches of Economics
Based on Scope: Microeconomics and Macroeconomics
Microeconomics
•Microeconomics looks at specific economic
units or we talk of an individual like
households,
firms
Industries, etc
Cont.…
Macroeconomics
the economy as a whole
large aggregates and its fundamental
relationship
theories of distribution and growth in
national output
• Unlike microeconomics, aggregates and sub- aggregates
in macroeconomics relates to the whole economy with a
great deal of products, markets and industries.
• Microeconomics & macroeconomics are interdependent.

Macroeconomic theories are derived from theories of
individual behavior.
1.3 Explanation (Analysis) of Economics
Positive Vs Normative
• Positive economics: concerned with the explanations of economic
conditions.
It tries to answer the question “What?” as in “What is the price of
commodity X in market A?”
The answer may be 10 Birr per unit or 100 Birr per unit.
This shows that positive economics tries to understand the existing
economic situation.
• Normative Economics deals with value judgment on economic
situation.
It tries to answer questions like “What should be?”
“What should be done to increase employment and to reduce price?”
The answer may be cutting wage rates or that the government should
increase expenditure on the construction of public infrastructure so that the
unemployed will be employed in the project and that they in turn generate
employment through spending their increased income.
1.4 Reasoning in Macroeconomics
Deductive Vs Inductive Methods of Analysis
i. Deductive method: it is an abstract, analytical,
or a priori approach that involves the
movement from general to particular
ii. Inductive method
it is an abstract, analytical, or a priori approach
that involves the movement from Particular to
general
1.5 DEFINITION OF MACROECONOMICS
Is concerned with the structure, performance
and behavior of the economy as a whole.
The prime concern of macroeconomists is
To analyze and attempt to understand the
main aggregate trends in the economy with
respect to
a) GDP,
b) Unemployment,
c) Inflation and
d) International transactions.
1.5 Goals of Macroeconomics
• Macroeconomics studies the working of an economy in
aggregation or as a whole.
• It aimed at how;
To achieve high economic growth
To reduce unemployment
To attain stable prices
To reduce budget deficit & balance of payment (BoP) deficit
To ensure fair distribution of income
• The goals of macroeconomics can be given as ways towards
full employment,
price stability,
economic growth and
fair distribution of income among citizens of a country.
1.6 Macroeconomic issues
• Economic Growth/Development
• Inflation/Price
• Unemployment
• Trade (Deficit and Surplus)
• Budget (Deficit and Surplus)
• Business cycle
• Balance of Payment (Bop)
• Exchange rate
• Consumer Price Index (CPI)
• Per-capital income (PCI)
1.7 Macroeconomic Policy
• To solve certain macroeconomic problems,
macroeconomists often propose certain types of
policies.
1. Fiscal policy: deals with changes in government

expenditures and/or taxes. For example, a proposal to cut
taxes is a fiscal policy measure. Instruments/tools: Tax and
Government Expenditure
2. Monetary policy: Deals with changes in the money supply.
For example, a proposal to decrease the rate of growth of the
money supply is a monetary policy measure:
Instruments/tools- Reserve requirement (RR), interest rate or
discount rate (r), and Open Market Operation (OMO)
Chapter One
Part II:
Overview of the main Schools of
Macroeconomics
14
1.8 State of Macroeconomics: Evolution and
Recent Developments
• Macroeconomic thoughts have evolved considerably over time.
• Recent macroeconomic ideas have evolved over time beginning from the
mercantilist (1500s – 1600s) period to present.
• The focuses of most of these ideas are on the way to national development
or better economic performance.
• The major schools of thoughts include
Mercantilists, and Physiocrats = Called Pre-classical schools
classical,
neo-classical,
new classical,
monetarist,
Keynesian and
new Keynesian and each of them remained influential in different
periods.
Main Schools of Macroeconomics Con’d
1. Mercantilists
 National development (wealth) achieved through accumulating precious
metals, especially gold
 Trade is considered as the only productive sector
 Government should promote export and protect imports.
2. Physiocrats
Agriculture is the most important source of economic activity,
3. Classical (non-interventionist)
 They believe government intervention is not necessary for the efficient
functioning of the nation
 Adam Smith (1723-1790), David Hume (1711-1776), David Ricardo (1772-
1823), John Stuart Mill (1806-1873), Knut Wicksell (1851-1926), and Irving
Fisher (1867-1947)
 The market operates at full employment and any deviation from the market is
adjusted by itself
 Both fiscal policy and monetary policy are useless they do not affect the real
economic variables such as GDP
4. Keynesians (Interventionist)
 Keynes, support the intervention of the government
After the occurrence of great depression of the 1936, the Keynesians widely
advocated the adoption of fiscal policy
For the Keynesians, markets do not adjust automatically like the classical asserted
because of price rigidities.
It is quite likely that markets fail to clear which means that expenditures
(aggregate demand) may lag behind output (aggregate supply) and the economy
may remain below full employment levels resulting in economic stagnation.
Hence, this situation calls for intervention of the government using fiscal policy.
5. Monetarism (led by Milton Freidman)
 Advocated the intervention of the government but by
manipulating money supply and interest rate (using monetary
policy) on the contrary of Keynesian economists.
6. Neo-classical school like Alfred Marshal

 They were opponents of government intervention like the
classical school.
 The basic difference between them is that
 the classical economists follow an objective method and
emphasize on wealth while
 the neo-classicals are humanists (also called subjectivists)
and emphasize on human welfare.
End of chapter One
Questions and suggestions, welcome, if
any
19

Chapter I - Fundamentals of Macroeconomics

Uploaded by

Copyright:

Available Formats

Chapter I - Fundamentals of Macroeconomics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter I - Fundamentals of Macroeconomics

Uploaded by

Copyright:

Available Formats

ADDIS ABABA UNIVERSITY

Addis Ababa, ETHIOPIA

Economics can be defined in different way

It is a science which tries to find out the method of

It tries to identify the way that helps economic agents

• Microeconomics & macroeconomics are interdependent.

1. Fiscal policy: deals with changes in government

6. Neo-classical school like Alfred Marshal

You might also like