• This chapter distinguishes macroeconomics from microeconomics, explaining how macroeconomics deals with the economy as a whole, while microeconomics focuses on individual markets and economic agents.
• Macroeconomics raises questions that concern the broader economy, such as whether prices will rise or fall, whether employment conditions are improving or worsening, and what steps the State can take to improve the economy.
• The study of macroeconomics introduces some basic principles, often using elementary algebra for simplicity and rigor.
• Macroeconomics examines the relationship between various economic variables (like output, price level, and employment) and attributes like interest rates, wages, and profits.
• When analyzing the entire economy, the output levels of different goods and services tend to move together, with the output of one sector often accompanying the rise or fall of another, such as food grain and industrial goods.
• The price level and employment level in various production units also exhibit similar movements, making it easier to analyze the economy in aggregate terms.
• A representative good can be used to simplify the analysis, reflecting the general production, price, and employment levels of the economy as a whole.
• Changes in the prices, interest rates, wages, and profits for one commodity generally affect others in the same way, especially when there are widespread changes like inflation or depression.
• While simplifying the economy into a single representative good is convenient, sometimes a more detailed analysis of specific sectors, such as agriculture and industry, or sectors like the household, business, and government, is necessary.
• Macroeconomics may focus on different kinds of goods (like agricultural goods, industrial goods, and services) to capture distinctive characteristics of individual goods.
• In microeconomics, the focus is on individual economic agents (consumers, producers, etc.), aiming to maximize personal satisfaction (as consumers) or profits (as producers).
• Macroeconomics deals with large-scale phenomena like inflation and unemployment, which are not addressed in microeconomics or are taken as given in individual markets.
• Macroeconomics addresses the aggregate effects of market forces and also modifies these forces to achieve societal goals, such as employment, education, and healthcare.
• Macroeconomics is rooted in microeconomics because it analyzes the aggregate effects of demand and supply forces but also modifies these forces when needed for public welfare.
• In a developing country like India, macroeconomic policies focus on issues like unemployment, education, healthcare, and defense.
• The key decision-makers in macroeconomics are the State and statutory bodies like the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI).
• Macroeconomic policies aim to serve public goals defined by law or the Constitution, which differ from the self-interest of individual economic agents.
• The macroeconomic decision-makers aim to deploy economic resources for public welfare, not for individual profit or self-interest.

Economic Agents

• By economic units or economic agents, we mean those individuals or institutions which take economic decisions.
• They can be consumers who decide what and how much to consume.
• They may be producers of goods and services who decide what and how much to produce.
• They may be entities like the government, corporation, banks which also take different economic decisions like how much to spend, what interest rate to charge on the credits, how much to tax, etc.

Adam Smith

• Adam Smith is regarded as the founding father of modern economics, which was known as political economy at that time.
• He was a Scotsman and a professor at the University of Glasgow.
• Smith was a philosopher by training and his famous work, An Enquiry into the Nature and Cause of the Wealth of Nations (1776), is considered the first major comprehensive book on the subject of economics.
• A well-known passage from his book states, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest,” emphasizing the importance of self-interest in economic transactions.
• This passage is often cited as an advocacy for free market economy, suggesting that individuals act based on their own self-love and personal advantage rather than out of benevolence.
• Before Smith, the Physiocrats of France were prominent thinkers in the field of political economy.

EMERGENCE OF MACROECONOMICS

• Macroeconomics emerged as a separate branch of economics after John Maynard Keynes published his book The General Theory of Employment, Interest and Money in 1936.
• Before Keynes, the dominant economic thought was the classical tradition, which believed all labourers ready to work would find employment and factories would operate at full capacity.
• The Great Depression of 1929 drastically reduced output and employment in Europe, North America, and other countries.
• In the USA, unemployment rose from 3% to 25% between 1929 and 1933, and aggregate output fell by about 33% during the same period.
• These events prompted economists to rethink the economy’s functioning and address the issue of long-lasting unemployment.
• Keynes’ approach was to examine the economy in its entirety and the interdependence of different sectors, which laid the foundation for macroeconomics as a field of study.

John Maynard Keynes

• John Maynard Keynes, a British economist, was born in 1883.
• He was educated at King’s College, Cambridge and later became its Dean.
• Apart from being a sharp intellectual, Keynes actively participated in international diplomacy after World War I.
• He predicted the breakdown of the peace agreement of the War in his book The Economic Consequences of the Peace (1919).
• His book General Theory of Employment, Interest and Money (1936) is regarded as one of the most influential economics books of the twentieth century.
• Keynes was also a shrewd foreign currency speculator.

CONTEXT OF THE PRESENT BOOK OF MACROECONOMICS

• The subject under study has a specific historical context related to the economy of a capitalist country.
• In a capitalist country, production is carried out by capitalist enterprises.
• A typical capitalist enterprise has one or more entrepreneurs who control major decisions and bear a large portion of the risk.
• Entrepreneurs may supply the capital needed or borrow it, and they also need natural resources (raw materials, land) and labour for production.
• After production, the entrepreneur sells the output in the market to earn revenue, which is then distributed as:
  • Rent for land services
  • Interest for capital
  • Wages for labour
  • The remaining revenue is profit, which is reinvested to buy new machinery or build new factories for investment expenditure.
• A capitalist economy is defined by:
  1. Private ownership of means of production
  2. Production for selling in the market
  3. Sale and purchase of labour services at a price called the wage rate
• Capitalist economies emerged only in the last 300–400 years, with only a few countries currently qualifying as capitalist.
• In many underdeveloped countries, peasant families carry out production, and wage labour is seldom used.
• Production is often not for the market and is consumed by the family.
• Some developing countries have capitalist production units called firms, where entrepreneurs hire wage labour, use capital and land, and produce goods to earn profits.
• Entrepreneurs in firms face risks and uncertainties, such as not receiving a high enough price for goods, leading to reduced profits.
• In both developed and developing countries, there is the institution of the State, which frames laws, enforces them, delivers justice, and sometimes undertakes production.
• The government also imposes taxes, builds infrastructure, runs schools, and provides health services.
• Another major sector in the economy is the household sector, consisting of individuals or groups making consumption decisions, saving, and paying taxes.
• Households earn money by working in firms for wages, in government departments for salaries, or as owners of firms earning profits.
• Households also earn rent by leasing land or interest by lending capital.
• The external sector is the fourth important sector, engaging in trade and affecting the domestic economy.
  • Countries may sell goods to the rest of the world (exports).
  • Countries may buy goods from the rest of the world (imports).
  • Foreign capital may flow into the domestic country, or the domestic country may export capital.