Overview of Macroeconomics and National Income

Microeconomics Vs Macroeconomics Microeconomics is concerned with parts of the economy rather than with the economy as a whole Microeconomics is the economics of individual units, households and business firms, as they carry on their activities. The pricing and output of the goods and services that make up the flow from firms to households are also the concern of microeconomics, as are the pricing and employment of each of the many resources that constitute the flow from households to firms

Microeconomics Vs Macroeconomics Macroeconomics is the study of the behaviour of the economy as a whole, rather than in terms of individual economic units or specific products, resources and prices. It examines the forces that affect many firms, consumers and workers at the same time As such it is the aggregate flows that are more important rather than the items that make up each flow. Macroeconomics is particularly concerned with problems of Economic stability Causes and control of inflation and depression Aggregate level of employment Problems of economic growth and development

Major concerns of Macroeconomics Output and Employment Why do output and employment sometimes fall and how can unemployment be reduced? All market economies show patterns of expansion and contraction known as business cycles. One key goal of macroeconomics is to use monetary and fiscal policy to reduce the severity of business cycle downturns and unemployment Macroeconomics examines the sources of persistent unemployment and also suggests possible remedies, such as increasing aggregate demand or reforming labour market institutions

Major concerns of Macroeconomics Inflation What are the sources of inflation and how can it be kept under control? Macroeconomic policy has increasingly emphasised price stability as a key goal When prices are rapidly rising we experience inflation, where prices as a means to measure economic values and do business loses its value. Macroeconomics can suggest the proper role of monetary and fiscal policies, exchange rate systems and also central bank in containing inflation

Major concerns of Macroeconomics Economic Growth Macroeconomics is concerned with economic growth, which refers to the growth in the productive potential of an economy. An economy’s productive potential is the central factor in determining the growth in its real wages and living standards Rapid economic growth requires free markets, high rates of saving and investment, low trade barriers and honest government.

Objectives of Macroeconomics Employment High level of employment with low involuntary unemployment is one of the most important goals of macroeconomics The unemployment rate tends to reflect the state of the business cycle: when output is falling the demand for labour falls and unemployment rate rises

Objectives of Macroeconomics Price Stability-1 Price stability means that the overall price level is either unchanged or rising very slowly (low rates of inflation) Inflation is considered to be undesirable because of its adverse effects on income distribution, lending and borrowing, speculation and international trade competetiveness (people with fixed incomes suffer, there is speculation which drives away resources from industry into property and commodity speculation, exports become relatively more expensive and exports cheaper

Objectives of Macroeconomics Price Stability-2 Hyperinflation or galloping inflation:- is very serious because people lose confidence in the use of money for exchange purposes and the economic system might collapse Inflation occurs mainly due to 1) demand pull inflation:- caused by excess supply of money and 2) cost-push inflation mainly due to excessive rise in wage rates

Objectives of Macroeconomics Price Stability-3 Deflation is a reduction in the level of national income and output usually accompanied by a fall in the general price level A deflation is often deliberately brought about by the authorities in order to reduce inflation and to improve the balance of payments by reducing import demand.

Objectives of Macroeconomics Output The most comprehensive measure of the total output in an economy is the Gross Domestic Product (GDP) GDP is the measure of the market value of all final goods and services produced in a country in a year Nominal GDP :- is measured in actual market prices Real GDP :- is calculated in constant or invariant prices

Instruments of Macroeconomics Fiscal Policy denotes the use of taxes and government expenditure Monetary Policy acts through managing the nation’s money credit and banking system. This acts primarily through various interest rates.

Aggregate Demand Aggregate demand refers to the total amount that different in the economy willingly spend in a given period Aggregate demand is the sum of spending by consumers, businesses and governments The components of aggregate demand include consumption goods bought by consumers, factories and equipment bought by businesses, government, expenditure (equipment etc) and exports Aggregate demand depends on the level of prices, monetary policy, fiscal policy and other factors

Aggregate Supply Aggregate supply refers to the total quantity of goods and services that the nation’s businesses willingly produce and sell in a given period. Aggregate supply depends on the price level, the productive capacity of the economy and the level of costs.

Gross National Product Gross National Product (GNP) is the value of all final goods and services produced by domestically owned factors of production within a given period. GNP is the value of final goods and services produced. The insistence on final is simply to make sure that we do not double count. GNP consists of the value of output currently produced. It thus excludes transaction in commodities which are already in existence GNP values goods at market prices. The market price includes indirect taxes, such as sales tax, excise tax etc. (Market price- taxes= factor cost)

Net National Product or National Income Net National Product (NNP) is defined as GNP less depreciation NNP = GNP – Depreciation Depreciation is that part of total productive assets which is used to replace the capital worn –out in the process of creating national output The net output gives the measure of net output available for consumption by the society Since the NNP is the measure of the market value of all goods and services minus depreciation, it is also called National Income at Market Prices

National Income at Factor Cost or National Income The value of output measured at factor cost is referred to as National Income at Factor Cost. It is the sum of all incomes earned by factor owners for their contribution of factor services, viz., land, labour, capital and enterprise in the form of rent, wages, interest and profit It shows the quantum of economic resources required to produce the net output. NI = NNP – Indirect Taxes + Subsidies

Gross Domestic Product Gross Domestic Product (GDP) is the value of final goods produced within the country The difference between GNP and GDP:- Part of GNP is earned abroad, e.g. income of Indians working abroad is part of GNP but not GDP But on the other hand income of a foreign national working in India is part of Indian GDP but not Indian GNP, because it is earned in India. It is part of GNP of that country

Gross Domestic Product at Market Prices GDP at market price refers to the total value of goods and services, produced inside the country in a given year. GDPmp = C + I + G + (X – M) C - Consumption I - Investment or capital goods G – Government Expenditure X- Exports M- Imports

Gross Domestic Product at Factor Cost GDPfc = GDPmp- IT + S GDPfc - Gross Domestic Product at Factor Cost GDPmp - Gross Domestic Product at Market Prices IT – Indirect Taxes S- Subsidies

National Income at Current Prices When goods and services produced in a given year are multiplied with their current market prices, we get national income at current prices. The value of national income at current prices changes according to the changes in prices When we measure, national income at current prices, what we get is the nominal national income Thus during a period of price rise, the nominal national Income would rise even when the physical quantity of output produced remains constant

National Income at Constant Prices National Income at Constant Prices or the Real National Income measures changes in Physical output in the economy between different time periods by valuing all goods produced in the two periods at the same prices or constant prices. In order to find out the real rise in national income, the physical quantity of output should be multiplied with constant prices or base year prices. This process is called deflating the national income figures for the change in prices that have taken place during a period.

Deflating the NI The national income at current prices is deflated by price index numbers to obtain national income at constant prices. NI at Constant Prices = (NI at Current Prices/ Price Index Number) * 100

Estimationg NI at Constant Prices Year NI at Current prices Rs. Crores WPI (1981-82 prices) NI at Constant Prices (Rs. Crores) 1990-91 477.8 191.8 249.1 1991-92 552.8 217.8 253.8 1992-93 630.2 233.1 270.3 1993-94 723.1 258.3 279.9 1994-95 854.1 285.2 299.5

Price Indices A price index is a measure of the average level of prices. It is a weighted average of the prices of selected goods, services, commodities or financial assets measured over time Inflation denotes a rise in the general level of prices Deflation is the opposite of inflation and occurs when the general level of prices is falling.

Consumer Price Index-1 The Consumer Price Index (CPI) compares the total money that is required to purchase a given basket of consumption goods and services, over a period of time, in percentage terms The basket represents the actual consumption pattern of a typical family from a specific group, for which CPI is being constructed. Some such groupings are urban industrial workers, agricultural labourers, urban non-manual employees etc.

Consumer Price Index-2 In order to construct the index for a given year with reference to a base year, the following information is required Consumption basket in the base year Prices of the items in the basket in the base year Respective prices for each item in the given year

Wholesale Price Index-1 The construction method of the Wholesale Price Index (WPI) is similar to that of CPI. But there are some differences, they are as follows The items included in WPI are different from that of the CPI. The WPI includes items like industrial raw materials, semi finished goods, minerals, fertilizers, machinery, equipment etc. in addition to items from food, fuel, and power The WPI can be considered as an index of prices paid by producers for their inputs. Prices are whole sale prices Weights are based on the value of transaction in the various items in the base year.

Wholesale Price Index-2 The main groups of items are: Primary Articles:- food grains like rice, wheat, non food items like raw cotton, jute, minerals like iron ore, manganese ore. (in all there are 80 primary articles) Manufactured articles- 270 items Fuel, power, lubricants- 10 items

Measurement of National Income In NI estimates all goods and services produced and exchanged for money during a year are taken into account. NI can be estimated at three different levels, viz., production, distribution and expenditure Thus there are three methods of measuring national income, they are The Census of Products method or output method The Census of Income Method or Factor Income The Expenditure Method

The Census of Products Method This method is used in USA, where it is also known as Total Product Method or Goods Flow Method According to this method, the economy is classified into three sectors, viz., industry, services and external sector

Census of Income Method This method is also known as Factor Income Method This method looks at income from the distribution point of view The NI is obtained by adding up the incomes of all individuals of the country in the form of rent, wages, interests, profits and incomes of self employed persons

The Expenditure Method This method is also known as the ‘Consumption and Investment Method’ NI from expenditure point of view is the sum of consumption expenditure and investment expenditure According to this method NI is computed in the following manner Estimate private and public consumption expenditure Add the value of investment in fixed capital and stocks Add the value of net exports and net receipts