What is Macroeconomics?

Its
Origin

Scope of Macroeconomics
1. Theory of National Income.
2. Theory of Employment.
3. Theory of Money.
4. Theory of General Price Level.
5. Theory of Economic Growth.
6. Theory of International Trade.
7. Macro Theory of Distribution.
8. Theory of Trade Cycles.
9. Balance of Payments and Exchange Rates.
 Scope of Macroeconomic Theory

Theory of Theory of Theory of Macro theory

Income and General Price Economic of Distribution
Employment Level and Inflation Growth

Theory of Investment
Theory of Consumption
function

Theory of Business Cycles

 GROWTH

Macro Economic Concepts

BUSINESS CYCLES

UNEMPLOYMENT

INFLATION
 Importance of Macroeconomics
1. Macroeconomic paradoxes show the importance of
Macroeconomic analysis: The study of macroeconomics is important
in its own sake, as it tells us how the economy as a whole works. We
cannot obtain and derive laws governing macroeconomic variables such
as national income, total employment, general price level by studying
the microeconomic decisions of individual consumers, firms and
industries. This is because what is true and valid in case of an individual
firm or industry may not be valid for the economy as a whole.
2. Important nature of Macroeconomic Issues: Macroeconomics is
concerned with the study of issues and problems which are of vital
importance for determining well-being of the people. Macroeconomic
problems such as unemployment, inflation, instability of foreign
exchange rate case a lot of human sufferings.
3. Importance of Macroeconomics for Accelerating Economic
Growth: Macroeconomics explains the factors which determine
economic growth and brings out what causes slowdown in productivity
growth. All the economic models explains the same.
4. Understanding Business Cycles: Fluctuations in aggregate
demand due to volatile nature of investment demand.

5. Formulating Government’s Macroeconomic Policies: In

formulating the monetary and fiscal policies of the government.

6. Individual Decision-making: The understanding about the

working of the economy as a whole helps the individuals to take
better decisions. The individuals can take care of situations like
saving during inflation, investment during interest rise etc.
Buying a new asset-whether it is the right time or not.
7. Importance in Business Decisions: The changes in domestic
business environment and the changes in International business
environment can have a great impact in business decisions of
investors and business houses.
Limitations of Macroeconomics

1. Many propositions which are true for either individuals or for small groups of
individuals or for small groups of individuals turn out to be false when the
economy as a whole is considered.

2. The Macroeconomic approach, which focuses attention on the large aggregates,

often treats these aggregates as homogeneous forgetting the significance of the
internal composition and structure of such aggregates.

3. The utility of Macroeconomic analysis is further restricted by the fact that the
bulk of the macroeconomic theory developed so far has relevance to the
developed countries since most macroeconomic models have been constructed
to approximate reality in the developed countries.
 National Income
Some countries are rich, some are poor and yet some others are in between. How do we
measure the performance of an economy? Performance of an economy is related to the
level of production (of goods and services) or total economic activity. Measures of national
income and output are used in economics to estimate the total value of production in an
economy. The standard measures of income and output are Gross National Product (GNP),
Gross Domestic Product (GDP), Gross National Income (GNI), Net National Product
(NNP), and Net National Income (NNI). In India, the Central Statistical Organization has
been estimating the national income.
National income per person or per capita income is often used as an
indicator of people’s standard of living or welfare. However, many
development economists have criticized that GNP as a measure of
welfare has many limitations. They argued that human well-being does
not depend on national income alone. As measures of GNP exclude
poverty, literacy,
public health, gender equity, and many human issues of well-being, they
developed other measures of welfare such as the Human Development
Index (HDI).
Some rich countries in terms of national income are poor in human
development. Similarly, poor countries in terms national income have
performed well in human development. In the case of India, though the
 National Income Accounting
National income of a country can be defined as the total
market value of all final goods and services produced in the
economy in a year.
Two things must be noted in regard to the meaning of National
Income.
First, it measures the market value of annual output. In other
words national income is a monetary measure.
Secondly, for calculating national income accurately all goods
and services produced in any given year must be counted only
once.
Thus the total value of all final goods and services produced by
various productive firms or businesses in a year is known as
national product.
Wages
Value of Final +
National Product= Goods and Services = Rent
=National Income
Produced +
 National Income and Related
Concepts
GROSS DOMESTIC PRODUCT (GDP):
Gross domestic product is the total money value of all final goods and
services produced in an economy during a particular year by normal
residents as well as non-residents in the domestic territory of a
country but excludes the incomes received from abroad.
GDP=Money Value of all Final Goods and Services Produced by National
Residents + Income Earned Locally by Foreigners—Income Received
by Nationals Abroad.
We can think of actual GDP and potential GDP.
Actual GDP means what the economy produces while Potential GDP
represents what the economy could produce.
GDP can be computed both at factor cost as well at market price. GDP
at factor cost provides an estimate of the total value of final goods
and services produced during a year at cost of production. For
computing GDP at market price, all final goods and services are
valued at their market prices and the values thus obtained are
added.
The market price of goods include indirect taxes such as sales tax and
excise duty.
GDPMP =GDPFC + Indirect Taxes – Subsidies
GDPFC=GDPMP – Indirect Taxes + Subsidies

GROSS NATIONAL PRODUCT (GNP):

Gross National Product is defined as the total money value of all final
goods and services produced in an economy during a particular year
plus net income from abroad.
GNP=Money Value of Final Goods and Services (both consumer and
capital) + Income Earned by National Residents in Foreign Countries--
Income Earned Locally but Accruing to Foreigners.
The difference between GDP and GNP is due to ‘net factor income from
abroad’.
GNPMP=GNPFC + Indirect Taxes -- Subsidies
GNPFC=GNPMP – Indirect Taxes + Subsidies
 Relation between different concepts of
National Income
1. Gross Domestic Product
Market Value of Final Goods and Services produced within the domestic
territories.
(+) Net Factor Income from Abroad
= 2. Gross National Product
(--) Depreciation
= 3. Net National Product at Market Price
(--) Net Factor Income from Abroad
= 4. Net Domestic Product at Market Price
(--) Net Indirect Taxes (i.e. Indirect Taxes minus Subsidies)
= 5. Net Domestic Product at Factor Cost or Domestic Income
(+) Depreciation
= 6. Gross Domestic Product at Factor Cost
(+) Net Factor Income from Abroad
= 7. Gross National Product at Factor Cost
(--) Depreciation
= 8. Net National Product at Factor Cost or National
Income
(--) Property and Entrepreneurial Income of the Government
(--) Savings of Non-Departmental Enterprises
(--) Social Security Contributions
(--) Net Factor Income from Abroad
= Income from Domestic Product Accruing to Private Sector
(+) Interest on National Debt
(+) Transfer Earnings from the Government
(+) Current Foreign Transfer Payments
(+) Net Factor Income from Abroad
= 9. Private Income
(--) Corporate Tax
(--) Saving of Corporation
(--) Retained Earnings of Foreign Companies
= 10. Personal Incomes
(--) Direct Taxes
(--) Miscellaneous Receipts of Government Administration
= 11. Disposable Income
= Consumption + Saving

Measurement of National Income

There are three methods of measuring National Income

1. Census of Production Method
2. Census of Income Method
3. Census of Expenditure Method
1. Census of Production Method : This method measures the output of
he country.
Y=( P-D) + ( S-T) + ( X-M) + ( R-p)
Y= Total income of the nation.
P= Domestic output of all production sectors, D= Depreciation allowance.
S= Subsidies, T= Indirect taxes
X= Exports, M= Imports.
R= Receipt from abroad, p= Payments made abroad.
2. Census of Income Method: In this method the income of all factors
of production is added together.
Y= (w + r + i + profit) + ( X-M) + ( R-p)
w = wages, r = rent, i = interest
3. Census of Expenditure Method : National income on the
expenditure side is equal to the value of consumption plus investment.
Y= ( C + I + G) + ( X – M) + ( R - P),
Where, C= Consumption Expenditure, I= Investment Expenditure
G= Government Expenditure.
 GDP and GNP
While GDP indicates productive capacity of an economy, GNP is a crude
indicator for living standard. The significance of the distinction between
GNP and GDP depends on the nature of a particular economy. For
instance, if a country has more non-resident inflows and produces a
considerable portion of its output by multinational corporations (i.e. with
the help of external factors of production), its GNP will be higher than
GDP. Otherwise the distinction will be negligible.

Many countries have foreign firms. In the case of US Ford Motors in

Chennai, the income from the car factory would be counted as Indian
GDP and not as US GDP. But the amount of profit the company sends to
US will be added to their GNP. Similarly, our GNP can be arrived by
adding to our GDP the net factor income receipts from abroad for the
factor inputs owned by Indians. That is, the non-resident Indians income
will be added to GDP to arrive at our GNP.
 NI at Current Prices and Constant Prices
The concepts of national income discussed above can be measured either at
‘current price’ or at ‘constant price’. The measure based on current price
uses the ongoing market prices to compute the value of output. It is quite
possible that the current price may always be higher than real value due to
many factors like taxes and inflation (or rising prices). Hence, national
income arrived at ‘current price’ includes such influences as inflation and
taxes.
With inflation as a common feature in almost all the economies, it is necessary
to measure the national income after deducting any such increase in the
value of any output or income. National income at ‘constant price’
measures the national income after making necessary adjustment to
eliminate the effect of inflation. Thus it is based on unchanged price of
output. As the national income at ‘constant price’ is computed based on the
real worth of the purchasing power of income, it is also called as ‘real
national income’ or national income in ‘real’ terms.
 Difficulties in the Calculation of
National Income

1. Definition of Nation ( in a open economy)

2. Choice of Goods ( only goods having money value can be taken)
3. Choice of Method ( availability of data)
4. Stage of Economic Activity ( production stage, consumption
stage or expenditure stage)
5. Double Counting.
6. Transfer Payments ( pension, unemployment allowance, interest
on loans etc)
7. Illegal Income. ( Black Money)
8. Non-Availability of Data.
9. Non Monetized Sector.
10. Price Level Changes.
11. Difficulties in Underdeveloped Countries.
 Importance of National Income
Studies
1. Indicator of Economic Structure.
2. Indicator of Economic Welfare.
3. Helpful in Economic Policy.
4. Helpful in Economic Planning
5. Inflationary and Deflationary Gaps.
6. Importance in International Sphere.
7. Determination of Grants in Aid.
8. Basis of Budgetary Policies.
9. Importance in Defense and Development
10. Basis of Social Accounting
11. Importance in Economic Analysis-growth of the
economy, the trends in various sectors, the trends of
various macro variables ( saving, investment, inflation,
forex reserves etc.)
Circular Flow Model

Injections, withdrawals
and equilibrium
 The circular flow of income

Consumption of
domestically
produced goods
and services (Cd)
 The circular flow of income

Consumption of
Factor domestically
payments produced goods
and services (Cd)
 The circular flow of income

Consumption of
Factor domestically
BANKS, etc
payments produced goods
and services (Cd)

Net
saving (S)
 The circular flow of income

Investment (I)

Consumption of
Factor domestically
BANKS, etc
payments produced goods
and services (Cd)

Net
saving (S)
 The circular flow of income

Investment (I)

Consumption of
Factor domestically
BANKS, etc GOV.
payments produced goods
and services (Cd)

Net
Net taxes (T)
saving (S)
 The circular flow of income

Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV.
payments produced goods
and services (Cd)

Net
Net taxes (T)
saving (S)
 The circular flow of income

Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Net expenditure (M)
Net taxes (T)
saving (S)
 The circular flow of income

Export
expenditure (X)
Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Net expenditure (M)
Net taxes (T)
saving (S)
 The circular flow of income

Export
expenditure (X)
Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Net expenditure (M)
Net taxes (T)
saving (S)

WITHDRAWALS
 The circular flow of income

INJECTIONS

Export
expenditure (X)
Investment (I)
Government
Consumption of expenditure (G)

Factor domestically
BANKS, etc GOV. ABROAD
payments produced goods
and services (Cd)
Import
Net expenditure (M)
Net taxes (T)
saving (S)

WITHDRAWALS
 Economic Base Model Collapses All Spending
into Regional and Non-Regional

INJECTION

Export
expenditure (X)
Regional Purchases of
Factor regionally produced goods OUTSIDE OF REGION
payments and services
Import
expenditure (M)

WITHDRAWAL