x Contents 3.3 Circular Flows in a Four-Sector Model: A Model with the Foreign Sector 47 Suggested Readings 48 Questions for Review MEASUREMENT

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1 Contents Preface v PART 1 Introduction 1. INTRODUCTION TO MACROECONOMICS 3 Introduction What is Economics? What is Macroeconomics? Macroeconomics is both a Theoretical and a Policy Science Microeconomics vs. Macroeconomics Origin and Growth of Macroeconomics Importance of Macroeconomics Limitations of Macroeconomics 21 Suggested Readings 22 Questions for Review MACROECONOMIC ISSUES, CONCEPTS AND MODEL BUILDING 23 Introduction Macroeconomic Issues Some Concepts used in Macroeconomic Analysis Macroeconomic Model Building 36 Questions for Review THE CIRCULAR FLOW MODELS OF ECONOMY 40 Introduction Circular Flows in a Two-Sector Model Circular Flows in Three-Sector Model: A Model with Government Income and Expenditure 45

2 x Contents 3.3 Circular Flows in a Four-Sector Model: A Model with the Foreign Sector 47 Suggested Readings 48 Questions for Review MEASUREMENT OF NATIONAL INCOME 50 Introduction Some Concepts Related to National Income National Income Measures Nominal and Real GNP Methods of Measuring National Income Treatment of Net Income from Abroad Double Entry System of Accounting Measurement of National Income in India 67 Suggested Readings 74 Questions for Review 74 PART 2 Product Market Analysis: Theory of National Income Determination 5. THE CLASSICAL THEORY OF OUTPUT AND EMPLOYMENT 79 Introduction The Classical Postulates Say s Law: The Foundation of Classical Macroeconomics Classical Theory of Employment: A Formal Model of Say s Law 83 Suggested Readings 90 Questions for Review KEYNESIAN THEORY OF INCOME DETERMINATION: A SIMPLE ECONOMY MODEL 92 Introduction The Concepts and Functions Income Determination in Simple Economy Model The Change in Aggregate Demand and the Multiplier A Simple Model of Investment Multiplier Static and Dynamic Multiplier The Uses and Limitations of Multiplier Applicability of Multiplier Theory to LDCs The Paradox of Thrift and the Multiplier 115 Suggested Readings 116 Questions for Review INCOME DETERMINATION IN A CLOSED ECONOMY MODEL: A MODEL WITH GOVERNMENT SECTOR 118 Introduction Income Determination with the Government Sector The Fiscal Multipliers 127 Suggested Readings 131 Questions for Review 131

3 Contents xi 8. INCOME DETERMINATION IN OPEN ECONOMY MODEL: A MODEL WITH THE FOREIGN SECTOR 133 Introduction Exports, Imports and the Aggregate Demand National Income Equilibrium in a Four-Sector Model A Complete Four-Sector Model of Income Determination 138 Suggested Readings 140 Questions for Review 140 PART 3 Theories of Consumption and Investment 9. THEORIES OF AGGREGATE CONSUMPTION 145 Introduction The Absolute Income Hypothesis: Keynesian Theory of Consumption The Relative Income Hypothesis: Duesenberry s Theory The Permanent Income Hypothesis: Friedman s Theory of Consumption The Life-Cycle Theory of Consumption: The Life-cycle Hypothesis Consumption Under Uncertainty: Robert Hall s Random-Walk Theory Concluding Remarks on Consumption Theories Non-Income Factors Affecting Consumption 163 Suggested Readings 168 Questions for Review THEORY OF INVESTMENT AND CAPITAL ACCUMULATION 170 Introduction Some Basic Concepts Methods of Investment Decision The Marginal Efficiency of Investment (MEI) and Aggregate Demand for Capital The Theory of Capital Accumulation Income and Investment: The Accelerator Theory of Investment The Rental Cost of Capital and Investment Tobin s q Theory of Investment: Stock Market and Investment 188 Suggested Readings 189 Questions for Review 190 PART 4 Money Market Analysis: Theory of Money and Interest 11. MONEY: DEFINITION, KINDS AND FUNCTIONS 193 Introduction Definition of Money The Kinds of Money The Functions of Money The Significance of Money in Modern Economy 199 Suggested Readings 202 Questions for Review 202

4 xii Contents 12. THE SUPPLY OF MONEY 203 Introduction The Sources of Money Supply The Measures of Money Supply in India The Theory of Money Supply Monetary Expansion and the Money Multiplier: A Simplified Model Monetary Expansion, Currency Drain and Deposit Multiplier 220 Suggested Readings 221 Questions for Review THE CLASSICAL THEORY OF MONEY AND INTEREST 222 Introduction The Classical Quantity Theory of Money The Cambridge Version of Quantity Theory of Money The Classical Theory of Interest Keynes s Criticism of Classical Theory of Interest 228 Suggested Readings 230 Questions for Review THE KEYNESIAN THEORY OF MONEY AND INTEREST 232 Introduction The Classical and Neoclassical Views on Holding Money: A Precursor The Keynesian Theory of Demand for Money The Keynesian Theory of Interest and Money Market Equilibrium Changes in the Money Market and the Interest Rate Criticism of the Keynesian Theory of Interest 244 Suggested Readings 245 Questions for Review THE POST-KEYNESIAN THEORIES OF DEMAND FOR MONEY An Overview Portfolio Theories of Demand for Money Baumol Tobin Approach to Transaction Demand for Money Tobin s Theory of Speculative Demand for Money: the Portfolio Optimisation Approach Friedman s Quantity Theory of Money 258 Suggested Readings 261 Questions for Review 262 PART 5 Integration of Product and Money Market Equilibrium 16. THE IS-LM MODEL IN TWO-SECTOR ECONOMY 265 Introduction The Interdependence of Product and Money Markets The IS-LM Model: An Elementary Exposition Algebraic Version of the IS-LM Model From Disequilibrium to Equilibrium The Dynamics of Adjustment 278

5 Contents xiii 16.5 Shift in IS and LM Curves and the General Equilibrium 280 Suggested Readings 286 Questions for Review THE IS-LM MODEL WITH THE GOVERNMENT SECTOR 288 Introduction IS-Curve with the Government Sector Monetary Changes and Money-Market Equilibrium The Product and money Market Equilibrium in Three-Sector IS-LM Model Fiscal and Monetary Changes and General Equilibrium Application of the Three-Sector Model 309 Suggested Readings 314 Questions for Review 315 Appendix to Chapter THE IS-LM MODEL WITH FOREIGN SECTOR 319 Introduction The Product-Market Equilibrium with Foreign Trade Derivation of the IS Curve Derivation of the IS Curve: An Alternative Method The Four-Sector IS-LM Model The Shift in the IS Curve and the General Equilibrium The IS-LM Model with the Balance of Payments 327 Suggested Readings 333 Questions for Review DETERMINATION OF OUTPUT, PRICES AND EMPLOYMENT: A KEYNESIAN-CLASSICAL SYNTHESIS 337 Introduction Determination of Aggregate Price and Output: A Preview Derivation of Aggregate Demand Curve The Classical and Keynesian Approaches to Aggregate Supply Curve The Aggregate Demand Supply Model: The Final View Achieving Full Employment: Policy Options Under the Keynesian System Supply Shocks and Policy Dilemma 353 Suggested Readings 355 Questions for Review POST-KEYNESIAN MACROECONOMICS 356 Introduction The Modern Monetarism: A Counter-Revolution The Keynesian vs. Monetarist Debate: Does Money Matter? The Reconciliation of Keynesian and Monetarist Controversy The New Classical Macroeconomics: The Radicalism The Supply-Side Economics 372 Suggested Readings 376 Questions for Review 377

6 xiv Contents PART 6 Economic Growth and Business Cycles 21. THEORIES OF ECONOMIC GROWTH 381 Introduction The Meaning of Economic Growth Factors in Economic Growth Production Function and Growth Accounting Theories of Economic Growth: An Overview Harrod-Domar Model of Growth The Neo-Classical Theory of Growth Endogenous Growth Theory 402 Suggested Readings 404 Questions for Review 405 Appendix to Chapter BUSINESS CYCLE THEORIES AND GLOBAL RECESSION 407 Introduction What is Business Cycle? Phases of Business Cycles Theories of Business Cycle What Theory of Trade Cycle? The Global Recession The Business Cycle of Need for Controlling Business Cycles Policy Measures to Control Business Cycle 430 Suggested Readings 435 Questions for Review 436 PART 7 Inflation and Unemployment 23. INFLATION: MEANING, MEASURE AND EFFECTS 439 Introduction What is Inflation? Methods of Measuring Inflation Types of Inflation inflation, Disinflation and Deflation Inflation in India: A Long-Term View Economic Effects of Inflation 450 Suggested Readings 457 Questions for Review 457 Appendix to Chapter THEORIES OF INFLATION AND CONTROL MEASURES 461 Introduction The Classical and Neo-classical Theories of Inflation The Keynesian Theory of Inflation The Monetarist View on Inflation 465

7 Contents xv 24.4 Modern Theories of Inflation Interaction between Demand-Pull and Cost-Push Inflation Inflation in Less Developed Countries (LDCs) Measures to Control Inflation 482 Suggested Readings 490 Questions for Review INFLATION AND UNEMPLOYMENT 492 Introduction The Meaning, Measurement and the Kinds of Unemployment Inflation and the Rate of Unemployment Modifications in Phillips Curve What Rate of Unemployment is the Natural Rate of Unemployment? Policy Dilemma: What is Desirable Inflation or Unemployment? 506 Suggested Readings 509 Questions for Review 509 PART 8 International Aspects of Macroeconomics 26. INTERNATIONAL MONETARY ASPECT: THE FOREIGN EXCHANGE RATE 513 Introduction The Foreign Exchange Market Determination of Exchange Rate in Free Exchange Market The Fixed Exchange Rate and its Determination The Controversy on Fixed vs. Flexible Exchange Rate 524 Suggested Readings 525 Questions for Review BALANCE OF PAYMENTS: MEANING AND ASSESSMENT 527 Introduction The Balance of Payments: Meaning and Purpose The Balance of Payments Accounts India s Balance of Payments Assessment of Balance of Payments Causes and Kinds of BOP Disequilibrium 534 Suggested Readings 535 Questions for Review BALANCE OF PAYMENTS: DISEQUILIBRIUM AND ADJUSTMENTS 537 Introduction The Classical Approach: The Automatic Adjustment Method BOP Adjustment by Policy Measures: Mundell-Fleming Model The Expenditure Changing Policies The Expenditure Switching Policy: Devaluation Monetary Approach to BOP Adjustments 557 Suggested Readings 561 Questions for Review 561

8 xvi Contents PART 9 Macroeconomic Policies: Monetary and Fiscal Policies 29. MACROECONOMIC POLICY: MEANING, OBJECTIVES AND FORMULATION 565 Introduction Macroeconomic Policy: Meaning and Scope The Need for and Advent of Macroeconomic Policies Objectives of Macroeconomic Policies Objectives of India s Macroeconomic Policy Formulation of the Macroeconomic Policy 572 Suggested Readings 575 Questions for Review MONETARY POLICY 577 Introduction Meaning and Scope of Monetary Policy Instruments of Monetary Policy Transmission Mechanism of Monetary Policy: The Portfolio Adjustment The Limitations and Effectiveness of Monetary Policy Monetary Policy of India 589 Suggested Readings 597 Questions for Review 598 Appendix to Chapter FISCAL POLICY 600 Introduction Meaning and Scope of Fiscal Policy Fiscal Instruments and Target Variables Kinds of Fiscal Policy Fiscal Policy and Macroeconomic Goals Limitations of Fiscal Policy Crowding-out and Crowding-in Controversy Fiscal Policy of India 619 Suggested Readings 623 Questions for Review 624 Appendix to Chapter APPENDIX: SOLUTION TO THE NUMERICAL QUESTIONS 626 INDEX 655

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