Scope Of Macroeconomics introduction and basic theories

Student of university of Sargodha

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What is Macroeconomics:
Macroeconomics is a branch of economics that focuses on the overall behavior and
performance of an economy as a whole. It examines factors such as national
income, output, employment, inflation, and economic growth. Macroeconomists
study how different sectors of the economy interact with each other and analyze
the impact of government policies and external factors on the economy. It helps us
understand the broader economic trends and how they affect individuals,
businesses, and the overall well-being of a country.
Scope of Macroeconomics:
1-The Theory of National income:
The theory of national income focuses on measuring and analyzing the total
economic output of a country. It involves concepts like Gross Domestic Product
(GDP) and examines the factors influencing a nation's income, including
consumption, investment, government spending, and net exports. Theories such as
Keynesian economics and classical economics provide different perspectives on
how to understand and manage national income levels
a) GDP
Gross domestic product (GDP) is the total monetary or market value of all the
finished goods and services produced within a country’s borders in a specific time
period.
Calculate methods
GDP can be calculated in three ways, using expenditures, production, or incomes.
Calculate GDP
Formula
GDP=C+G+I+NX
where:
C=Consumption
G=Government spending
I=Investment

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NX=Net exports
The calculation of a country’s GDP encompasses all private and public
consumption, government outlays, investments, additions to private inventories,
paid-in construction costs, and the foreign balance of trade. Exports are added to
the value and imports are subtracted.
 Real GDP
Real GDP adjusts economic output for inflation, revealing actual growth or
contraction. It's vital for long-term trends, policy-making, and accurate
comparisons.
 Nominal GDP
Nominal GDP measures output at current market prices, valuable for shortterm
analysis, revenue calculation, and budget alignment.
 GDP Per Capita
GDP per capita is a measurement of the GDP per person in a country’s population.
It indicates that the amount of output or income per person in an economy can
indicate average productivity or average living standards. GDP per capita can be
stated in nominal, real (inflation-adjusted), or purchasing power parity (PPP)
terms.
 GDP of Pakistan

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 GDP of US


b) GNP
Gross national product (GNP) is the total monetary or market value of all the
finished goods and services produced within a country’s borders and net factors of
in come from abroad in a specific time period.
Formula
GNP = GDP +income made by firms
Or
GNP=citizens abroad-income earned by foreign firms

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c) NDP
The net domestic product (NDP) equals the gross domestic product (GDP) minus
depreciation on a country's capital goods. Net domestic product accounts for
capital that has been consumed over the year in the form of housing, vehicle, or
machinery deterioration.
formula
NDP = GDP - Depreciation cost
d)NNP
Net national product (NNP) is gross national product (GNP), the total value of
finished goods and services produced by a country's citizens overseas and
domestically, minus depreciation.
Formula
NNP = GNP - Depreciation cost
e) PI
In economics, personal income refers to the total earnings of an individual from
various sources such as wages, investment ventures, and other sources of income.
It encompasses all the products and money received by an individual.

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f) DI
Disposable personal income is the total amount someone has after taxes to spend
on necessities, like housing and food.
Formula
DPI = Gross Wages – Taxes
2- The Theory of Money:
In macroeconomics, the theory of money focuses on the role of money in the
overall economy. It explores how changes in the money supply, interest rates, and
other factors impact the economy as a whole. The theory examines how money
affects variables like inflation, employment, and economic growth. It helps
economists understand the relationship between money and the broader
macroeconomic indicators, providing insights into monetary policy and its effects
on the economy.
a) Evolution of money
The word money derives from the Latin word moneta with the meaning "coin" via
French monnaie. The Latin word is believed to originate from a temple of Juno, on
Capitoline, one of Rome's seven hills. In the ancient world, Juno was often
associated with money. The temple of Juno Moneta at Rome was the place where
the mint of Ancient Rome was located. The name "Juno" may have derived from
the Etruscan goddess Uni and "Moneta" either from the Latin word
"monere"(remind, warn, or instruct) or the Greek word "Moneres" (alone, unique).
 Barter system
Barter is an act of trading goods or services between two or more parties without
the use of money —or a monetary medium, such as a credit card. In essence,
bartering involves the provision of one good or service by one party in return for
another good or service from another party.
 Commodity money

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Commodity money is money whose value comes from a commodity of which it is
made. Commodity money consists of objects having value or use in themselves
(intrinsic value) as well as their value in buying goods.
 Metallic money
Metallic money refers to coins made of various metals such as gold, silver, bronze,
nickel, and so on. Its worth is guaranteed by the state's exclusive monopoly. The
state owns the mining rights to the coins.
 Token money
Token money, or token, is a form of money that has a lesser intrinsic value
compared to its face value. Token money is anything that is accepted as money,
not due to its intrinsic value but instead because of custom or legal enactment.
Token money costs less to produce than its face value.
 Paper money
Paper money is a country's official, paper currency that is circulated for the
transactions involved in acquiring goods and services. The printing of paper money
is typically regulated by a country's central bank or treasury in order to keep the
flow of funds in line with monetary policy.
 Legal tander money and Non legal tander money
Coins and banknotes are usually defined as legal tender in many countries, but
personal cheques, credit cards, and similar non-cash methods of payment are
usually not.
b) Money supply
Excess currency (money) supply in an economy is one of the primary cause of
inflation. This happens when the money supply/circulation in a nation grows
above the economic growth, therefore reducing the value of the currency
i. Deflationary Gap
Deflationary Gap is the amount by which the aggregate demand falls short of
aggregate supply at the full employment level. It is called deflationary
Expansionary fiscal policies expand aggregate demand (AD) by increasing

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government spending and/or decreasing income and corporate taxation. As a
result, a recessionary (a.k.a. deflationary) gap, which is caused by insufficient AD
can be closed.



 Expansionary fiscal policies
expand aggregate demand (AD) by increasing government spending and/or
decreasing income and corporate taxation. As a result, a recessionary (a.k.a.
deflationary) gap, which is caused by insufficient AD can be closed.

Inflationary gap
An inflationary gap measures the difference between the current real GDP and the
potential GDP where an economy operates at full employment. The current real
GDP is higher than the potential GDP for the gap to be inflationary. Contractionary
fiscal policy is when the government either cuts spending or raises taxes. It gets its
name from the way it contracts the economy. It reduces the amount of money
available for businesses and consumers to spend.

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 Contractionary fiscal policy
is when the government either cuts spending or raises taxes. It gets its name
from the way it contracts the economy. It reduces the amount of money available
for businesses and consumers to spend
c) Role of Central Bank
Central banks carry out a nation's monetary policy and control its money supply,
often mandated with maintaining low inflation and steady GDP growth.
On a macro basis, central banks influence interest rates and participate in open
market operations to control the cost of borrowing and lending throughout an
economy.
Central banks also operate on a micro-scale, setting necessary the commercial
banks' reserve ratio and acting as lenders of last resort when necessary.
3- The Theory of NI Fluctuation
The theory of national income fluctuation, also known as business cycle theory,
seeks to explain the periodic ups and downs in an economy's level of output and
employment. It suggests that economies go through cycles of expansion and
contraction, with fluctuations in economic activity. These fluctuations are
influenced by various factors, including changes in consumer spending, business
investment, government policies, and external shocks. The theory helps us
understand the causes and consequences of these fluctuations and provides insights
into how policymakers can manage and stabilize the economy during different
phases of the business cycle.

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 The Business Cycle:
A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)
around its long-term natural growth rate. It explains the expansion and contraction
in economic activity that an economy experiences over time.
A business cycle is completed when it goes through a single boom and a single
contraction in sequence. The time period to complete this sequence is called the
length of the business cycle.
A boom is characterized by a period of rapid economic growth, whereas a period
of relatively stagnated economic growth is a recession. These are measured in
terms of the growth of the real GDP, which is inflation adjusted.
 Stages of the Business Cycle
In the diagram above, the straight line in the middle is the steady growth line. The
business cycle moves about the line. Below is a more detailed description of each
stage in the business cycle:

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1. Expansion
The first stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income, output,
wages, profits, demand, and supply of goods and services. Debtors are generally
paying their debts on time, the velocity of the money supply is high, and
investment is high. This process continues as long as economic conditions are
favorable for expansion.
2. Peak
The economy then reaches a saturation point, or peak, which is the second stage
of the business cycle. The maximum limit of growth is attained. The economic
indicators do not grow further and are at their highest. Prices are at their peak.
This stage marks the reversal point in the trend of economic growth. Consumers
tend to restructure their budgets at this point.

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3. Recession
The recession is the stage that follows the peak phase. The demand for
goods and services starts declining rapidly and steadily in this phase.
Producers do not notice the decrease in demand instantly and go on
producing, which creates a situation of excess supply in the market. Prices
tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.
4. Depression
There is a commensurate rise in unemployment. The growth in the economy
continues to decline, and as this fall below the steady growth line, the stage is
called a depression.
5. Trough
In the depression stage, the economy’s growth rate becomes negative. There is
further decline until the prices of factors, as well as the demand and supply of
goods and services, contract to reach their lowest point. The economy
eventually reaches the trough. It is the negative saturation point for an
economy. There is extensive depletion of national income and expenditure.
6. Recovery
After the trough, the economy moves to the stage of recovery. In this phase,
there is a turnaround in the economy, and it begins to recover from the negative
growth rate. Demand starts to pick up due to low prices and, consequently,
supply begins to increase. The population develops a positive attitude towards
investment and employment and production starts increasing.
Employment begins to rise and, due to accumulated cash balances with the
bankers, lending also shows positive signals. In this phase, depreciated capital is
replaced, leading to new investments in the production process. Recovery
continues until the economy returns to steady growth levels.
This completes one full business cycle of boom and contraction. The extreme
points are the peak and the trough.
4-Theory of Consumption and Saving

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The theory of consumption and saving is all about how people decide to spend
their money and save it for the future. When people have more money, they
usually spend more on things they want or need. But they also save some of their
money for later, like for emergencies or big purchases. This theory helps us
understand why people make certain spending and saving choices, and how it
affects the economy as a whole.
Y=C+S
Y=C+I
Y=Y
C+S=C+I
S=I
Where:
Y=Total income
C=Consumption
S= Saving
I= Investment
a) Income/ consumption relationship (Consumption function)
Consumption is the part of income which is spent on those goods and services
from which direct satisfaction is derived (House-hold goods), consumption
changes with the in the change in income and it is direct and positive change, thus
C=f(y)
Is an increasing function.
The standard form of consumption function in two sector economy is ,
C=Co+ by
Where :
C= Consumption
Co= Autonomous consumption (which does not depend on the level of income).
The value of Co is greater than zero. (Co>0)

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b= Marginal propensity to consume (MPC). The value of MPC is less than unity
(one) and greater than zero
i.e 0<b<1
The following concepts are explained to make consumption function more
understandable.
 Average propensity to consume (APC):
APC may be defined as the ratio of consumption expenditure to any
particular level of income in a specific time period.
APC= c/y
If, monthly income of a consumer is RS. 10,000/- and his consumption is
Rs. 80,000/-
APC=8000/10000
=0.8
 Marginal Propensity to consume:
MPC is the ratio of change of in consumption to the change in income.
MPC=^C/^Y
Where
^C= change in consumption
^Y= change in income
If, increase in consumer income=5000 and his consumption rises by
Rs.4000/-
The MPC= 4000/5000
= 0.8
Special Note: Although consumption rises with increase in income and vice
versa, yet the rate of increase in consumption is smaller than the rate of
increase in income. Hence, APC and MPC go on diminishing with the
increase in income

b)Saving/ income relationship:
That part of income which is not consumed is called saving.
Thus,
S=Y-C
Saving depends upon the level of income. As income rises, saving also
increases and vice versa. We can say that S=f(I) saving is function of
income.

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The standard form of saving function is:
S=-Co+(1+b)Y
or emergency, for children’s education, for old age, for investment in future,
for performing Hajj, for better life style etc.
by)
Where are two elements which determine saving:
1-Will to save
There may be any purpose behind the will to save such as: to face
unexpected situation
2- Power to save:
Whereas, the power to save money depends upon income and consumption,
political stability, tax system, money and banking system, transport and
communication, natural resources, saving schemes etc.
To understand the saving function more comprehensively, following
concepts are explained.










Saving Schedule:


Income (Y)
(₹ Crores)
Consumption (C)
(₹ Crores)
Saving (S)
(₹ Crores)
0 80 -80
100 140 -40

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The above schedule shows saving at different income levels

.In the above graph, X-axis represents National Income and Y-axis represents Saving.
200 200 0
300 260 40
400 320 80
500 380 120
600 440 160

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Observation:
1. Starting Point: The saving curve (SS) starts from point S on Y-axis and not from
point O, which means that at zero income level, there is a negative saving equal to the
amount of autonomous consumption.
2. Slope of Saving Curve: The slope of the saving curve SS is positive, which means
that there is a positive relationship between saving and income.
3. Break-even Point; i.e., S = 0: The saving curve SS crosses the X-axis at point R,
which is the break-even point. This point is known as the break-even point because
here, saving is zero, or consumption is equal to income. In the above example, break-
even point occurs at ₹200 Crores income level.
4. Positive Saving: After the break-even point; i.e., after S = 0, saving is positive.
The saving curve will have a negative intercept on Y-axis which is of the same
magnitude as the positive intercept of consumption curve on Y-axis. It is because if at
zero income level, consumption is positive, then it means that there is dissaving of the
same magnitude.
Types of Propensities to Save
The two types of Propensities to Save are Average Propensity to Save
(APS) and Marginal Propensity to Save (MPS).
1. Average Propensity to Save (APS):
APS may be defined as the ratio of saving to any particular level of income in a
specific time period,
APS =s/y
If, monthly income of a consumer is Rs.10,000 and his saving is Rs.2000.
APS= 2000/10,000
=0.2
As saving is inverse of consumption thus
APS= 1-APC
AND
APS+APC=1
Average Propensity to Save can never be one or more than one; however, it can be zero.
The point at which the APS is equal to zero is known as the break-even point. Also, the
average propensity to save increases with the increase in income because the income
proportion saved keeps on increasing.
2. Marginal Propensity to Save (MPS):
It is the ratio of the change in saving to the change in total income. The formula to
determine Marginal Propensity to Save (MPS) is:
MPS= ^s/^y
Here,
^S= change in saving

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^Y= change in income
If, the income of consumer increases from Rs.10,000 to Rs.15000 and saving rises from
Rs. 2000 to Rs. 3000.
Then
^Y= 15000-10000= 5000
And
^S=3000-2000=1000
Thus
MPS= ^S/^Y
= 1000/5000
= 0.2
One thing must be remembered that:
MPS=1-MPC
Thus, MPC+MPS=1
Marginal Propensity to Save varies between 0 and 1. If the whole additional income is
saved then MPS will be equal to one, and if the whole additional income is consumed
then MPS will be equal to zero.
Equation of Saving Function
The equation of linear consumption function can be used to derive the equation of
Saving Function.
As we know,
S = Y – C …………………..(1)
and C=(\bar{c})+b(Y) …………………..(2)
By putting the value of (1) in (2), the equation of Saving Function will be:


Where,
S = Saving

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= Negative saving at zero income level
1 – b = MPS
Y = National Income
As the above equation is a straight line with intercept (-\bar{c}) and slope ‘1 – b’, it is a
case of the linear saving function. The equation of the saving function can be used to
prepare the saving curve by calculating saving expenditure at different income levels, if
the value of (-\bar{c} and (1-b); i.e., MPS is given. For example, If the value of (-
\bar{c}) and 1 – b are ₹30 Crores and 0.20 respectively, then the Saving Expenditure at
income level ₹200 Crores will be

S = -30 + 0.20(200)
= – 30 + 40
₹10 Crores



5-Theory of Stabilization:
The theory of stabilization in macroeconomics focuses on how governments and
central banks can use policy tools to stabilize the economy and promote steady
growth. It involves managing aggregate demand, which is the total spending in
the economy, to keep inflation in check and minimize fluctuations in output and
employment. Stabilization policies typically involve fiscal policy, such as
government spending and taxation, and monetary policy, which involves adjusting
interest rates and controlling the money supply.
 Deflationary Gap
Deflationary Gap is the amount by which the aggregate demand falls short of
aggregate supply at the full employment level. It is called deflationary
Expansionary fiscal policies expand aggregate demand (AD) by increasing
government spending and/or decreasing income and corporate taxation. As a
result, a recessionary (a.k.a. deflationary) gap, which is caused by insufficient AD
can be closed.

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 Expansionary fiscal policies expand aggregate demand (AD) by increasing
government spending and/or decreasing income and corporate taxation.
As a result, a recessionary (a.k.a. deflationary) gap, which is caused by
insufficient AD can be closed.
 Inflationary Gap
An inflationary gap measures the difference between the current real GDP and the
potential GDP where an economy operates at full employment. The current real
GDP is higher than the potential GDP for the gap to be inflationary. Contractionary
fiscal policy is when the government either cuts spending or raises taxes. It gets its
name from the way it contracts the economy. It reduces the amount of money
available for businesses and consumers to spend.

 Contractionary fiscal policy is when the government either cuts spending
or raises taxes. It gets its name from the way it contracts the economy. It

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reduces the amount of money available for businesses and consumers to
spend
Monetary Policy
Central banks use interest rates, money supply, and other tools to influence economic
activity and control inflation
Fiscal Policy:
Governments adjust taxation and spending to manage demand, especially during
economic downturns or periods of inflation.
6-Theory of Growth:
The theory of growth in macroeconomics explores the factors that contribute to
long-term economic growth and development. It examines how a country's
productivity, technological advancements, investment in physical and human
capital, and institutional factors influence its economic growth rate. The theory
helps us understand the drivers of economic prosperity and provides insights into
policies that can promote sustainable and inclusive growth.