LECTURE ONE

INTRODUCTION TO MACROECONOMICS
1.1 Introduction
This lecture will lay foundation for this course principles of macroeconomics. We will introduce
you with the key concepts and terms which underpin the study of the macroeconomics and we will
analyze in greater detail in the subsequent lectures. We shall begin the study of this lecture by
highlighting the meaning of macroeconomics and related terms. Furthermore, we shall explain the
objectives, importance and limitations of macroeconomics and the role government plays in the
economy.

1.2 Learning Objectives:

At the end of this lecture, the learner will be able to:

 Appreciate the key variables and features in macroeconomics

 Appreciate the basic macroeconomic objectives which governments pursue
 Recognize the importance of macroeconomics in an economy
 Understand the challenges facing economies with attainment of macroeconomic goals
 Analyze the role of government in an economy.
1.3 Definition of key Concepts
1.3.1 Microeconomics
 It involves the study of the individual parts of the economy with respect to individual
market prices, individual firms’ revenues and costs of production and the employment of
factors of production at the individual firm or market level.
1.3.2 Macroeconomics
 It is a field of economics which deals with the economy as a whole and the determination
of national output, income and expenditure and the implications for employment and
prices.
 It attempts to analyze and explain the interrelationships between aggregate (totals)
variables such as output, employment, interest rates, money and prices in the economy
 Macroeconomics therefore analyses the performance of the economy as a whole.
Macroeconomics deals with the following:
(i) Total output of goods and services (GNP)
 What determines the GNP level?
 Why is it that GNP grows at a lower rate in some years than in others?
(ii) Total employment and unemployment levels
 What proportion of total population is unemployed?
 What determines levels of unemployment?
(iii) General price level
 Shows cost of purchasing by a typical consumer
 Estimates inflation and anticipated effects
(iv) Balance of payment problem
(v) Exchange rates
1.3.3 Economic Models
These refer to simplified explanations of how the economy works

1.3.4 Macroeconomic Models

These are simplified explanations or theories of how the economy works, i.e. simplified
explanations of the real word.

For example

The behaviour of consumption spending in an economy can be represented by a simple model as

follows

C t    Yt  Yt 1
Where
C t  consumption in the current period
Yt  Current level of income
Yt 1  Pr evious period ' s level of income

This model is a simplification of the real world situation because some factors that are important
in influencing consumption behaviour are excluded. The other factors that affect level of
consumption in the economy include; wage rate, interest rate, price, capital gains, money stock,
attitudes, consumer credit and money illusion among others.

Macroeconomic models help in the forecasting of future trends of the economy.

A model can be tested by how well it can explain past events and if it can predict accurately the
path of the economy.

A good model improves understanding, forecasts and decision-making by policy makers.

1.4 The major goals/aims of Macroeconomic Policy

1. Full employment
- Unemployment is where some resources are not optimally utilized and are lying idle.
Full employment is favored because the greater the level of employment, the greater
the amount of goods and services available in the economy. It is also argued that the
burden of unemployment and loss of goods and services fall disproportionately on
people who are without jobs.
2. Price stability
- Inflation should be avoided at all costs so that prices remain stable and predictable over
time. This is important because inflation affects other people more adversely than
others. For example, people whose incomes rise more rapidly than prices and those
who are able to borrow at relatively low interest rates prior to inflation benefit from
inflation.
3. Economic growth
- Economic growth takes place when real output increases more rapidly than the increase
in population, thus with economic growth the society has more goods and services at
its disposal and a correspondingly higher standard of living.
4. External balance
- If a country has a favourable balance of payment (BOP), its foreign exchange
reserves will increase, hence can import the much needed capital for investment.
Unfavorable BOP would lead to an outflow of foreign exchange to finance the trade
deficit
1.5 Importance of Macroeconomics
1. Facilitates estimation of GNP, which aids in the analysis of the economy’s performance;
2. Facilitates the study of the nature and size of material welfare of the society;
3. Knowledge of macroeconomics is important in economic policy formulation by governments.
For example we are able to understand how aggregate variables like GNP, wage rate,
 consumption, savings, investment, interest rates etc, will be affected by a change in
government expenditure, tax policy, monetary policy, foreign exchange rates,
4. It predicts the impact of exogenous variables on the endogenous variables.

1.6 The limitations of Macroeconomics

1. Macroeconomic theory treats the aggregate which it deals with as internally homogenous.
Therefore, it overlooks the significance of internal composition and structure of such variables
2. It tends to make generalizations about the whole economy based on small samples, yet the
samples may not accurately reflect the overall picture. The propositions that are true for
individuals or small groups are not necessarily true for the economy.
3. The aggregates may not be functionally related. In such a case, the macroeconomic policies
that are formulated will be erroneous. For example, aggregate consumption will only be useful
for analysis if it is functionally related to levels of income, wealth interest rates, capital gains,
relative prices, money stock, attitudes and expectations, consumer credit, etc
4. Aggregate models that may be derived to explain the behaviour of the economy may end up
not conforming to the real world. For example, the bulk of the macroeconomic theory
developed so far has been relevant to developed countries since most models have been
constructed in those countries. These models are far from reality in developing countries
1.7 Reasons for Government Intervention
a) Provision of essential services
Governments may provide certain services such as health, education, policing, sanitation, etc. for
everyone regardless of their ability to pay.

b) Transfer payments
These are payments by the state for which no goods or services have been offered in return and
are intended as a means of maintaining standard of living for those in society who are in most
need. Examples of transfer payments include unemployment benefits and pensions for retired
workers provided by the state.

c) Natural monopolies
Free market competition is beneficial because it provides consumers with the maximum choice of
suppliers and provides maximum incentives for firms to produce efficiently. However,
governments may decide to intervene directly in certain sectors of the economy where, for
technical reasons, competition cannot occur.

d) Social costs and benefits

Governments intervene to control or prohibit certain goods and services which are considered to
have a detrimental effect on society, for example drugs and pornography. In addition, governments
may also intervene to protect society from the side-effects of others’ actions, for instance the
control of pollution and the prosecution of polluters. Government intervention with regard to
control of these externalities may take many forms including laws and regulations, fines and
compensation payments, as well as taxes and subsidies aimed at reducing or encouraging supply.

e) Support for industry and commerce

Just as governments provide support for individuals so they may also choose to support individual
firms or entire industries. Governments support firms because of the desire to increase investment,
to finance risky research and development, to redistribute employment, to increase total
employment and to benefit exports.

f) Management of total demand in the economy

Government may intervene to control and stimulate the level of total economic activity. This is
based on the view that, left to its own devices, the free market does not necessarily lead to full
employment of the nation’s scarce resources and therefore operation on its optimum or highest
potential production possibility curve

1.7 Lecture Activities

a) What do you understand by the terms macroeconomics and microeconomics?
b) Explain the main objectives of studying macroeconomics.
c) What role can government play in the economy?