Christopher R. Makler, Stanford University
A suite of around 350 interactive graphs, illustrating microeconomic, financial and mathematical concepts, that run in a modern web browser without additional technology. They can be used in lectures or incorporated into other sites via an iframe.
More than twenty interactive workbooks for Microeconomics, Macroeconomics and Econometrics, created using the Wolfram programming language. Each chart illustrates a concept or model, and gives many parameters that the reader can adjust to see the resulting changes. The interactive workbooks can be viewed online or downloaded to the reader’s computer to run in the free Wolfram player. These were created by Angulo while still an undergraduate at Warwick.
In economics, inflation means rise in the general level of prices of goods and services over a period of time in an economy. Inflation may affect the economy either in positive way or negative way.
The causes of inflation are as follows −
Inflation is also caused by decrease in supplies, consumer confidence, and corporate decisions to charge more.
There are many ways of controlling inflation in an economy −
The most important method of controlling inflation is monetary policy of the Central Bank. Most central banks use high interest rates as a way to fight inflation. Following are the monetary measures used to control inflation −
Fiscal measures are another important set of measures to control inflation which include taxation, public borrowings, and government expenses. Some of the fiscal measures to control inflation are as follows −
Wage and price controls help in controlling wages as the price increases. Price control and wage control is a short term measure but is successful; since in long run, it controls inflation along with rationing.
Inflation is of course the all too familiar problem of too much money (demand) chasing too few goods (supply), with the upshot of prices and expectations everywhere tending to rise higher and higher.
In these circumstance, a business manager has to take appropriate decisions and measures based on macro economic uncertainties like inflation and the occasional recession.
A true test of a business manager lies in delivering profitability ie., the extent to which he increases revenues and also reduces costs even during economic uncertainties.
In the current scenario, they are supposed to get faster solutions to the problems of coping with soaring prices (for example) by understanding the process of how inflation distorts the traditional functions of money along with recommendations.
The bottom-line impact is that, Customers / clients reward efficient management with profits and penalize inefficient management with losses. Hence, it is advisable to be well prepared to tackle these areas.
Business cycles are the rhythmic fluctuations in the aggregate level of economic activity of a nation. Business cycle comprises of following phases −
Business cycles occur because of reasons such as good or bad climatic conditions, under consumption or over consumption, strikes, war, floods, draughts, etc
According to Schumpeter, an innovation is defined as the development of a new product or introduction of a new product or a process of production, development of new market or a change in the market.
Professor Hayek says, primary cause of business cycles is monetary overestimate. He says business cycles are caused by over investment and consequently by over production. When a bank charges rate of interest below the equilibrium rate, the business has to borrow more funds which leads to business fluctuations.
According to Professor Hawtrey, all the changes in the business cycles take place due to monetary policies. According to him the flow in the monetary demand leads to prosperity or depression in the economy. Cyclical fluctuations are caused by expansion and contraction of bank credit. These conditions increase or decrease the flow of money in the economy.
Stabilization policies are also known as counter cycle policies. These policies try to counter the natural ups and downs of business cycles. Expansionary stabilization policies are useful to reduce unemployment during contraction and contractionary policies are used to reduce inflation during expansion.
The flow chart of stablilization policies is described below:
Monetary policy is employed by the government as an effective tool to promote economic stability and achieve certain predetermined objectives. It deals with the total money supply and its management in an economy. Objectives of monetary policy include exchange rate stability, price stability, full employment, rapid economic growth, etc.
Fiscal policy helps to formulate rational consumption policy and helps to increase savings. It raises the volume of investments and the standards of living. Fiscal policy creates more jobs, reduces economic inequalities and controls, inflation and deflation. Fiscal policy as an instrument to fight depression and create full employment conditions is much more effective as compared to monetary policy.
When monetary policy and fiscal policy are inadequate to control prices, government adapts physical policy. These policies can be introduced swiftly and thus the result is quite rapid. Theses controls are more discriminatory as compared to monetary policy. They tend to vary effectively in the intensity of the operation of control from time to time in various sectors.
Economic growth refers to an increase in the goods and services produced by an economy over a particular period of time. It is measured as a percentage increase in real gross domestic product which is GDP adjusted to inflation. GDP is the market value for all the final goods and services produced in an economy.
Adam Smith laid emphasis on increasing returns as a source of economic growth. He focused on foreign trade to widen the market and raise productivity of trading countries. Trade enables a country to buy goods from abroad at a lower cost as compared to which they can be produced in the home country.
In modern growth theory, Lucas has strongly emphasized the role of increasing returns through direct foreign investment which encourages learning by doing through knowledge capital. In Southeast Asia, the newly industrialized countries (NICs) have achieved very high growth rates in the last two decades.
The neoclassical approach to economic growth has been divided into two sections −
The neoclassical growth model developed by Solow fails to explain the fact of actual growth behavior. This failure is caused due to the models prediction that per capita output approaches a steady state path along which it grows at a rate that is given. This means that the long-term rate of national growth is determined outside the model and is independent of preferences and most aspects of the production function and policy measures.
The modern approach to market comprises of several features. The new economy emerging today is spreading all over the world. It is a revolution in knowledge capital and information explosion. Following are the important key elements −
Modern theory of economic growth focuses mainly on two channels of inducing growth through expenses spent on research and development on the core component of knowledge innovations. First channel is the impact on the available goods and services and the other one is the impact on the stock of knowledge phenomena.
According to Keynes there are two major factors that determine the national income of an economy −
Aggregate supply comprises of consumer goods as well as producer goods. It is defined as total value of goods and services produced and supplied at a particular point of time. When goods and services produced at a particular point of time is multiplied by the respective prices of goods and services, it helps us in getting the total value of the national output. The formula for determining the aggregate national income is follows −
Aggregate Income = Consumption(C) + Saving (S)
Few factor prices such as wages, rents are rigid in the short run. When demand in an economy increases, firms also tend to increase production to some extent. However, along with the production, some factor prices and the amount of inputs needed to increase production also increase.
Aggregate demand is the effective aggregate expenditure of an economy in a particular time period. It is the effective demand which is equal to the actual expenditure. Aggregate demand involves concepts namely aggregate demand for consumer goods and aggregate demand for capital goods. Aggregate demand can be represented by the following formula −
AD = C + I
As per Keynes theory of nation income, investment (I) remains constant throughout, while consumption (C) keeps changing, and thus consumption is the major determinant of income.
The total net value of all goods and services produced within a nation over a specified period of time, representing the sum of wages, profits, rents, interest, and pension payments to residents of the nation.
For the purpose of measurement and analysis, national income can be viewed as an aggregate of various component flows. The most comprehensive measure of aggregate income which is widely known is Gross National Product at market prices.
Gross emphasizes that no allowance for capital consumption has been made or that depreciation has yet to be deducted. Net indicates that provision for capital consumption has already been made or that depreciation has already been deducted.
The term national denotes that the aggregate under consideration represents the total income which accrues to the normal residents of a country due to their participation in world production during the current year.
It is also possible to measure the value of the total output or income originating within the specified geographical boundary of a country known as domestic territory. The resulting measure is called “domestic product”.
The valuation of the national product at market prices indicates the total amount actually paid by the final buyers while the valuation of national product at factor cost is a measure of the total amount earned by the factors of production for their contribution to the final output.
GNP at market price = GNP at factor cost + indirect taxes – Subsidies.
NNP at market price = NNP at factor cost + indirect taxes – Subsidies
For some purposes we need to find the total income generated from production within the territorial boundaries of an economy irrespective of whether it belongs to the inhabitants of that nation or not. Such an income is known as Gross Domestic Product (GDP) and found as −
GDP = GNP – Nnet Factor Income From Abroad
Net Factor Income from Abroad = Factor Income Received From Abroad – Factor Income Paid Abroad
The NNP is an alternative and closely related measure of the national income. It differs from GNP in only one respect. GNP is the sum of final products. It includes consumption of goods, gross investment, government expenditures on goods and services, and net exports.
GNP = NNP − Depreciation
NNP includes net private investment while GNP includes gross private domestic investment.
Personal income is calculated by subtracting from national income those types of incomes which are earned but not received and adding those types which are received but not currently earned.
Personal Income = NNP at Factor Cost − Undistributed Profits − Corporate Taxes + Transfer Payments
Disposable income is the total income that actually remains with individuals to dispose off as they wish. It differs from personal income by the amount of direct taxes paid by individuals.
Disposable Income = Personal Income − Personal taxes
The concept of value added is a useful device to find out the exact amount that is added at each stage of production to the value of the final product. Value added can be defined as the difference between the value of output produced by that firm and the total expenditure incurred by it on the materials and intermediate products purchased from other business firms.
Lets have a look at the following ways of measuring national income −
In product approach, national income is measured as a flow of goods and services. Value of money for all final goods and services is produced in an economy during a year. Final goods are those goods which are directly consumed and not used in further production process. In our economy product approach benefits various sectors like forestry, agriculture, mining etc to estimate gross and net value.
In income approach, national income is measured as a flow of factor incomes. Income received by basic factors like labor, capital, land and entrepreneurship are summed up. This approach is also called as income distributed approach.
This method is known as the final product method. In this method, national income is measured as a flow of expenditure incurred by the society in a particular year. The expenditures are classified as personal consumption expenditure, net domestic investment, government expenditure on goods and services and net foreign investment.
These three approaches to the measurement of national income yield identical results. They provide three alternative methods of measuring essentially the same magnitude.
Circular flow model is the basic economic model and it describes the flow of money and products throughout the economy in a very simplified manner. This model divides the market into two categories −
The circular flow diagram displays the relationship of resources and money between firms and households. Every adult individual understands its basic structure from personal experience. Firms employ workers, who spend their income on goods produced by the firms. This money is then used to compensate the workers and buy raw materials to make the goods. This is the basic structure behind the circular flow diagram. Lets have a look at the following diagram −
In the above model, we can see that the firms and the households interact with each other in both product market as well as factor of production market. The product market is the market where all the products by the firms are exchanged and factors of production market is where inputs such as land, labor, capital and resources are exchanged. Households sell their resources to the businesses in the factor market to earn money. The prices of the resources, the businesses purchase are costs. Business produces goods utilizing the resources provided by the households, which are then sold in the product market. Households use their incomes to purchase these goods in the product market. In return for the goods, businesses bring in revenue.
Macroeconomics is a part of economic study which analyzes the economy as a whole. It is the average of the entire economy and does not study any individual unit or a firm. It studies the national income, total employment, aggregate demand and supply etc.
Macroeconomics is basically known as theory of income. It is concerned with the problems of economic fluctuations, unemployment, inflation or deflation and economic growth. It deals with the aggregates of all quantities not with individual price levels or outputs but with national output.
As per G. Ackley, Macroeconomics concerns itself with such variables −
Macroeconomics is much of theoretical and practical importance. Following are the points covered under the scope of macroeconomics −
The study of macroeconomics is crucial to understand the working of an economy. Economic problems are mainly related to the employment, behavior of total income and general price in the economy. Macroeconomics help in making the elimination process more understandable.
Macroeconomics is very useful in an economic policy. Underdeveloped economies face innumerable problems related to overpopulation, inflation, balance of payments etc. The main responsibilities of government are controlling the overpopulation, prices, volume of trade etc.
Following are the economic problems where macroeconomics study are useful −
The demand for individual products depends upon aggregate demand in the economy therefore understanding the behavior of individual units is very important in macroeconomics. Firstly, to solve the problem of deficiency in demand of individual products, understanding the causes of fall in aggregate demand is required. Similarly to know the reasons for increase in costs of a particular firm or industry, it is first required to understand the average cost conditions of the whole economy. Thus, the study of individual units is not possible without macroeconomics.
Macroeconomics enhances our knowledge of the functioning of an economy by studying the behavior of national income, output, savings, and consumptions.
Demand is a widely used term, and in common is considered synonymous with terms like want or ‘desire’. In economics, demand has a definite meaning which is different from ordinary use. In this chapter, we will explain what demand from the consumers point of view is and analyze demand from the firm perspective.
Demand for a commodity in a market depends on the size of the market. Demand for a commodity entails the desire to acquire the product, willingness to pay for it along with the ability to pay for the same.
The law of demand is one of the vital laws of economic theory. According to the law of demand, other things being equal, if the price of a commodity falls, the quantity demanded will rise and if the price of a commodity rises, its quantity demanded declines. Thus other things being constant, there is an inverse relationship between the price and demand of commodities.
Things which are assumed to be constant are income of consumers, taste and preference, price of related commodities, etc., which may influence the demand. If these factors undergo change, then this law of demand may not hold good.
According to Prof. Alfred Marshall The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchase. Lets have a look at an illustration to further understand the price and demand relationship assuming all other factors being constant −
| Item | Price (Rs.) | Quantity Demanded (Units) |
|---|---|---|
| A | 10 | 15 |
| B | 9 | 20 |
| C | 8 | 40 |
| D | 7 | 60 |
| E | 6 | 80 |
In the above demand schedule, we can see when the price of commodity X is 10 per unit, the consumer purchases 15 units of the commodity. Similarly, when the price falls to 9 per unit, the quantity demanded increases to 20 units. Thus quantity demanded by the consumer goes on increasing until the price is lowest i.e. 6 per unit where the demand is 80 units.
The above demand schedule helps in depicting the inverse relationship between the price and quantity demanded. We can also refer the graph below to have more clear understanding of the same −
We can see from the above graph, the demand curve is sloping downwards. It can be clearly seen that when the price of the commodity rises from P3 to P2, the quantity demanded comes down Q3 to Q2.
The demand for a commodity depends on the utility of the consumer. If a consumer gets more satisfaction or utility from a particular commodity, he would pay a higher price too for the same and vice – versa.
In economics, all human motives, desires, and wishes are called wants. Wants may arise due to any cause. Since the resources are limited, we have to choose between urgent wants and not so urgent wants. In economics wants could be classified into following three categories −
Utility is a term referring to the total satisfaction received from consuming a good or service. It differs from each individual and helps to show the satisfaction of the consumer after consumption of a commodity. In economics, utility is a measure of preferences over some set of goods and services.
Marginal Utility is formulated by Alfred Marshall, a British economist. It is the additional benefit / utility derived from the consumption of an extra unit of a commodity.
Following are the assumptions of Marginal utility analysis −
This theory assumes that utility is a cardinal concept which means it is a measurable or quantifiable concept. This theory is quite helpful as it helps an individual to express his satisfaction in numbers by comparing different commodities.
For example − If an individual derives utility equals to 5 units from the consumption of 1 unit of commodity X and 15 units from the consumption of 1 unit of commodity Y, he can conveniently explain which commodity satisfies him more.
This assumption is a bit unreal which says the marginal utility of money remains constant throughout when the individual spending on a particular commodity. Marginal utility is measured with the following formula −
MUnth = TUn − TUn − 1
Where, MUnth − Marginal utility of Nth unit.
TUn − Total analysis of n units
TUn − 1 − Total utility of n − 1 units.
A very well accepted approach of explaining consumers demand is indifference curve analysis. As we all know that satisfaction of a human being cannot be measured in terms of money, so an approach which could be based on consumer preferences was found out as Indifference curve analysis.
Indifference curve analysis is based on the following few assumptions −
An indifference curve represents all those combinations of goods and services which provide same level of satisfaction to all the consumers. It means thus all the combinations provide same level of satisfaction, the consumers can prefe them equally.
A higher indifference curve signifies a higher level of satisfaction, so a consumer tries to consume as much as possible to achieve the desired level of indifference curve. The consumer to achieve it has to work under two constraints namely − he has to pay the required price for the goods and also has to face the problem of limited money income.
The above graph highlights that the shape of the indifference curve is not a straight line. This is due to the concept of the diminishing marginal rate of substitution between the two goods.
A consumer achieves the state of equilibrium when he gets maximum satisfaction from the goods and does not have to position the goods according to their satisfaction level. Consumer equilibrium is based on the following assumptions −
Consumer equilibrium is quite superior to utility analysis as consumer equilibrium takes into consideration more than one product at a time and it also does not assume constancy of money.
A consumer achieves equilibrium when as per his income and prices of the goods he consumes, he gets maximum satisfaction. That is, when he reaches highest indifference curve possible with his budget line.
In the figure below, the consumer is in equilibrium at point H when he consumes 100 units of food and purchases 5 units of clothing. The budget line AB is tangent to the highest possible indifference curve at point H.
The consumer is in equilibrium at point H. He is on the highest possible indifference curve given budgetary constraint and prices of two goods.