Mister Keynes and the Visible Hand : Part I

Imagine if you were asked to introduce a bright 12 year old child to the subject matter of Macroeconomics. I can visualize the following conversation between me and her :-

Me : You know, there are quite a few people in this world who don't have enough to eat, its really sad...

She: Yeah....i know. Is there nothing we can do to solve the problem ?

Me : You see, they need money to buy things and...

She : I wish I were the Prime Minister. I would think of a clever way to give them 'lots and lots of money' to buy things!

Me : Sweet of you . Hey, do you know where they print these notes ? ( showing her a 10-rupee note )

She : I know ! It is called a mint. There is one at Nasik I think - my teacher mentioned that in class.

Me : Oh I see. You mean, we can actually go to this mint tomorrow and ask them to print 'lots and lots of money' ? Hey, we can then bring it back and distribute it to the poor !

She : Wow !! Brilliant ! Lets.....umm....but wait....why hasn't the Government thought about this till now ? Maybe more money means.....hmm...what is the worth of money?....can we really...

Me : Welcome to Macroeconomics !!

So, I study 'Macroeco' this term - and am all excited . Before my MBA - I used to be extremely confused with concepts such as 'GDP', 'interest rates' - what decreases when what increases and so on. It was very ambiguous and I thought these economists con us by arguing one way or the other in a way that you can't distinguish which is what !

But now - after 10 classroom sessions [ and an exam :) ] I plan to bore my readers with 'lots and lots' of blog entries on Macroeconomics !!!

So, here goes....

At the very heart of economics , are observations which describe how individuals ( with wants and needs ) behave in society. That's it . All the complicated mathematics that follow are largely unsuccessful ( !) attempts at quantifying this behaviour.

Now, there are 4 Fundamental ( 'Most Important' ) Ideas of Macroeconomics :

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1) The idea that interest rate is the price of money.

Like any other good - money is subjected to demand-supply dynamics. The demand for a good increases when its price decreases and vice versa. Similarly, excessive supply of a good brings down its price. This is a fundamental concept in economics as a whole.

2) The idea that our tendency to consume increases with increase in Income.

Call it greed if you want :) , but this concept of wanting more when you already have more - is discussed in the Vedas and the Bhagavad Gita!

3) The idea that our demand for money :

a) increases if our income levels are higher and
b) decreases if money becomes too costly to hold in idle form. ( why keep it with you when you can park it in a bank and make it grow ) .

4) The idea that corporates need to borrow money to make Investments in machines and factories ( which produce goods ) . So, they are worried if the price of money ( interest rate ) is too high.

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Now, if we can't do much if we hang around merely with these behavioural insights. We need more than that - we need hard numbers , to tell us by how much do things 'increase' and 'decrease' in the statements above.

The first step towards quantifying is developing a framework for writing equations.

Basis for the Framework of Equations :

1) The idea that we need a measure of the output of an economy and we can look at output as
the sum-total of :
a) All that is consumed ( by the individual and the government )
b) All that is "invested" : that is , spent by companies for buying machines , building
factories ( to produce the goods we consume in a) ! )
c) All that is exported on a 'net' basis( i.e. remove the imported goods since we didn't produce
them )

2) The idea that , at an aggregate level, 'Income' and 'Output' are two different ways of looking at the same thing.

3) The idea that income at your disposal is the sum total of consumption and savings. This may include income received ( a gift , say ) but not earned and income earned ( tax part of your salary ) but not received. So, we make a distinction between 'income' and 'disposable income'.

Now , we are kind of set - In my next blog entry, I'll write about how to understand those 'confusing' things we read in the papers - about RBI , US Fed decreasing interest rates , Bush planning to give a fiscal stimulus to the sub-prime crisis etc.