Introduction An Overview

1. Chapter 1 Introduction An Overview

2. 1. Economics • Social / Behavioural science • Material well-being • Adam Smith, 1776 • Alfred Marshall, 1890 • Dismal science • Scarcity, uncertainty, and choice • Lionel Robbins, 1932 • Production possibility curve • - Law of increasing cost • - No free lunch

3. Figure 1 : Production Possibility Curve a A c b e d g f h goods Defence O B Civilian goods

4. * Decision issues • - Production:Who,what, how, where • - Exchange: Whom to sell at what price • Consumption: Basket • Growth: Non-renewable resources use, strategies • Decision units: Households, firms, workers, govt. * Science of numbers * Economics methodology - Rational Behaviour (self interest) - Inductive - Fallacy of causation - Positive and normative - Ceteris paribus * Consensus and dis-agreements * Inexact science - No controlled experiments

5. 2. Economists * Classical • Adam Smith, 1723-90 (1776): Father of modern economics: specialisation, foreign trade, laissez-faire, self-interest • Robert Malthus 1766-1834 (1798): Population growth to outstrip food production David Ricardo, 1772-1823 (1817): Foreign trade: principle of comparative advantage, theory of rent Karl Marx, 1818-83 (1867): Capitalist system as unfair, unstable and unsustainable * Neo – classical • Leon Walras, 1834-1910 (1874): General equilibrium • Alfred Marshall, 1842-1924 (1890): Partial equil., demand–supply tools, elasticity concept, eco. as a separate discipline for study • Vilfredo Pareto 1848-1923 (1906): Pareto optimal: None could gain without someone else’s loss • A C Pigou, 1877-1959 (1920): Real balance effect Irving Fisher 1869-1947 (1930): Father of monetary economics, quantity theory of money, theory of interest rate Lionel Robbins (1932): Resource scarcity and choice J. B. Say: Supply creates its own demand

6. * Others John Maynard Keynes, 1883-1946 (1936): Father of Macro economics, saviour of capitalism, greatest economist of the 20th century (Time magazine) Simon Kuznets 1901-85: Measurement of income, Kuznets’ curve John R. Hicks, 1904-89 (1940s): IS-LM apparatus, yield curve elasticity of substitution, indifference curves Joan Robinson, 1903-83 (1930s): Golden Rule, imperfect competition Edward Chamberlin, 1899-1967 (1930s): Monopolist competition theory Harbert A. Simons, 1916- (1952): Satisficing - theory of firm Ragner Frisch 1895-1973: Micro-macro dichotomy

7. Modern economists • Milton Friedman, 1912- (1968): Natural rate of output/ unemployment, adaptive expectations theory, permanent income hypothesis, policy lags, fooling of workers, monetarist • Paul Samuelson, 1915- (1949): Non-monetarists leader, revealed preference theory • James Tobin, 1918- (1956): Tobin tax, transaction demand for money, portfolio theory, separation theorem • Robert Solow, (1956): Growth model, saving as a temporary source of growth only • Amartya Sen 1933- (1960): Freedom as development, human capabilities: Health and education, questioned rational behavior assumption. • Arthur Laffer, (1968): Laffer curve • Robert Lucas, 1937- (1973): Rational expectation theory, theory of policy irrelevance

8. 3. Two branches and the bridge (Rupees) • * Micro and macro Ragnar Frisch Resource allocation --- resource utilisation and augmentation Given national income and general price, determine relative price and output --- reverse • Interdependence • Micro foundation of macro * Theory/fallacy of aggregation

9. Cjt = Ct aj = A • bj Yjt¹ B Yt • Paradox of thrift • Bumper crop • Relative grading Cjt = aj + bj Yjt (1.1) Ct = A + B Yt (1.2)

10. 4. Subject matter of Macro-economics • Measurement/monitor the economy • Economic fluctuations / stability (short-run) • Unemployment • Inflation • Growth(long-run)

11. 5. Major macro-economic variables • * National income * Wage rate • * Unemployment/employment * Interest rate • * Inflation *Money supply *Fiscal deficit* Foreign trade /investment * Saving - investment gap * Forex rate * Current account deficit *Forex reserves *External debt

12. 6. Tinbergen’s classification of variables • Target • Indicators • Intermediate • Policy 7. Macro economic policy goals and relationships • High and growing income • Price stability • Social justice • Globalization and sovereignty • - Phillips’ Curve • - Kuznets’ Curve • - Okun’s law

13. 8. Economic systems and decisions * Free enterprise (capitalist) economies • Demand/supply • * Command (socialist) economies • Central planning authority • * Mixed economies • Dual system • Guiding principle Efficiency:Production and distribution Pareto optimality : Sardar Sarovar Dam Project • Market/Govt. dichotomy !! / Market-Govt. failures • Decisions: rational Vs. emotions / traditions / customs

14. 9. Role of government: Mixed economy • Defense (public goods) • Justice (law and order) • Provision and maintenance of certain public works (roads, bridges, canals, rivers, harbors etc) and institutions (central bank, public work depts, etc) for improving welfare (infrastructure and regulation)

15. 10. Study of economics To understand environment, including policies To take economic decisions: Levels of national income, inflation, unemployment matters for firms • 11. Economic Policies Stabilization : Fiscal, monetary and forex rate Regulating : Agriculture, industry, trade, labour, etc New initiatives • Liberalization • Privatization • Globalization Policy alternatives vis-à-vis performance

16. 12. India’s economic position vis-à-vis world • Levels • Fluctuations/Growth • Economic ills/policy 13. Macro- economic problems/issues • Recession / unsustainable growth • Inflation / deflation • Unemployment / poverty • Three gaps • Saving-investment • Fiscal deficit • Trade deficit

17. Table 1.1 International Data on National Goal Variables Country Popul Land GNP per capita GDP Inflation Unemp Below poverty line Share in GDP Total Gross BOP current ation area growth rate (CPI) loyme (% of Population) (%) external int’l account balance rate (average) nt rate debt reserves (Milli (‘000 Measured PPP (%) (%) (%) Nationa Int’l (US $ Poores Richest (US $ Billions) (US $ billions) on) Sq. l 1/day)* t 20% 20% (US $) kms) 2002 2002 2002 1990- 1990-2001 2002 1987 – 2002** 1994 – 2002** 2001 2002 2002 2001 India 1048 3287 480 2570 5.9 8.7 - 28.6 34.7 8.1 46.1 97.1 71 4.67 USA 288 9629 35060 35060 3.4 2.7 5.8 - 14.1 5.2 46.4 NA 79 -480.9 UK 59 243 25250 25870 2.7 2.8 3.2 - 13.1 6.1 43.2 NA 42.8 -14.41 Japan 127 378 33550 26070 1.3 0.6 5.4 - 3.7 10.6 35.7 NA 462.4 112.5 Singapore 4.2 0.62 20690 23090 7.4 1.6 4.3 - - 5 49 NA 82 18.7 Indonesia 212 1905 710 2990 3.8 13.9 - 15.7 7.2 8.4 43.3 135.7 32.1 7.82 Malaysia 24 330 3540 8280 6.5 3.4 3.5 15.5 <2 4.5 53.8 43.4 34.3 7.19 Republic of 48 99 9930 16480 5.7 4.9 3.1 <2 <2 7.9 37.5 110.1 121.4 6.09 Korea China 1281 9598 940 4390 10 7.6 3.1 6 16.1 5.9 46.6 170.1 295.2 35.42 Pakistan 145 796 410 1940 3.7 9.1 7.8 28.6 13.4 9.5 41.1 32 8.8 3.87 Sri Lanka 19 66 840 3390 5 9.9 8.8 20 6.6 8 42.8 8.5 1.7 -0.29 Australia 20 7741 19740 26960 3.9 2.2 6.3 — 7.8 5.9 41.3 - 21.6 -17.26 Nigeria 133 924 290 780 2.5 30 — 43 70.2 4.4 56.7 31.1 7.3 0.51 Russian 144 17075 2140 7820 –3.7 85.9 9 30.9 6.1 4.9 51.3 152.6 47.8 29.52 Federation World 6201 1E+05 5080 7570 2.7 — — — — — — — — — Sources: World Development Indicators 2003, UNDP: Human Development Report 2003, and IMF: International Financial Statistics, * For OECD countries, the benchmark figure is US$ 14.40 at 1985 instead of US$1.00 ** Data refer to the latest available year.

18. Growth Rate:Real GDP 30 USA 20 China 10 India % Growth Rate 0 World -10 1950 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 Year

19. Unemployment Rate 14 12 10 USA 8 Japan % Unemployment UK 6 Malaysia 4 2 0 1950 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 Year

20. Inflation Rate: USA China India World CPI 35 30 25 20 15 10 5 0 -5 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 -10 1950