By:Prof. Vani DhawanMACRO ECONOMICS AND BUSINESS

Why to study Macroeconomics?To understand the functioning of an economy as a whole.What determines a nations long-run economic growth ?What causes unemployment ?What causes prices to rise ?Can government policies (Fiscal and Monetary) be used to improve a nations economic performance ?What causes a nations economic activity to fluctuate ?How does being a part of a global economic system affect nations economies ?So, Macro economics is both a Theoretical science and a Policy science.

Meaning of Macro-Economics Macroeconomicsis a branch ofeconomicsdealing with the performance, structure,behavior, and decision-making of aneconomy, rather than individual markets.It is often called as Aggregative Economics and mainly it deals with the theory of Income, Employment, Prices and Money.

According to M.H. Spencer, Macro Economics is concerned with the economy as a large segments of it. In macro economics, attention is focused on such problems as the level of unemployment, the rate of inflation, the nations total output and other matters of economy wide significance.

Functions of an EconomyAn economy is a complex arrangement of closely linked sectors households, businesses, financial institutions, government and the rest of the world.

An economy employs various resources to produce a variety of goods and services for domestic and world consumption and provides income for the resources.

The CIRCULAR FLOW OF INCOME AND OUTPUT diagram shows the income received and payments made by each sector of the economy

Two Sectors Circular FlowHouseholdsBusiness/ FirmsWages, rent, interest, profitGoods & Services boughtIncomeFinancial SectorSavingInvestment

Three Sectors Circular FlowHouseholdsBusiness/ FirmsWages, rent, interest, profitConsumption Spending (C)Financial MarketSaving = Investment (S=I)GovernmentGovt. expenditure (G)Direct taxesDirect/Indirect taxesGovt. expenditure (G)

Four Sectors Circular Flow HouseholdsBusiness/ FirmsWages, rent, interest, profitConsumption Spending (C)Saving = Investment (S=I)GovernmentGovt. expenditure (G)Direct taxesDirect/Indirect taxesGovt. expenditure (G)ExternalSectorExport of servicesPayments for importsReceipts from exportsRemittances

Main Macroeconomic IndicatorsMacroeconomic indicators are statistics that indicate the current status of the economy of a state depending on a particular area of the economy (industry, labor market, trade, etc). These statistics are published regularly at a certain time by governmental agencies and the private sector.

In truth, these statistics help Forex traders monitor the economy's pulse, thus it is not surprising that these are religiously followed by almost everyone in the financial markets.

After publication of these indicators we can observe volatility of the market. The degree of volatility is determined depending on the importance of an indicator. That is why it is important to understand which indicator is important and what it represents.

Cont..1. Interest Rates Announcement::Interest rates play the most important role in moving the prices of currencies in the foreign exchange market and central bank are the most influential actors. When central banks change interest rates they cause the forex market to experience movement and volatility.

2. Gross Domestic Product (GDP)::The GDP is the broadest measure of a country's economy, and it represents the total market value of all goods and services produced in a country during a given year.

3. Consumer Price Index::CPI is probably the most crucial indicator of inflation. It represents changes in the level of retail prices for the basic consumer basket. If the economy develops in normal conditions, the increase in CPI can lead to an increase in basic interest rates. This, in turn, leads to an increase in the attractiveness of a currency.

4. Employment Indicators::It reflect the overall health of an economy or business cycle. In order to understand how an economy is functioning, it is important to know how many jobs are being created or destructed, what percentage of the work force is actively working, and how many new people are claiming unemployment.

Cont..

5. Retail Sales::The retail sales indicator is released on a monthly basis and is important to the foreign exchange trader because it is a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables.

6. Balance of Payments::The Balance of Payments represents the total foreign trade operations, trade balance, and balance between export and import, transfer payments. If coming payment exceeds payments to other countries and international organizations the balance of payments is positive.

Cont..

7. Government Fiscal and Monetary Policy::Stabilization of the economy (e.g., full employment, control of inflation, and an equitable balance of payments) is one of the goals that governments attempt to achieve through manipulation of fiscal and monetary policies. Fiscal policy relates to taxes and expenditures, and Monetary policy to financial markets and the supply of credit, money, and other financial assets.

There are many economic indicators, and even more private reports that can be used to evaluate the fundamentals of forex. It's important to take the time to not only look at the numbers, but also understand what they mean and how they affect a nation's economy.

Cont..

Gross Domestic ProductA measure of a countrys economy.

Commonly the Expenditure Method is used for measuring and quantifying GDP. So the formula is ::

GDP = C + I + G+(X-M)

Where

C = consumption, I = gross investment,G = government spending, X = exports, andM = imports.

BUSINESS CYCLE

What is Business Cycle ?According to Keynes,"A Business cycle is composed of periods of Good Trade, characterized by rising prices and low unemployment percentages, shifting with periods of bad trade characterized by falling prices and high unemployment percentages." Pattern of the Business Cycle::

The pattern of that of a period of growth, called expansion, which hits a peak.The growth is followed by a fall in the economy, called a contraction.The bottom of the fall is called the trough.

Phases of Business CycleProsperity - highest period of economic growth.

Recession - economic slowdown

Depression - prolonged recession

Recovery - renewed economic growth.

Phase 1 : ProsperityWhen there is an expansion of output, income, employment, prices and profits, also a rise in the standard of living termed as Prosperity phase.Features of prosperityare :-High level of output and trade.High level of effective demand.High level of income and employment.Rising interest rates & large expansion of bank credit.Inflation and Overall business optimism.A high level of MEC (Marginal efficiency of capital) and investment.

Due to full employment of resources, the level of production is Maximum and there is a rise inGNP. There is an upswing in the economic activity and economy reaches itsPeak. This is also called as aBoom Period.

Phase 2 : RecessionThe turning point from prosperity to depression is termed as Recession Phase.During a recession period, the economic activities slow down.

When demand starts falling, the overproduction and future investment plans are also given up. There is a steady decline in the output, income, employment, prices and profits. The businessmen lose confidence and become pessimistic (Negative). It reduces investment. The banks and the people try to get greater liquidity, so credit also contracts. Expansion of business stops, stock market falls. Orders are cancelled and people start losing their jobs. The increase in unemployment causes a sharp decline in income and aggregate demand. Generally, recession lasts for a short period.

Phase 3 : DepressionWhen there is a continuous decrease of output, income, employment, prices and profits, also fall in the standard of living and depression sets in.Features of depressionare :-Fall in volume of output and trade.Fall in income and rise in unemployment.Decline in consumption and demand.Fall in interest rate.Deflation and Overall business pessimism.Contraction of bank credit.Fall in MEC (Marginal efficiency of capital) and investment.

In depression, there is under-utilization of resources and fall in GNP. The aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy reaches itsTrough(low point).

Phase 4 : RecoveryThe turning point from depression to expansion is termed as Recovery or RevivalPhase.During the period of revival or recovery, there are expansions and rise in economic activities. When demand starts rising, production increases and this causes an increase in investment. There is a steady rise in output, income, employment, prices and profits. The businessmen gain confidence and become optimistic (Positive). This increases investments. The stimulation of investment brings about the revival or recovery of the economy. The banks expand credit, business expansion takes place and stock markets are activated. There is an increase in employment, production, income and aggregate demand, prices and profits start rising, and business expands. Revival slowly emerges into prosperity, and the business cycle is repeated.

Thus, during the expansionary or prosperity phase, there is inflation and during the contraction or depression phase, there is a deflation.

FORECASTING OF BUSINESS

What is Business forecasting?Business forecasting is an estimate or prediction of future developments in business such as sales, expenditures, and profits (usually are made by past events).

It is the activity of estimating the quantity of a product or service that consumers will purchase in the future period of time.

Why do we need Business forecasting ??

Reduces the cost .Reduces the investment risk. Know about the market (have a general idea of market).Reduce the problem of decision in the times of uncertainty. To provide information for optimum decision making.Change the strategies of company in time.

Business Cost Benefit ForecastingBenefits:

Aids decision makingInforms planning and resource allocation decisionsIncreased revenue and efficiencyIncreased customer retention Decreased costs

Cont...........Costs:

Data not always reliable or accurate,Data may be out of date,The past is not always a guide to the future,Qualitative data may be influenced by peer pressure,Difficulty of coping with changes to external factors out of the businesss control,For Example: change in economic policy, political developments (9/11?), natural disasters hurricanes, earthquakes, etc.

INPUT-OUTPUT ANALYSIS

Input-output analysis explains that the output of one sector can in turn become an input for another sector, which results in an interlinked economic system. It is also known as Analysis of Inter Industry Relations.

According to Wassily Leontief,

The input output analysis, seeks to analyze inter industry relationship in order to understand the interdependences and complexities of the system and to find the conditions for maintaining the balance between demand and supply of each industry.Meaning of Input Output Analysis

ASSUMPTIONS Each industry produces only one homogenous product. No two commodities are produced jointly.Production technology is assumed to be static.The use of inputs are employed in rigidly fixed proportion.Inputs & outputs of industries are expressed in terms of money value and are technical in nature.All producing firms are competitive in nature.There is pure competition in producing sector.

Examples of Inter-relationships Between SectorsConsider an economy with several industries. Each industry has a demand for products from other industries i.e. internal demand. There are also external demands from the outside. Find a production level for the industries that will meet both internal and external demands.

The IO model is centered on the idea of inter-industry transactions: Industries use the products of other industries to produce their own products.Outputs from one industry become inputs to another.When you buy a car, you affect the demand for glass, plastic, steel, etc.

Basic Input-Output LogicAutomobile Factory

From the Tire Producers PerspectiveTire FactorySchool DistrictsTrucking CompaniesAutomobile FactoryIndividual ConsumersInter-Mediate DemandForTiresFinal DemandFor Tires

Importance of Input Output Analysis This model is powerful tool of economic analysis for the firms as well as for economy:

Helpful for producer to make necessary adjustments in production process and improve his position.Helpful for Business Forecasting.It is the master chart of the economy (or macro economic balance sheet) which depicts the inter-dependence of the various sectors and their money flow.To study the effects of consumption, investment, expenditure etc. with reasonable accuracy.It is quite helpful for providing information for the formulation of economic policies in the developing economies.

Limitations of Input Output Analysis This technique suffers from various limitations are as follows:

Ignores the fluctuations in price level of goods and services.Based on linear equations which is unrealistic (increase in output do not always require proportionate increase in inputs).It is very expensive in terms of time and money.The assumption constant returns to scale will not hold for long period of time (in reality, economy faces dynamic economic conditions).Errors in forecasting final demand will have grave consequences.It has only limited application.

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