# Paper 2. MACRO-ECONOMIC THEORY

* **Note**: Part A consists upon intermediate level material while in Part B advanced literature will be covered. Mathematical Approach may be adopted in Part B.*

__Part A:__

__Part A:__

**Topic:1 Introduction and National Income**

- The Development of Macroeconomics, Actual vs. Potential Output,
- Analytical Approach to Macroeconomics.
- Circular Flow of National Income.
- Measurement of GNP: Expenditure Approach, Product Approach / Income Approach
- GNP as measure of welfare.
- Leakages and Injections: Saving and Investment and their Role.
- Nominal and Real Variables.
- Economic Models, Exogenous and Endogenous Variables and their Functional Relationships.
- Leading and Lagged variables.
- Measuring Unemployment: Oken’s Law.
- How to build simple Macroeconomic Models, Price Indices; Inflation Indexes, Deflation and Stagflation.
- Introduction to Keynesian and Classical School of Thoughts.

**Topic:2 Income Determination**

- Firm’s Demand for Factors of Production, Production Function, Demand for Labor and Capital:
- Marginal Product of Factors and their Demand.
- Labor Market and its Equilibrium.
- Demand for Goods and Services:
- Aggregate Demand and its Components:
- Consumption, Investment, Government Spending, and Net Exports.
- Equilibrium of Aggregate Demand and Supply: Mathematical Solution and Equilibrium. Saving and Investment Balance.
- Derivation of Simple Multiplier, Tax Multiplier. Inclusion of Imports and Multiplier.

**Topic:3 Theories of Consumption and Their Implications**

- Theories of Consumption:
- Dusenbury Hypothesis, Keynesian Consumption Function. Permanent Income Hypothesis / Life-Cycle Hypothesis,
- Beyond Permanent Income Hypothesis, Kuznet’s findings and Reconciliation of Marginal Propensity to Consume and Average Propensity to Consume and Evidences.
- Mathematical derivation of Consumption Models.
- The MPS Model, Wealth effect in the Static Model.
- Implications of Consumption Theories for Policy Formulation and Stabilization Policy. Random Walk Model.

**Topic:4 Saving and Investment**

- Definition and Kinds of Investment; Autonomous and Induced etc.
- Determinants of investment.
- Present Value Criteria for Investment.
- Investment Demand and Output Growth.
- Tobin’s Q-Theory.
- Lags in Investment Demand.
- Derivation of IS-curve, Shape of IS-curve.
- Volatility of Investment.
- Investment Demand and Fiscal Policy.
- Shifts in Investment Demand Curve and output determination.

**Topic:5 Money Market: The Demand and Supply of Money**

- Money Demand and its Determinants, Regressive Expectation Model.
- Portfolio Balance Approach, Empirical Estimation of Income and Interest Elasticities.
- Supply of Money, Determinants of Money Supply.
- Measurement of Money Supply and its implications, Instruments of Monetary Policy.
- Interest Sensitivity of Money Supply.
- Quantity Theory of Money and its Critical Review.
- Fischer effect, Money, Prices and Inflation.
- Derivation of LM Curve and its Slope.
- LM Curve and Money Market Equilibrium.
- Interaction of IS-LM and Equilibrium.

**Topic:6. Aggregate Demand, Supply and Stabilization Policy**

- Keynesian Models: Liquidity Trap.
- Effectiveness of Policy and Price Rigidity.
- Slope of Aggregate Supply and Demand Curves.
- Liquidity Trap.
- Grand Aggregate Demand Curve.
- Interaction of IS-LM and Determination of output: Short-run and Long-run analysis:
- Aggregate Demand and Supply and their Slopes.
- Slope of IS-LM in Short-run and Long-run.
- Vertical / Horizontal Shapes of these Curves. Classical and Keynesian Models.
- Shocks to Aggregate Demand and Supply and Stabilization Policy.
- Supply Side Economics.
- Stagflation and Stabilization Policies, Shocks to IS- LM and its Outcomes and Policy Implications.
- Short-run – Long-run Philip Curves.
- Long run and Vertical Aggregate Supply Curve.
- Ineffectiveness of Keynesian Policies, Technical Change and Shift in Vertical Aggregate Supply Curve.

__Part B:__

__Part B:__

**Topic:7. Open Economy and Macroeconomic Stabilization**

- Exchange Rates and their Determinants:
- Mundell – Fleming Model (MFM): Small open Economy with perfect Capital Mobility.
- IS-LM: Goods and Money Market. Small Open Economy, Floating Exchange Rate and Fiscal Policy. Fixed Exchange Rate and Fiscal Policy. Flexible and Managed Exchange Rates.
- Monetary Policy, Devaluation, and Recovery from the great depression.
- Trade Policy:
- Mundell-Fleming Model (MFM) with changing Price Level.
- MFM and large open Economy.
- Depreciation and its impacts. Income Absorption Approach and exchange Adjustment and Balance of Payment.

**Topic:8. Labor Market, Price Expectation and Unemployment**

- Demand and Supply of Labour, Equilibrium in the Labour Market.
- The Sticky Wage Model
- Insider-Outsider Models
- The Workers – Misperception Model
- The Imperfect – Information Model
- The Sticky Price Model. Rational Expectation (RE)
- Adaptive Expectations
- RE and Painless Disinflation
- Hysteresis and challenge to Natural rate Hypothesis.

**Topic:9. Macroeconomic Policy Debate**

- Policy Actions: Active or Passive, Ignorance, Expectations and the Lucas Critique.
- Conduct of Policy: Rule vs. Discretion
- Distrust of Policymakers and Political Process.
- Macroeconomics Policy: Rules for Fiscal Policy, making Policy in uncertain World.
- Seignorage and Inflation: What can Policy Accomplish?
- Monetarists vs. Activists debate.
- Phillips Curve: Short run and Long run analysis.
- The expectation augmented Phillips Curve.
- Money Inclusion and output.
- Short Run and Long Run Adjustment.
- Perfect Foresight and Adjustment.

**Topic:10. Government Debt and Budget Deficit**

- The size of Government Debt
- Measurement Problem: Inflation, Capital Assets, Business Cycle etc.
- Ricardian view of Debt: Ricardian Equivalence, Consumers and Future Taxes.
- Tax shooting, Delayed Stabilization, Ricardo and Ricardian Equivalence and Debate. Model of Debt Crises.

**Topic:11. Economic Fluctuation and Its Sources**

- The Theory of Real Business Cycles: Interpretation: Labor Market, Technology Shocks. Household Behaviour, the persistence of output Fluctuations. Limitations of the Model. The Challenges: What we know and what we don’t know? Long-run and Country’s Capacity to Produce. Short-run and influence of Aggregate Demand.
- Random Walk Model. What Determines Inflation Rate, Unemployment Rate and Output Growth? Can we revise Natural Rate of Output? Should we stabilize the Economy? The cost of Inflation? The problem of Budget Deficit?

**Topic:12. Long-Term Growth and Full Employment**

- Basic Neo-Classical Growth Model and Equilibrium Capital / Output Ratio, Wage- Profit Relative Shares.
- Neo-Classical Model with Technical Progress:
- Capital Embodied Technical Progress.
- Neutral Disembodied Technical Progress.
- Labor-Augmenting Disembodied Technical Progress.
- Kaldor Saving Function and Neoclassical Production Function.
- Golden Rule and Optimal Growth Models.
- New Growth Theory / Endogenous Growth.

#### Recommended Books:

- Branson, William H., (1979), Macroeconomic Theory and Policy, Harper and Row Publishers, New York /
- Branson, William H., and Litvack James M., Macroeconomics*, (Latest Edition), Princeton
- Glahe, Fred R., (Latest Edition), Macroeconomics, Theory and Policy, Harcourt Brace Jovanovich
- Mankiw, Gregory N., (2000) Macroeconomics*, Worth Publishers, New
- Peel D. and Minfow P., (2002). Advance Macroeconomics, Edward Elgar, Cheltenham, U.K.
- Romer, David, (2001). Advanced Macroeconomics*, McGraw Hills, New York /
- Sargent, Thomas J., (1988) Rational Expectations and Inflation*, Harper and Raw Publishers, New York /
- Rosalind Leveic and Alexander Reborens, Macro-economics: An Introduction to Keynesian Neo-Classical Controversies; Macmillan (Latest edition).
- Denison, Edward 1985.
*Trends in American Economic Growth, 1929-1982. Washington: The Brookings Institution.*

* *

** Strongly Recommended*

#### Additional Reading Material / Research Papers:

- Ball, Laurence, Mankiw, N. Gregory, and Romer, David. 1988. “The New Keynesian Economics and the Output-Inflation Tradeoff.”
*Brookings Papers on Economic Activity, No. 1, 1-65,*Reprinted in Mankiw and Romer (1991). - Barro, Robert J. 1976. “Rational Expectations and the Role of Monetary Policy.”
*Journal of Monetary Economics 2*(January): 1-32. - Barro, Robert 1989. “Interest-Rate Targeting.”
*Journal of Monetary Economics 23*(January): 3-30. - Barro, Robert, J., and Gordon, David B. 1983b. “Rules, Discretion and Reputation in a Model of Monetary Policy.”
*Journal of Monetary Economics*12 (July): 101-121. Reprinted in Persson and Tabellini (1994). - Bernheim, B. Douglas. 1987, “Ricardian Equivalence: An Evaluation of Theory and Evidence.”
*NBER Macroeconomics Annual*2: 263-304. - Blanchard, Olivier J. 1984. “The Lucas Critique and the Volcker Deflation.”
*American Economic Review*74 (May): 211-215. - Fischer, 1993. “The Role of Macroeconomic Factors in Growth.”
*Journal of Monetary Economics*32 (December): 485-512. - Friedman, Milton, 1968. “The Role of Monetary Policy”.
*American Economic Review*58 (March): 1-17. - Genberg, Hans. 1978. “Purchasing Power Parity under Fixed and Flexible Exchange ”
*Journal of International Economics*8 (May): 247-276. - Long, John B., and Plosser, Charles I. 1983. “Real Business Cycles.”
*Journal of Political Economy*91 (February): 39-69. - Mankiv, G., N. (1990), A quick Refresher Course in Macroeconomics,
*Journal of Economic Literature*, Vol. XXVIII, 1645-60. - Romer, Christina 1999. “Changes in Business Cycles: Evidence and Explanations.”
*Journal of Economic Perspectives*13 (spring): 23-44. - Romer, Paul M. 1990. “Endogenous Technological Change.”
*Journal of Political Economy*1998 (October, Part 2): S71-S102.

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