Contents

List of Figures

Preface

UNIT I INTRODUCTION

1 An Introduction to Macroeconomics

Macroeconomics and Microeconomics

Background of Macroeconomics

Need to Study Macroeconomics

Concepts in Macroeconomics

Summary

Review Questions

2 The Circular Flow of Income and Expenditure

Introduction

The Circular Flow of Income in a Two Sector Economy

The Circular Flow in a Three Sector Economy

The Circular Flow of Income in a Four Sector Economy

Summary

Review Questions

UNIT II NATIONAL INCOME AND ITS DETERMINATION

3 National Income

Introduction

National Income Aggregates

Measurement of National Income

Summary

Review Questions

4 The Classical Model of Income Determination

Introduction

Say’s Law

Output and Employment in the Classical Model

A Criticism of the Classical Model

Summary

Review Questions

5 The Keynesian Model of Income Determination in a Two Sector Economy

Introduction

Aggregate Demand in a Two Sector Economy

Consumption

Saving as a Counterpart of the Consumption Function

Determination of Equilibrium Income or Output in a Two Sector Economy

Summary

Review Questions

6 Shifts in the Aggregate Demand and The Multiplier

Introduction

Shifts in Aggregate Demand and the Multiplier

Uses and Limitations of the Multiplier

Applicability of the Multiplier to Less Developed Countries

The Multiplier and the Paradox of Thrift

Summary

Review Questions

7 The Keynesian Model of Income Determination in a Three Sector Economy: Introduction of the Government Sector

Introduction

Determination of Equilibrium Income or Output in a Three Sector Economy

Multipliers in a Three Sector Economy–The Fiscal Multipliers

Summary

Review Questions

8 The Keynesian Model of Income Determination in a Four Sector Economy: Introduction of the Foreign Sector

Introduction

Determination of Equilibrium Income or Output in a Four Sector Economy

Equilibrium Income and Output

Introduction of Government Transfer Payments in a Four Sector Model

Multiplier in a Four Sector Economy–The Foreign Trade Multiplier

Summary

Review Questions

UNIT III THEORIES OF CONSUMPTION AND INVESTMENT SPENDING

9 Theories of Consumption

Introduction

Absolute Income Hypothesis

Relative Income Hypothesis

Permanent Income Hypothesis

Life Cycle Hypothesis

Other Factors Influencing Consumption

Summary

Review Questions

10 Theories of Investment Spending

Introduction

Basic Concepts

The Decision to Invest

Changes in the Rate of Interest, the MEC and Capital Accumulation

Theories of Investment

Summary

Review Questions

UNIT IV AN ANALYSIS OF THE MONETARY SECTOR

11 Money

Introduction

Evolution and Forms of Money

Definition of Money

Money and Near Money

Functions of Money

Significance of Money

Summary

Review Questions

12 Supply of Money

Introduction

Measures of Money Supply in India

The Theory of Money Supply

The Process of Credit Creation and the Deposit Multiplier

Summary

Review Questions

13 Demand for Money and the Rate of Interest: The Classical Approach

Introduction

Fisher’s Transactions Approach to the Quantity Theory of Money

The Cambridge Cash Balance Approach

The Classical Theory of Interest

The Loanable Funds Theory

Summary

Review Questions

14 Demand for Money: The Keynesian Approach

Introduction

The Keynesian Theory of the Demand for Money

The Keynesian Theory of Interest

Variations in the Interest Rate

A Criticism of the Keynesian Approach

Summary

Review Questions

15 Demand for Money: The Post-Keynesian Approach

Introduction

Portfolio Theories of Demand for Money: Tobin’s Port Folio Balance Theory

Transactions Theories of Demand for Money: Baumol Tobin Model of Cash Management

Modern Quantity Theory of Money: Friedman’s Model

Summary

Review Questions

UNIT V THE IS–LM FRAMEWORK: EQUILIBRIUM IN THE GOODS AND MONEY MARKETS

16 The IS–LM Model for a Two Sector Economy

Introduction

The IS–LM Model in a Two Sector Economy

The Goods Market Equilibrium in a Two Sector Economy: The IS Curve

The Money Market Equilibrium in a Two Sector Economy: The LM Curve

Equilibrium in the Two Markets: The Goods Market and Money Market

Disequilibrium to Equilibrium: The Process of Adjustment

A Shift in the IS–LM Curves

Summary

Review Questions

17 The IS–LM Framework for a Three Sector Model

Introduction

The IS–LM Model for a Three Sector Economy

The Goods Market Equilibrium in a Three Sector Economy: The IS Curve

The Money–Market Equilibrium in a Three Sector Economy: The LM Curve

Equilibrium in the Goods and the Money Market in Three Sector Economy

Shifts in the IS Curve Due to Changes in Fiscal Policy

Shifts in the LM Curve Due to Monetary Policy

The Elasticities of IS and LM Curves and the Effectiveness of Monetary and Fiscal Policies

Summary

Review Questions

18 Aggregate Demand and Aggregate Supply

Introduction

The Aggregate Demand Curve

The Aggregate Supply Curve

The Aggregate Demand and Aggregate Supply Model

The Effects of a Monetary Expansion

Effects of a Decrease in Government Budget Deficit

Effects of a Shift in Aggregate Supply: Supply Shocks

The Supply Side Economics

Summary

Review Questions

UNIT VI INFLATION AND UNEMPLOYMENT

19 Inflation

Introduction

Meaning of Inflation

Measurement of Inflation

The Economic and Social Effects of Inflation

Inflation in India

Summary

Review Questions

20 Theories of Inflation

Introduction

Monetarist Approach to Inflation

Keynesian Approach to Inflation

Modern Approach to Inflation

Control of Inflation

Summary

Review Questions

21 Unemployment

Introduction

Unemployment and Related Terms

Types of Unemployment

Costs of Unemployment

Relationship Between Inflation and Unemployment

Modern Phillips Curve

Sacrifice Ratio

Summary

Review Questions

UNIT VII THE OPEN ECONOMY MACROECONOMICS AND THE FRAMEWORK OF MACROECONOMIC POLICIES

22 Foreign Exchange

Introduction

Foreign Exchange Market

Exchange Rate Systems

Exchange Rate Determination

Fixed Versus Flexible Exchange Rate

Summary

Review Questions

23 Balance of Payments

Introduction

Meaning and Structure of Balance of Payments

Double Entry Book Keeping

A Disequilibrium in the Balance of Payments

Kinds of Disequilibria in the Balance of Payments

The Process of Adjustment in the Balance of Payments

Analysis of Performance of Indian Economy in the External Sector

Summary

Review Questions

24 Macroeconomic Policies

Introduction

Meaning and the Advent of Macroeconomic Policy

Objectives of Macroeconomic Policy

The Formulation of Macroeconomic Policy

Summary

Review Questions

25 Monetary Policy and Fiscal Policy

Introduction

Meaning of Monetary Policy

Instruments of Monetary Policy

Monetary Policy Developments in India

Limitations of Monetary Policy

Meaning of Fiscal Policy

Instruments of Fiscal Policy

Fiscal Policy and Stabilization in the Economy

Full Employment Budget Surplus

Limitations of Fiscal Policy

Crowding Out and its Importance

Summary

Review Questions

Appendix A

Appendix B

Appendix C

Glossary

To My Parents

Figures

1.1 Aggregate Demand and Aggregate Supply

2.1 The Circular Flow of Income in a Two Sector Economy

2.2 Withdrawals and Injections in an Economy

2.3 The Circular Flow of Income in a Three Sector Economy

2.4 The Circular Flow of Income in a Four Sector Economy

4.1 The Short-run Aggregate Production Function

4.2 Aggregate Demand Curve for Labour

4.3 Derivation of the Individual’s Supply Curve of Labour

4.4 The Individual’s Supply Curve of Labour

4.5 The Determination of Employment, Real Wage Rate and Output

5.1 The Non-linear Consumption Function

5.2 The Linear Consumption Function

5.3 The Saving Function

5.4 The Aggregate Demand Function

5.5 Determination of Equilibrium Income or Output in a Two Sector Economy

6.1 Effect of a Change in Investment on the Equilibrium Income or Output

6.2 Paradox of Thrift

7.1 Determination of Equilibrium Income or Output in a Three Sector Economy

8.1 The Import and Export Functions

8.2 Determination of Equilibrium Income or Output in a Four Sector Economy

9.1 Relationship Between Income and Consumption: The Absolute Income Hypothesis

9.2 Relationship Between Income and Consumption: The Life Cycle Hypothesis

10.1 The Marginal Efficiency of Capital Schedule

10.2 The Aggregate Marginal Efficiency of Capital Schedule

10.3 Determination of the Equilibrium Investment

10.4 Marginal Efficiency of Capital Schedule and Marginal Efficiency of Investment Schedule

10.5 A Fall in the Rate of Interest and Capital Accumulation

10.6 The Shift in the MEC Schedule and Capital Accumulation

13.1 Determination of the Rate of Interest: The Classical Theory

13.2 A Change in Saving and its Effect on the Rate of Interest

13.3 Interest Rate Determination in the Loanable Funds Theory

14.1 Individual’s Money Holdings for Transactions

14.2 Transactions Demand for Money as a Function of the Income Level

14.3 Transactions Demand for Money as Interest Inelastic

14.4 Transactions Demand for Money as Interest Elastic

14.5 Speculative Demand Curve for Money

14.6 The Total Demand for Money

14.7 Determination of the Rate of Interest: The Keynesian Theory

14.8 Effect of Changes in the Money Supply on the Interest Rate

14.9 Effect of Changes in the Transactions Demand for Money on the Interest Rate

15.1 Maximization of Utility by the Individual Wealth Holder

15.2 Effects of a Change in the Interest Rate on the Individual Wealth Holder’s Asset Portfolio

15.3 Effects of a Change in the Interest Rate on the Individual Wealth Holder’s Asset Portfolio: The Substitution Effect and the Wealth Effect

15.4 Effects of a Change in the Shape of the Indifference Curves on the Individual Wealth Holder’s Asset Portfolio

15.5 Effects of an Increase in the Risk on Bonds on the lndividual Wealth Holder’s Asset Portfolio

15.6 The Individual’s Average Money Holdings Over a Year

16.1 The Goods Market Equilibrium in a Two Sector Economy: The IS Curve

16.2 The Money Market Equilibrium in a Two Sector Economy: The LM Curve

16.3 Equilibrium in the Two Markets: The Goods Market and Money Market

16.4 The IS Curve Equation Y = 1400 – 20r

16.5 The LM Curve Equation Y = 1200 + 16r

16.6 Simultaneous Equilibrium for IS and LM Curves When Y = 1200 and r = 10%

16.7 A Shift in the IS Curve

16.8 A Shift in the LM Curve

16.9 A Simultaneous Shift in Both IS and LM Curves

16.10 IS Curves of Equation Y = 520–8r and Y = 600–8r

16.11 LM Curves of Equation Y = 1200 + 25r and Y = 1500 + 25r

16.12 IS Curves of Equation Y = 720–16r and Y = 720–32r

17.1 The Goods Market Equilibrium in a Three Sector Economy: The IS Curve

17.2 Equilibrium in the Goods and the Money Market in a Three Sector economy

17.3 Simultaneous Equilibrium for IS and LM Curves Exist When Y = 527.5 and r = 2.375%

17.4 Shift in the IS Curve Due to Changes in Fiscal Policy

17.5 Shift in the IS Curve Due to an Increase in Tax

17.6 Shift in the IS Curve Due to a Decrease in Tax

17.7 The Effects of an Increase in the Money Supply

17.8 The LM Curve

17.9 Effectiveness of Fiscal Policy

17.10 Effectiveness of Monetary Policy

17.11 The IS Curves Plotted

18.1 Derivation of the Aggregate Demand Curve from the IS—LM Model

18.2 Shifts in the Aggregate Demand Curve

18.3 The Classical Approach to the Aggregate Supply Curve

18.4 The Keynesian Approach to the Aggregate Supply Curve

18.5 Derivation of Upward Sloping Aggregate Supply Curve through the Change in Real Wage

18.6 Derivation of Upward Sloping Aggregate Supply Curve through the Production Function

18.7 Determination of the Output Level and the Price Level

18.8 Effects of a Monetary Expansion

18.9 Effects of a Decrease in Government Budget Deficit

18.10 Effects of a Shift in Aggregate Supply: Supply Shocks

18.11 Adverse Supply Shock and Accommodating Monetary or Fiscal Policies

18.12 Effects of a Tax Cut

20.1 Inflationary Gap

20.2 Demand Pull Inflation Arising from Real Factors

20.3 Demand Pull Inflation Arising from Monetary Factors

20.4 Cost Push Inflation Arising from an Autonomous Increase in the Wage Rate

20.5 Relationship Between Demand Side Inflation and Supply Side Inflation

20.6 Supply Side Inflation and Restrictive Monetary and Fiscal Policies

21.1 Wait Unemployment

21.2 Okun’s Law

21.3 Phillips’ Curve for the United Kingdom

21.4 (a) Labour Market

21.4 (b) The Phillips’ Curve

21.5 Modern Phillips’ Curve: Short-run

21.6 Modern Phillips’ Curve: Long-run

22.1 Demand for Foreign Exchange

22.2 Supply of Foreign Exchange

22.3 Determination of the Equilibrium Exchange Rate under a Flexible Exchange Rate System

22.4 An Effect of a Change in Demand on the Equilibrium Exchange Rate

22.5 Determination of the Exchange Rate under a Fixed Exchange Rate System

23.1 Policy Mix and a Simultaneous External and Internal Balance

25.1 Budget Surplus

25.2 Effects of Expansionary Fiscal Policy

25.3 A Fiscal Expansion and Monetary Accommodation

A.1 Investment Demand Curve

A.2 A Derivation of the IS Curve

A.3 A Derivation of the LM Curve

A.4 The Goods and Money Markets

B.1 The Goods Market Equilibrium in a Four Sector Economy: The IS Curve

B.2 Equilibrium in the Goods and the Money Market in a Four Sector Economy

B.3 Shifts in the IS Curve in a Four Sector Economy

C.1 An Adverse Supply Shock