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Macro Economics




                    Notes          money  supply,  general  price  level,  unemployment,  economic  growth  rate,  economic
                                   development, etc. In this unit, you will be introduced to the knowledge area of macro economics.

                                   1.1 Developments of Macro Economics


                                   The Great Depression of the 1930s gave birth to a branch of economics that in 1933 Ragnar Frisch
                                   called Macro Economics. The developments in Macro Economics can be studied under three
                                   distinct heads:

                                       Classical Macro Economics
                                       Keynesian Macro Economics
                                       Post-Keynesian Macro Economics

                                   1.1.1  Classical Macro Economics

                                   The classical economists took a simple view of Macro Economic environment of an economy to
                                   champion the cause of 'laissez faire' capitalism guided by free market price mechanism, private
                                   property rights and commercial profit motive. There are three pillars of classical Macro Economics.

                                   JB Say's Law of Market

                                   Say's law argued that an economy is self-regulating provided that all prices, including wages,
                                   are flexible enough to maintain it in equilibrium. In a more simplistic, and somewhat inaccurate
                                   form, Say's law states that supply creates its own demand and over-production is impossible.
                                   This  theory  has  major  implications  for  how  governments  respond  to  periods  of  high
                                   unemployment or widespread underemployment.


                                       !
                                     Caution  Say's law was accepted as a major plank in classical Macro Economic theory until
                                     English economist John Maynard Keynes challenged its applicability in modern economies.

                                   Fisher's Quantity Theory of Money

                                   If free market price mechanism has to play its role and responsibility, then price must come to
                                   exist so as to reflect the relative position of either scarcity or abundance in the market. Price
                                   itself is measured in terms  of money. In fact, price is the value of something expressed in a
                                   monetary unit. Thus, we may have rupee price or dollar price or yen price, which was stated by
                                   Fisher. Starting from his 'equation of exchange', we worked out earlier that the money is an
                                   instrumental variable to control prices.

                                       !

                                     Caution  A reduction of money by 10% may bring about deflation, i.e., price reduction by
                                     exactly 10%. Otherwise, when money increases in the system, more money chases few
                                     goods, people's propensity to spend money goes up and this is reflected in a price rise,
                                     called inflation.
                                   In other words, when prices are required to fall during inflation time, the Central Bank must
                                   reduce money supply. Thus, the quantity of money matters. However, money should always be
                                   treated as a servant rather than as a master. The economy needs to keep money stock under
                                   control so that the general free level does not get disturbed and price mechanism functions to
                                   ensure an optimal allocation of resources.



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