Macro economics for business decisions PDF

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1.3 MACROECONOMICS FOR BUSINESS DECISIONS Objectives: 1. To familiarise students with key macro economic variables and their behaviour, and enable them to critically evaluate different economies. 2. To enable students to integrate macroeconomic analysis into business decisions. Module – 1 Introduction to economics, macro economics, and its interface with business and industry. Resources and goals of an economic systems, free market and mixed economy. National income and product concept, computation of national income and related aggregates, problems in computation of national income. Module – 2 Consumption, Savings, investment, marginal propensity to consume, marginal propensity to save, multiplier, paradox of thrift, income and employment determination. Module – 3 Money, monetary system, role of credit, financial inter-mediaries, level and structure of interest rates - interest and macroeconomic equilibrium, central bank, monetary management and policy. Fiscal policy – Objectives, tools, fiscal variables and the public debt, co-ordination of monetary and fiscal policies. Module – 4 Economic growth, factors determining economic growth, growth models, capital output ratio, problems of growth. Policies towards economic stability, business cycle, inflation and deflation, control measures, conflicts between growth and stability. Books for Reference: 1. Gupta G. S. - Macroeconomic theory- Tata Mc-Graw Hill publications 2. Samuelson,Paul – Economics, Tata Mc-Graw Hill publications 3. Dornbush R & Fisher S – Macroeconomics – Tata Mc-Graw Hill publications 4. Blanchard O. J & Stanley Fischer – Lectures on Macro-economics – Tata Mc Graw Hill publications 5. Dwivedi D N – Managerial Economics – Vikas publications 6. J. K. Bhagawathi – Economics of Underdeveloped Countries – All India Traveler Book Seller Publishing Company. 7. A. K. Agarwall – Indian Economics – Problems of Development and planning – D.K Publishers. 8. V. K. R. V. Rao - National Income of India – 1950 to 1980 Sage Publishers 9. Bimal Jalan – India’s Economic Crisis, Oxford, IBM. 10. Rangarajan C. – Principles of Macro Economics, Tata McGraw Hill Pub co. 11. Vaish M. C – Macro Economic Theory – Willey Eastern 12. Jha. R – Contemporary Macroeconomic Theory and Policy

13. Schultze C. L – National Income Analysis 14. Bramhananda P R & V R Panchamukhi – Development process of Indian Economy Survey (Various issues) – Ministry of Finance Government of India Publications, New Delhi. 15. Sheth M. L – Macroeconomic theory – S.Chand, New Delhi. 16. Bhole. L.M, Financial Institutions and Markets, Tata McGraw Hill. 17. Frank R.H: Principles of Macroeconomics, Tata McGraaw Hill. 18. Colander: Macroeconomics TMH. 19. Fischer and Blanchard: Lecturer an Macroeconomics PHI.

Module – 1

1.1 1.2 1.3 1.4

1.1

Introduction to economics, macroeconomics, and its interface with business and industry. Resources and goals of an economic systems, free market and mixed economy. National income and product concept, computation of national income and related aggregates, problems in computation of national income. Introduction to economics, macroeconomics, interface with business and industry.

and its

What is Economics? Economics studies the allocation of scarce resources among people – examining what goods and services wind up in the hands of which people. Why scarce resources? Absent scarcity, there is no significant allocation issue. All practical, and many impractical, means of allocating scarce resources are studied by economists. Markets are an important means of allocating resources, so economists study markets. Markets include stock markets like the New York Stock Exchange, commodities markets like the Chicago Mercantile, but also farmer‘s markets, auction markets like Christie‘s or Sotheby‘s (made famous in movies by people scratching their noses and inadvertently purchasing a Ming vase) or eBay, or more ephemeral markets, such as the market for music CDs in your neighborhood. In addition, goods and services (which are scarce resources) are allocated by governments, using taxation as a means of acquiring the items. Governments may be controlled by a political process, and the study of allocation by the politics, which is known as political economy, is a significant branch of economics. Goods are allocated by certain means, like theft, deemed illegal by the government, and such allocation methods nevertheless fall within the domain of economic analysis; the market for marijuana remains vibrant despite interdiction by the governments of most nations. Other allocation methods include gifts and charity, lotteries and gambling, and cooperative societies and clubs, all of which are studied by economists. Some markets involve a physical marketplace. Traders on the Bombay Stock Exchange get together in a trading pit.

Traders on eBay come together in an electronic marketplace. Other markets, which are more familiar to most of us, involve physical stores that may or may not be next door to each other, and customers who search among the stores, purchasing when the customer finds an appropriate item at an acceptable price. When we buy bananas, we don‘t typically go to a banana market and purchase from one of a dozen or more banana sellers, but instead go to a grocery store. Nevertheless, in buying bananas, the grocery stores compete in a market for our banana patronage, attempting to attract customers to their stores and inducing them to purchase bananas. Price – exchange of goods and services for money – is an important allocation means, but price is hardly the only factor even in market exchanges. Other terms, such as convenience, credit terms, reliability, and trustworthiness are also valuable to the participants in a transaction. We may also define Economics as the study of how people choose to use resources. Resources include the time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services. Important choices involve how much time to devote to work, to school, and to leisure, how many dollars to spend and how many to save, how to combine resources to produce goods and services, and how to vote and shape the level of taxes and the role of government. Often, people appear to use their resources to improve their wellbeing. Well-being includes the satisfaction people gain from the products and services they choose to consume, from their time spent in leisure and with family and community as well as in jobs, and the security and services provided by effective governments. Sometimes, however, people appear to use their resources in ways that don't improve their well-being. In short, economics includes the study of labor, land, and investments, of money, income, and production, and of taxes and government expenditures. Economists seek to measure well-being, to learn how well-being may increase over time, and to evaluate the well-being of the rich and the poor. The most famous book in economics is the Inquiry into the Nature and Causes of The Wealth of Nations written by Adam Smith, and published in 1776 in Scotland. Let us go through some of the formal definitions of Economics. ―Economics is the study of people in the ordinary business of life.‖--

Alfred Marshall(Principles of Economics). ―Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses. ‖ -- Lionel Robbins(An Essay on the Nature and Significance of Economic Science) Economics is the ―study of how societies use scarce resources to produce valuable commodities and distribute them among different people.‖ -- Paul A. Samuelson(Economics).

1.2

Macro Economics and its interface with business and industry:

Importance of Decision Making in Business Decision making is an important job of corporate managers. They have to take decisions regarding the employment of land, labor, and capital in such a manner that output may be maximized at least possible cost. Hence, they are always in search of optimum combination of resources which would maximize corporate profit. Appropriate decision making is the strength of business. Success in business depends on proper and correct decision making. Location, scale of operation, quantum of resources to be employed, marketing etc are some of the important problems calling for decisions in business where macroeconomics may be applied for better results. Macro Economic Analysis Macroeconomics is concerned with the study of aggregate economic variables. It is concerned with the whole economy and studies the level and the growth of national income, the levels of employment, the level of private and government spending, the balance of payments, the consumption & the investment, saving functions and oscillations in business cycles. The objective of macroeconomics is to maintain macro equilibrium of the economy. According to Edwin Mansfield, ‘Macro economics deals with the behavior of aggregates like gross national product and the level of employment. A. koutsoyiannis says, ‘the aggregate econometric models are relevant for the study and prediction of aggregate magnitudes, such as total output of any economy, total employment, consumption, investment etc.

In all the economies of the world whether free or controlled, business and macroeconomics have become same. In the business decisions, tracking of macroeconomic variables has become an important element. (Macroeconomics, 2002) Managers face difficulty in decision making, understanding of macroeconomics helps CEO’s in running the business. Overall economic activity, economic policies (industrial policy, trade policy, monetary policy, fiscal policy), inflation affects the business. Decisions of CEO’s or managers are affected by this aggregate which makes up the overall environment of business. Future demand and investment depends upon the growth and the state of the economy. Macroeconomics in intertwined with business because business is afffected by the factors that constitute macroeconomics. Macroeconomics is a branch of economics that deals with issues relating to factors that aggect the economy of the country as a whole. Such factors include areas like the rate of unemployment, inflation, business cycles and gross domestic product. Entrepreneurs and other people related to business must take such factors into consideration as part of their market analysis. Role of Macroeconomic Analysis in formulation of Business Policies Macro economics helps the business in in-depth knowledge of macro economic environment of business relating to industrial policy, licensing policy, economic planning monetary and fiscal framework and overall economic policy. (Mathur, 2002)The role of macro economics in business policy formulation is being discussed in the following points: A. Macro economic policy Macro economics helps in formulation of economic policy. The subjects of an economic policy are monetary policy, fiscal policy, incomes policies and policy on balance of payment. Economic policy should be such that it promotes the business environment and provides impetus to business activities. (Mathur, 2002) B.Economic planning

A serious attempt towards self sustained growth of business is only possible by efficient planning. Planning is now a days synonymous with growth and development. Identification of priority areas, estimation of resources and coordination among various sectors of economy can be done through proper planning. Planning directs the growth in desirable corners. C. Solving macro paradoxes Macro economics helps in solving macro paradoxes like paradox of thrift related to savings, paradox of assumption by commercial banks that all depositors would not withdraw their money on any particular day and their right to withdrawal. D. Tracing effect of government policy on business Macro economics helps in tracing the implications of government policy changes on existing business activity. E. Help in solving problem of general unemployment Effective demand is the focal point of macro economics. Reduction in effective demand brings economic depression and thereby general unemployment. Hence, the level of effective demand should be increased in order to increase the level of employment. (Mathur, 2002) F. Analysis of trade cycles Macro economics tries to know about the behavior and occurrence of booms and slumps and their implication on business activity. This analysis is very useful for a free enterprise economy. Business cycles are bound to occur. Macro economics helps the business in facing booms and slumps so that negative impact is minimized. G.Macro analysis helps in development of micro analysis In the deductive method process of logic goes from general to particular. We go on deducting to draw specific conclusions. Many of micro economic conclusions are outcome of macro conclusion. The assumption that consumer is rational has been decided only after knowing about the behavior of a group. A medico is allowed to specialize in some part of

human body from surgical view point only when he has understood the anatomy and physiology of human body. H. Inability of micro economics to study some areas Micro economics is not able to study monetary problems, fiscal problems, financial sector problems, foreign exchange regulation problems and inflationary and recessionary situations problems. Business needs to be protected from these ticklish problems and therefore, needs the help of macro economics. I. Macro economic models Macro economics helps in building or constructing macro economic models. The major objective function of a macro economic model is to maintain the macro equilibrium in the country at the full employment level. The role of government through its monetary and fiscal operations becomes important as independent variables i.e. these policies are used to explain the dependent variable i.e. maintaining macro equilibrium. Macroeconomic Variables and Business Decisions are highly linked Business depends on the growth rate, when economic growth slows down; the overall economic environment becomes unfavorable to business. In a period of slow growth, the aggregate demand is very much reduced and the business has no choice but to curtail its operations. (Misra & Puri, 2007) Business depends on the inflation rate. Inflation of a mild sort increase aggregate demand which, in turn, opens up fresh opportunities for business growth. In such an environment, not only the demand for existing goods increases but the business can also introduce new items for which demand may be created through dynamic marketing. Savings and investment in a country determine its business potential. Investment can be undertaken in directly productive activities or in infrastructure. Excessive current account deficit in a country’s balance of payments is not desirable for business activity. Such a situation leads to a shortage of foreign exchange, which in turn forces restriction on imports. (Misra & Puri, 2007)This may have serious implications for the efficiency in production. In the interest of business the current account position has to be comfortable.

In addition, the net inflows from external assistance and direct foreign investment should be fairly large, but this should not be allowed to result in an overvalued exchange rate. In case the situation is otherwise, the country’s exports will fall and the business firms will feel seriously constrained account of it. Phase of economy is highly significant for the business. From the point of view of business, the prosperity phase of business cycle is ideal. In this phase, the economy expands in response to growing aggregate demand and the business firm has many options. There is expectation of rise in prices which induces managers to expand the scope of their activities. A company can introduce new products in this period and markets can be created for these products. Forces of recession get strengthened during recession. The recession usually gets reflected in the form of stock market crash and some fall in prices. The aggregate demand gradually declines and thus incentive for investment is killed. (Misra & Puri, 2007) At this time managers abandon new projects, resulting in a sharp reduction in demand for capital equipment. Since, finance is a basic requirement of business, the level of development of the financial system is of crucial importance for business. The basic function of financial markets – both money and capital market is the collection of savings and their transfer to business enterprises for investment purposes and thereby stimulating capital formation which in turn accelerates and process of business growth. The effective channel of domestic savings and obtaining finance from abroad are the important activities in the transfer process. In the transfer process, the principal activity is allocation of funds from the savings surplus to the savings deficit units. Financial markets, if they are well developed, allocate financial resources efficiently among the various business enterprises. (Misra & Puri, 2007)

Let us look at few instances Fall in Interest Rate - A rise or fall in interest rates affects business activities as well as the buying habits of the company's customers. Consumers take advantage of low interest rates by buying houses, cars etc because the interest payments they will have to make on loans to buy such

items will be low. So company during such phase of low interest rate generally expand because of the increase in demand for its products as well as the lower cost of expansion. Government Spending - Government mostly gets money from taxation ; Therefore higher government expenditures implies higher taxation which leads to low disposable income left at consumers hand which further leads to reduction of consumer spending on goods of various firms . On the other hand say government is spending higher on schools / education sector ; this would lead to increase in income of businesses that supply schools with books etc. Higher unemployment rate prevailing in economy => Lower spending by consumers => Decrease in demand for firm’s output =>Firm cut down its production and unemployment further increase. Inflation - A price rise leads to fall in real income of people and hence their purchasing power declines which leads to fall in demand for business’s products. Inflation also leads to people asking for higher wages which leads to rise in labour costs and hence lower profit for businesses. A high and volatile inflation isn't good for business confidence as well as they won't be sure on what their prices and costs going to be in future which will reduce their capital investment spending. 1.3: Resources and goals of an economic systems: Economic System Economic systems are the means by which countries and governments distribute resources and trade goods and services. They are used to control the five factors of production, including: labor, capital, entrepreneurs, physical resources and information resources. In everyday terms, these production factors involve the employees and money a company has at its disposal, as well as access to entrepreneurs, the people who want to run companies or start their own businesses. The physical materials and resources needed to run a business, along with the data and knowledge companies use to be successful, are also factors in production. Different economic systems view the use of these factors in different ways. An economic system is the combination of the various agencies, entities that provide the economic structure that guides the social community. These agencies are joined by lines of trade and exchange along which goods,money etc. Are continuously flowing. This affects production, allocation of

economic inputs, distribution, distribution of economic outputs and consumption of goods and services in an economy. It is a set of institutions and their social relations. Alternatively, it is the set of principles by which problems of economics are addressed, such as the economic problem of scarcity through allocation of finite prod...