Macro-Economic Framework

Prof. Swaha ShomeMumbai

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Measurement & Determination of National Income : Identify appropriate Macro-economic concepts

Growth, Unemployment, Trade cycles & Inflation

Performance Indicators – significance

Outline (1)

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Elements of Monetary & Fiscal System Implications of Monetary & Fiscal Policy

Patterns of international trade & trade policy, regional trading blocks, globalization of production

Balance of Payments, Foreign Exchange Markets & European Monetary Union

Outline (2)

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Stock vs. Flow variables (1)

Stock variables : Accumulation of flows• No time dimension • Change in stock – discontinuous

Flow variables : Changes in stocks• change over time : time dimension• rate of change at some point of time

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Stock vs. Flow variables (2)

Stock Flow

Capital Investment

Wealth Income

Price Index Inflation

Balance Sheet Profit/Loss account

Forex Reserves Exports/wages/taxes

Unemployment level GDP

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Macro-economic variables

Price

GDP

Unemployment rate

Forex Reserves

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Macro-economic targets

Price stability

Adequate growth

Minimum unemployment

Stable Foreign exchange rate

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Opportunity cost

Situation X Y

1 0 20

2 1 18

3 2 15

4 3 11

5 4 6

6 5 0

• Opp cost of X = Amount of Y to be

compensated for one more unit of X

• Opp cost of X increases as you

produce more of X

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Opportunity Cost - Illustrated Sacrifice of alternatives in

production/consumption of a good

Eg. Let a farm produce 1000 tonnes of wheat or 2000 tonnes of sugar

Opportunity Cost of producing 1 ton wheat = 2 tonnes of sugar foregone.

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Production Possibility Curve

0

1

2

3

4

5

6

0 1 2 3 4 5 6

X

Y

Enclosed region – unemployment

Outside graph – not feasible

Various combinations of 2 classes of goods produced provided resources in the economy are

fully employed

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PPF – Illustrated

PPF

012345678

0 5 10

Clothing

Fo

od

Units of Food Units of Clothing

8 0

7 2.2

6 4

5 5

4 5.6

3 6

2 6.4

1 6.7

0 7

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• Downward sloping

• Concave to origin

• Resources have alternative uses but not equally efficient in all

Properties of a PPC

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Production Possibility Frontier Curve shows all possible 2-goods

combination that an economy can produce - Specified time period- Resources fully & efficiently employed- Issues of choice & opportunity cost Concave to origin – increasing opportunity

cost Region interior to PPF – economy has not

attained Productive Efficiency - unemployment

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Production Possibility Frontier Shifting

PPF Shift

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8

X

Y

Economic Growth Improvement in skills

Improved Technology Increase in factors of production

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Economic growth shifting PPF

Necessities

Lu

xuri

es

Poor Nation High Income nation

Poor nation devotes resources mostly to food

Rich nation : expansion in food consumption low compared to increased consumption of luxuries

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Before Investment

Current consumption

Cap

ital

Investm

en

t

After Investment

Future Consumption

Cap

ital

Investm

en

t

Country I Country II Country III

Countries that invest more heavily forge ahead

Countries that invest heavily have higher investment and consumption in future

Households Firms

Real goods & services

Money FlowMoney

Flow

Factors of Production

Circular Flow

Payment for

Factors

Payment for

goods

Money Flow

Money Flow

Real flow

Real flow

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Leakages & Injections

Leakages :1. Savings2. Taxes 3. Imports

Injections : 1. Investment 2. Government expenditure 3. Exports