Macroeconomics
-Mani Govil
Macroeconomics
Macroeconomics is the study of the
behavior of the economy as a whole. It
concerns the business cycles that lead
to unemployment and inflation, as well
as the longer-term trends in output and
living standards.
The Roots of Macroeconomics
The Great Depression was a period of
severe economic contraction and high
unemployment that began in 1929 and
continued throughout the 1930s.
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The Roots of Macroeconomics
Classical
economists
applied
microeconomic models, or “market
clearing” models, to economy-wide
problems.
However, simple classical models failed
to explain the prolonged existence of
high unemployment during the Great
Depression. This provided the impetus
for the development of macroeconomics.
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The Roots of Macroeconomics
In 1936, John Maynard Keynes published The
General Theory of Employment, Interest, and
Money.
Keynes believed governments could intervene in
the economy and affect the level of output and
employment.
During periods of low private demand, the
government can stimulate aggregate demand to lift
the economy out of recession.
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Macroeconomic Goals
Output

High level and sustainable growth
Employment

High level of employment and low
involuntary unemployment
Stable Prices
International trade

Export and import equilibrium and
exchange rate stability
Output
The ultimate objective of economic
activity is to provide the goods and
services that the population desires.
The most comprehensive measure of
the total output in an economy is the
gross national product (GNP).
GNP
Nominal GNP is measured in actual market
prices.
Real GNP is calculated in constant or
invariant prices.
Potential GNP is the long-run trend in real
GNP. It represents the long-run productive
capacity of the economy or the maximum
amount the economy can produce while
maintaining stable prices.
Potential and Actual GNP
Real GNP
($)
Potential GNP
Actual GNP
Years
Employment
The unemployment rate measures the
fraction of the labour force that is
looking for but cannot find the work.
The labour force includes all employed
persons and those unemployed
individuals who are seeking jobs.
The unemployment rate tends to move
with the business cycle.
Stable Prices
The third macroeconomic goal is to
maintain stable prices within free
markets.
A market economy uses prices as a
yardstick to measure economic values.
Rapid price changes lead to economic
inefficiency.
The most common measure of the
overall price level is the consumer price
index (CPI). The CPI measures the cost
of a fixed basket of goods bought by the
typical urban consumer.
The rate of inflation measures changes
in the level of prices. It denotes the rate
of growth or decline of the price level
from one year to the next.
Inflation or Deflation
An inflation occurs when the level of
price is growing (the rate of inflation is
positive).
A deflation denotes that the level of
price declines (the rate of inflation is
negative).
A disinflation is a decrease in the rate of
inflation. The slowing of the rate of
inflation per unit of time.
International trade
International trade is
becoming
increasingly important to most country’s
economy.
International trade is beneficial to
society even if some individuals are
harmed by it.
International trade includes import and
export of goods, services, capital,
borrowing and lending money etc.
Net export is the numerical difference
between the value of a country’s
exports and the value of its imports.
When net exports are positive, a trade
surplus exists.
A trade deficit occurs when the value of
imports is greater than the value of
exports.
Exchange Rate Stability
Foreign exchange rate represents the
price of own currency in terms of the
currency of other nation.
When a nation’s exchange rate rises, the
prices of imported goods fall while
exports become more expensive for
foreigners  the nation becomes less
competitive in world markets and net
exports decline.
Changes in exchange rates can also
affect output, employment, and inflation.
Macroeconomic Policy
Instruments
A policy instrument is an economic
variable
under
the
control
of
government that can affect one or more
of the macroeconomic goals
Macroeconomic Policy
Instruments
Fiscal Policy
Monetary Policy
International Economic Policy
Growth or supply side policies
Fiscal Policy
Fiscal policy is the use of government
expenditures and taxes to affect
aggregate demand and aggregate
supply.
Fiscal Policy
Government expenditure includes
government spending on goods and
services. It determines the relative size
of the public and private sectors.
Taxation affects the overall economy in
two ways:
Taxes tend to reduce the amount people
spend on goods and services
 Taxes affect market prices, thereby
influencing incentives and behaviour.

Monetary Policy
Monetary policy determines the money
supply as well as interest rates, in order
to achieve desired economic objectives.
Changes in the money supply move
interest rates up or down and affect
spending in sectors such as investment,
housing, and net exports.
Monetary policy has an important effect
on both actual GNP and potential GNP.
International Economic Policy
International Economic Policy consists of
two sets of policies:
Trade policies, which consist of tarrifs,
quotas, and other devices that restrict or
encourage imports and exports.
 Exchange-rate
setting. Exchange rate
represents the price of one currency in
terms of the currencies of the other nations.
There are different systems to regulate
foreign exchange market.

CIRCULAR FLOW IN A TWO
SECTOR ECONOMY
NATIONAL INCOME
ACCOUNTING
National Income
Structure
Definition
Circular flow
Concepts of National Income
Methods of Measurement
Challenges in Measurement
Importance of Measurement
Trends in National Income in India
National Income
National Income is defined as the money
value of goods and services turned out
during a given period of time
National Income Accounting
is the measurement of indicators of
national output/income; .e.g. GDP, GNP.
National Income
Income
Period of Time
All goods and Services
Monetary value
Counts only once
The Circular-Flow Diagram
Revenue
Goods &
Services sold
Spending
Market for
Goods
and Services
Firms
Goods &
Services bought
Households
Inputs for
production
Wages, rent,
and profit
Market for
Factors
of Production
Labor, land,
and capital
Income
CIRCULAR FLOW IN A THREE
SECTOR ECONOMY
CIRCULAR FLOW IN A
FOUR SECTOR ECONOMY
The Measurement of GDP
GDP is the market value of all final goods and services
produced within a country in a given period of time
.
The Measurement of GDP
Output is valued at market prices.
It records only the value of final goods, not
intermediate goods (the value is counted only once).
It includes both tangible goods (food, clothing, cars)
and intangible services (haircuts, housecleaning,
doctor visits).
It includes goods and services currently produced, not
transactions involving goods produced in the past.
It measures the value of production within the geographic
confines of a country.
GDP includes all items produced in the economy and sold
legally in markets.
What Is Not Counted in GDP?
GDP excludes most items that are
produced and consumed at home and
that never enter the marketplace.
It excludes items produced and sold
illicitly, such as illegal drugs.
Other Measures of Income
Gross National Product (GNP)
Net National Product (NNP)
National Income
Personal Income
Disposable Personal Income
Gross National Product
Gross national product (GNP) is the total
income earned by a nation’s permanent
residents (called nationals).
It differs from GDP by including income
that our citizens earn abroad and excluding
income that foreigners earn here.
GNP v.s. GDP
Gross National Product (GNP)
The total value at market prices of final goods
and services produced by the citizens in an
economy in a specified period.
Gross Domestic Product (GDP)
The total value at market prices of final goods
and services produced within the domestic
boundary of a territory in a specified period
GNP = GDP + Net factor income from abroad
(NFIA)
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Net National Product (NNP)
Net National Product (NNP) is the
total income of the nation’s residents
(GNP)
minus
losses
from
depreciation.
Depreciation is the wear and tear on
the economy’s stock of equipment
and structures.
National Income
National Income is the total income
earned by a nation’s residents in the
production of goods and services.
It differs from NNP by excluding indirect
business taxes (such as sales taxes)
and including business subsidies.
NP= Value of final goods and services
produced=
wages+rent+interest+profits= NI
Personal Income
Personal income is the income that
households and noncorporate businesses
receive.
Unlike national income, it excludes retained
earnings, which is income that corporations
have earned but have not paid out to their
owners.
In addition, it includes household’s interest
income and government transfers.
Disposable Personal Income
Disposable personal income is the income
that household and noncorporate businesses
have left after satisfying all their obligations
to the government.
It equals personal income minus personal
taxes and certain nontax payments.
Measurement of National
Income
Income Approach
 NNP at factor cost OR National
Income
Output Approach
 GDP at factor cost
Expenditure Approach
 GDP at market Prices
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The Product or Value Added Method
GDP ≡ Sum total of gross value added of all the firms in the economy.
Value added of a firm is, value of production of the firm minus value of
intermediate goods used by the firm.
GVAi ≡ Value of sales by the firm (Vi ) +
Value of change in inventories (Ai) – Value of
intermediate goods used by the firm (Zi)
Net value added of the firm i ≡ GVAi –
Depreciation of the firm i (Di)
Items excluded from National
Income Accounting
Second-hand goods
Intermediate goods
Non-marketed goods / services
Volunteer work / Housework
Unreported / Illegal market transactions
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Expenditure method
The Components of GDP
GDP (Y ) is the sum of the following:
u
u
u
u
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
The Components of GDP
Consumption (C):
u
The spending by households on goods and
services, with the exception of purchases of
new housing.
Investment (I):
u
The
spending
on
capital equipment,
inventories, and structures, including new
housing.
u
Inventories are treated as capital. Addition to the stock of capital of a firm
is known as investment. Therefore change in the inventory of a firm is
treated as investment.
There can be three major categories of investment. First is the rise in the value
of inventories of a firm over a year which is treated as investment expenditure
undertaken by the firm. The second category of investment is the fixed
business investment, which is defined as the addition to the machinery, factory
buildings, and equipments employed by the firms. The last category of
investment is the residential investment, which refers to the addition of
housing facilities.
The Components of GDP
Government Purchases (G):
u
u
The spending on goods and services by local,
state, and federal governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
Net Exports (NX):
u
Exports minus imports.
Income Method
Limitations of National Income
Statistics
Factors that may understate the standard of living /
the welfare
Exclusion of the value of leisure
Same Q produced with fewer working hours  higher
welfare
Exclusion of non-marketed / unreported transactions
Factors that may overstate the standard of living / the
welfare
Undesirable Side-effects of Production
Air pollution / traffic congestion /…
Understate the real / social costs to society 
externality /divergence between social costs & private
costs
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Some Identities
C+I+G+X–M≡C+S+T
I+G+X–M≡S+T
If there is no government, no foreign trade then G = T = M
= X = 0.
I≡S
GNP ≡ GDP + Factor income earned by the domestic
factors of production employed in the rest of the world –
Factor income earned by the factors of production of the
rest of the world employed in the domestic economy.
Hence, GNP ≡ GDP + Net factor income from abroad
NNP ≡ GNP – Depreciation. We get the value of NNP
evaluated at market prices. But market price includes
indirect taxes.
Thus, NNP at factor cost ≡ National Income (NI ) ≡ NNP
at market prices – (Indirect taxes – Subsidies) ≡ NNP at
market prices – Net indirect taxes (Net indirect taxes ≡
Indirect taxes – Subsidies)
For calculation
Personal income (PI) ≡ NI – Undistributed profits – Net
interest payments made by households – Corporate tax +
Transfer payments to the households from the government and
firms.
Personal Disposable Income (PDI ) ≡ PI – Personal tax
payments – Non-tax payments.
National Disposable Income = Net National Product at market
prices + Other current transfers from the rest of the world
Diagrammatic representation of the subcategories of aggregate
income. NFIA: Net Factor Income from Abroad, D:
Depreciation,, ID: Indirect Taxes, Sub: Subsidies, UP:
Undistributed Profits, NIH: Net Interest Payments by
Households, CT: Corporate Taxes, TrH: Transfers received by
Households, PTP: Personal Tax PaymentsNP: Non-Tax
Real vs. Nominal GDP
Real GDP is calculated in a way such
that the goods and services are
evaluated at some constant set of
prices (or constant prices).
Nominal GDP, on the other hand, is
simply the value of GDP at the current
prevailing prices.
The ratio of nominal to real GDP is a
well known index of prices. This is
called GDP Deflator.
Consumer Price index
Consumer Price Index (CPI) is the index
of prices of a given basket of commodities
which are bought by the representative
consumer.
CPI is generally expressed in percentage
terms.
Like CPI, the index for wholesale prices is
called Wholesale Price Index (WPI).
GDP AND WELFARE
1. Distribution of GDP – how uniform
is it:
Non-monetary exchanges:
Externalities:
INDIA
GDP at factor cost at constant (2004-05) prices in the year 2012-13 is Rs. 55,05,
437 crore showing a growth rate of 5.0 percent over year 2011-12 of Rs. 52, 43,582
crore, released on 31th January 2013.
GDP at factor cost at current prices in the year 2012-13 is estimated at
94,61,013 crore,
Rs.
Gross National Income (GNI) at factor cost at 2004-05 prices is Rs. 54,49,104 crore
GNI at factor cost at current prices is now estimated at Rs 93,61,113 crore
Per capita net national income in real terms (at 2004-05 prices) during 2012-13 is
estimated to Rs. 39,168 per capita income at current prices during 2012-13 is
estimated to have attained a level of Rs. 68,757
Agriculture, forestry and fishing
Mining and quarrying
Manufacturing
Electricity, gas and water supply
Construction
Trade, hotels transport and communication
Financing, ins., real est. and business services
Community, social and personal services
ANNUAL ESTIMATES OF
EXPENDITURES ON GDP, 201213 (Expenditure method)
Private Final Consumption Expenditure-Rs. 56,94,362crore (at
current prices)
Government Final Consumption Expenditure-Rs. 11,86,761crore in
2012-13
Gross Fixed Capital Formation-Rs. 29,64,677crore in 2012-13
Exports- Imports
Gross domestic product 2010
Ranking
USA
CHN
JPN
DEU
FRA
GBR
BRA
ITA
IND
CAN
RUS
ESP
MEX
KOR
AUS
NLD
TUR
IDN
CHE
POL
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Economy
United States
China
Japan
Germany
France
United Kingdom
Brazil
Italy
India
Canada
Russian Federation
Spain
Mexico
Korea, Rep.
Australia
Netherlands
Turkey
Indonesia
Sw itzerland
Poland
Millions of US dollars)
14,582,400
5,878,629
5,497,813
3,309,669
2,560,002
2,246,079
2,087,890
2,051,412
1,729,010
1,574,052
1,479,819
1,407,405
1,039,662
1,014,483
924,843
783,413
735,264
706,558
523,772
468,585
National Income
Paradigm shift in sect oral shares since
planning period
Rising shares of Service Sector
Declining share of Agriculture
Steady state of manufacturing
India missed the manufacturing boom