INTRODUCTION OFMACROECONOMICS

MACROECONOMICS: Macroeconomics is defined as that

branch of economics which studies economic activities including economic issues and economic problems at the level of an economy as a whole.

In the words of Boulding , ‘ Macroeconomic theory is that part of economics which studies the overall averages and aggregates of the system.”

1. Helpful in understanding the functioning of economy.

2. Study National income.3. Formulation of Economic Policy.4. Study of trade cycles.5. Change in the general price level.

6. International Comparisons7. Economic Planning8. Estimate of material welfare9. Economic Growth.10. Helpful in understanding

macroeconomic paradoxes.

In the equilibrium Y=C+S=C+I=E=O

(Wages, Rent, Interest and Profits)Factor Payments

(Y)

Consumption expenditure

(C)

FirmsHouseholds

Goods and Services (O)

Factor Inputs

Financial Market Investment

(I)Savings

(S)

Government (G)

Remittances for

purchases

Foreign Nations(X-M)

Salaries

Taxes

Taxes

Consumption

Expenditure

Financial Market Investme

nt(I)

Savings (S) FirmsHousehol

ds

Factor Inputs

Goods

(O)

Factor Payment

s

Imports

(M)Import

s(M)

Exports

(X)Export

s(X)National Income=C+I+G+(X-M)

The third sector is Government (G) Government Spending

Subsidies, defence, health care, education, infrastructure Provides salaries to the households Pays to firms for purchases of goods and services

Government Revenue Households and firms pay various taxes and other payments and

provide factor inputs to the government. Government borrows from the financial market to fill revenue gap.

The fourth sector is the external sector Imports (M): Outflow of income occurs when the domestic firms buy

goods and services from foreign ones. Exports (X): Inflow of income takes place when foreign firms buy

goods and services from domestic ones C+I+G=C+S+T

WHAT IS NATIONAL INCOME? National income refers to the

aggregate income earned by the normal residents of a nation during a given period as a result of their productive services.

Domestic territory of a country includes: 1. Political boundaries including sea

shore of a country. 2. Ships and aeroplanes owned by the

residents of a country and operating between two or more countries.

3. Fishing boats of a country’s fisherman and ships engaged in the exploration of oil and natural gas in the international waters.

4. Embassies and military bases in other countries etc.

A normal resident of a country is said to be a person who ordinarily resides in a country and whose centre of interest lies in that country. To become a normal resident a person must reside in a country for more than an year.

During a course of production fixed capital like machines suffers wear and tear and obsolescence. So their is fall in the value of those machines.

Hence, Fall in the value of an asset is called Depreciation.

The difference between gross and net product is depreciation.

Net Product= Gross Product – Depreciation

Gross Product= Net Product + Depreciation

The basis of difference between market price and factor cost is Net Indirect Tax.

The factor cost includes the payments to the factors of production.

In Market price , it includes both the payments to the factors of production and net indirect tax.NET INDIRECT TAX = Indirect tax-- Subsidies

Factor Cost= Market Price – Net Indirect TaxOr Factor Cost= Market Price – Indirect tax +

Subsidies

AND

Market Price = Factor Cost + Net Indirect TaxOr Market Price= Factor Cost + Indirect tax -

Subsidies

Net factor income from abroad=Factor income from abroad by normal

residents– Factor income paid to Non-residents in

domestic territory

NI excludes sale & purchase of second hand goods.

It excludes income from illegal activities – smuggling, black marketing, gambling etc.,

It does not includes transfer payments – old age pension, scholarship to students etc.,

Transfer payment are those earning for which no contribution is made to the flow of goods & services.

In other words they are not earned but received only.

T.P are received without doing or producing any commodity or services.

Concepts of National Income Gross Domestic Product (GDP) Gross National Product (GNP) Net Domestic Product (NDP) Net National Product (NNP) Per Capita Income Personal Income Personal Disposable income

Gross domestic product at market price refers to the market value of the final goods and services produced within the domestic boundaries of a country during a period of one year.

GDPmp = Price x Quantity

Gross Domestic Product (GDP): GDP is the sum of money values of all final goods and services produced within the domestic territories of a country during an accounting year.

GDP= C+I+G+(X-M)

GDP at market price: includes the final value of goods and services also includes indirect taxes and excludes the subsidies given by the government.

Gross National Product (GNP): GNP is the aggregate final output of citizens and businesses of an economy in a year.

GNP may be defined as the sum of Gross Domestic Product and Net Factor Income from Abroad (NFIA).

GNP = GDP + NFIAGNP = C+I+G+(X-M)+NFIA

Net Factor Income from Abroad: difference between income received from abroad for rendering factor services and income paid towards services rendered by foreign nationals in the domestic territory of a country.

GDP at factor cost is the money value of final goods and services based on the cost involved in the process of production.

Gross Domestic Product at factor cost = GDP at Market Prices –Indirect Taxes+ Subsidies

Gross national product at market price:

GNPMP = GDPMP + N.F.I.A

GROSS NATIONAL PRODUCT AT

FACTOR COST: GNPFC = GNPMP – NET INDIRECT TAX

NET DOMESTIC PRODUCT AT MARKET PRICE:

NDPMP = GDPMP – DEPRICIATION

NET DOMESTIC PRODUCT AT FACTOR COST:

NDPFC = NDPMP -- NET INDIRECT TAX

NET NATIONAL PRODUCT AT MARKET PRICE:

NNPMP = NDPMP + N.F.I.A

NET NATIONAL PRODUCT AT FACTOR COST:

NNPFC = NNPMP – NET INDIRECT TAXNNPFC = National Income

Personal income is the total income received by the individuals of a country from all sources before direct taxes in one year.

Personal Income = National Income –Undistributed Corporate Profits – Corporate Taxes – Social Security Contributions + Transfer Payments + Interest on Public Debt

Personal Disposable Income is the income which can be spent on consumption by individuals and families.

Personal Disposable Income = Personal Income – Personal Taxes

Population TotalIncome National=Income CapitaPer

• Per capita income is the average income of the people of a country in a particular year.

Personal income is the total income received by the individuals of a country from all sources before direct taxes in one year.

Personal Income = National Income –Undistributed Corporate Profits – Corporate Taxes – Social Security Contributions + Transfer Payments + Interest on Public Debt

Personal Disposable Income is the income which can be spent on consumption by individuals and families.

Personal Disposable Income =

Personal Income – Direct Taxes – Misc. Fees etc.

There are three methods for the measurement of National Income:

Product (or Output) Method

Income Method

Expenditure Method

The market value of all the goods and services produced in the country by all the firms across all industries are added up together.

In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process.

1. Final Output Method: According to this method, the value of

intermediate good is deducted from the value of output.

2. Value Added Method:In this the sum total of value added by all

the producing units within the domestic territory of the country.

Problem of Double Counting: unclear distinction between a final and an

intermediate product. Not Applicable to Tertiary Sector:

This method is useful only when output can be measured in physical terms

Exclusion of Non Marketed Products E.g. outcome of hobby

Self Consumption of Output Producer may consume a part of his production.

Income method is that method which measures national income in terms of payments made in the form of wages, rent , interest and profits to the factors of production ie; labor, land, capital and entrepreneur for their productive services in an accounting year.

It is the income earned by the factors of production of a country.

1. Compensation of employees 2. Operating Surplus(Rent,interest,profit) 3. Mixed Income 4. Net factor income from abroadNet Domestic Product at Factor Cost=(Compensation of employees+ Operating Surplus+

Mixed Income)

Net National Product at Factor Cost= NDPFC + Net factor income from abroad

Exclusion of non monetary income: Ignores the non-monetized section of economic activities. Economic activities that contribute to national income, but due to

their non monetary nature, they go unrecorded. For e.g. a farmer and family working in their own field.

Exclusion of Non Marketed Services: People undertake a particular activity that are difficult to ascertain in money value. E.g. mother’s services to the family

Income from illegal activities are not included. Windfall gain or loss is not included.

The total expenditure incurred by the society in a particular year is added together to get that year’s national income.

Components of Expenditure Method: Private Final Consumption Expenditure Government Final Consumption

Expenditure Final Investment Expenditure Net Exports

Intermediate expenditure is not calculated.

Second hand goods not included. Exp. on share and bonds not included. No transfer payments are included.

National income is the most dependable indicator of a country’s economic health.

Difference between GDP and GNP indicates the contribution of net income earned abroad

Necessary for Economic planning: useful aid in judging which sectors should be given more emphasis

A measure of economic welfare. higher aggregate production implies more and more goods and

services being available to people Helps in determining the regional disparities, income

inequality and level of poverty in a country. Helps in comparing the situations of economic growth in

two different countries.

Non monetized transactions: Exchange of goods and services which have no monetary payments, like services rendered out of love, courtesy or kindness are difficult to include in the computation of national income.

Unorganized sector: Contribution of unorganized sector are unrecorded. It is very difficult to identify income of those who do not pay income tax.

Multiple sources of earnings: Part time activity goes unrecognized and such income is not included in national income.

Categorization of goods and services: In many cases categorization of goods and services as intermediate and final product is not very clear.

Inadequate data: Lack of adequate and reliable data is a major hurdle to the measurement of national income of underdeveloped countries.

Private income is the income of the private sector obtained from any source , productive or otherwise.

Personal income= Private income—Corporate savings—

corporate tax

Meaning: Price inflation is a persistent increase in the general price level or a persistent decline in the real income of people, i.e. decline in value of money.

Continuous rise in prices of goods is called Inflation.

In this situation prices keep on rising because of the shortage of goods.

Value of money falls and the real income (purchasing power) falls.

Continuous rise in prices of goods is called Inflation.

Headline Inflation: measure of the total inflation within an economy affected by the areas of the market which may experience sudden inflationary spikes such as food or energy.

Inflationary spikes: These spikes rise when there is a sudden price rise, due to external factors.

Hyperinflation: prices increase at such a speed that the value of money erodes drastically. This is also known as galloping inflation or runaway inflation.

Stagflation: a typical situation when stagnation and inflation co-exist. It is normally found in less developed countries. In is situation economy is working at low level.

Suppressed Inflation: In this the inflationary conditions exist but Govt. makes such policies that prices remain under check but when govt. decontrols then there is a sudden rise in prices.

Disinflation: a process of keeping a check on price rise by deliberate attempts. Inflation is kept under a specific target. Govt. brings down huge inflation rate to at low level.

Deflation: a state when prices fall persistently; just opposite to inflation. In this because the money supply is less so people’s demand is also low. It results in low profits of producers and hence low investment ,low production and low demand.

Wage price spiralPrices Wages Prices

Wages

Impact on Consumers increase in any price upsets the

home budget. Impact on Producers (or Suppliers)

Producers as sellers are benefited by inflation;

higher the prices, higher are their profits.

when as buyers of raw material, they are adversely affected by inflation.

Impact on Government: Government has to take the economy to higher levels of growth by encouraging production and investment, At the other end, has to see that taxpayers’ money is not eroded by hyperinflation. Thus government has to act as the balancing force between consumers and sellers.

Indexation: Indexation is the automatic linkage

between monetary obligations and price levels.

It applies to wages ,taxes and interest.

Producer price index Producer price index measures average

changes in prices received by domestic producers for their output.

Whole sale price index:

It is calculated on the basis of wholesale prices of a wide variety of goods , it is called whole sale price index.

It is available on weekly basis.

Consumer price index Consumer price index measures the

price of a selection of goods purchased by a typical consumer.

Cost of Living Indices Cost of living indices are used to adjust

fixed incomes to maintain the real value of such incomes.

The services producer price index is a business cycle indicator which provides information on the development of prices for numerous service industries.

This information is used for the analysis of inflation and its sources, but also for the deflation of value measures in the service sector.

1. Monetary policy2. Fiscal policy measures

The government has to adopt an appropriate combination of these measures after thorough examination of the causes of inflation

Increasing the bank rate: Minimum rate that is charged by central bank while lending money to commercial bank.

Open market operations: directly sell government securities to public and restrain their disposable income

Higher reserve ratios: Cash Reserve Ratio (CRR)

Statutory Liquidity ratio CRR - Cash Reserve Ratio - a portion of the

deposit (as cash) which banks have to keep/ maintain with the RBI. Ensures a portion of bank deposits is totally risk

free RBI’s control over liquidity and thus inflation

SLR - Statutory Liquidity Ratio - banks are required to invest a portion of their deposit in government securities.

d Ratio (SLR)

The government may reduce public expenditure or increase public revenue to keep a check on inflation

Reducing public expenditure When government spends on activities like health,

transport, communication, etc., income of individuals increases; this in turn increases the aggregate demand. Therefore the reverse will also be true.

Increasing public revenue Major source of government revenue is various types of

taxes Increase in income tax leaves less of disposable income in

the hands of consumers

Aggregate Demand: Aggregate demand (AD) is the

total demand for final goods and services in an economy at a given time.

It specifies the amounts of goods and services that will be purchased at all possible price levels.

Aggregate supply:Aggregate supply (AS) is the total

supply of goods and services that firms in a national economy plan on selling during a specific time period.

It is the total amount of goods and services that firms are willing and able to sell at a given price level in an economy.

Aggregate demand = C+I C= Consumption expenditure I =Investment Expenditure

Aggregate Supply = C+S C = Consumption expenditure S = Savings

Aggregate demand = C+I + G C= Consumption expenditure I =Investment Expenditure G = Govt. Expenditure

Aggregate Supply = C+S + T C = Consumption expenditure S = Savings T= Taxes

Aggregate demand = C+I + G + X--M C= Consumption expenditure I =Investment Expenditure G = Govt. Expenditure (X--M) = Net exports

Aggregate Supply = C+S + T C = Consumption expenditure S = Savings T= Taxes