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MACRO AGGREGATES GROSS NATIONAL PRODUCT (GNP) GNP IS THE SUM OF ALL FINAL GOODS AND SERVICES PRODUCED

DURING A SPECIFIED PERIOD OF TIME (1 Yr.) WHICH CAN BE MEASURED AT MARKET VALUE (GNPmp) OR AT FACTOR COST (GNPfc) ARRIVING AT REAL GNP NOMINAL GNP IS GROSS NATIONAL PRODUCT EXPRESSED IN CURRENT Rs. Where as REAL GNP IS DEFLATED FOR CHANGES IN THE PRICES OF ITEMS

REAL GNP (current period) = NOMINAL GNP * GNP DEFLATOR (base period) (current period) GNP DEFLATOR (current period)

PERSONAL DISPOSABLE = INCOME PERSONAL INCOME

PERSONAL INCOME PERSONAL TAXES

= NNPfc RETAINED EARNINGS CORPORATE TAXES + TRANSFER PAYMENTS + NET INTEREST AND DIVIDENDS = WAGES + PROPRIETORS INCOME + NET INTEREST + DIVIDENDS + TRANSFER PAYMENTS PERSONAL DISPOSABLE INCOME - CONSUMPTION

PERSONAL SAVING NET EXPORTS =

GNPmp - (C+I+G) Where (C+I+G) is Domestic absorption

PRIVATE INCOME = INCOME FROM DOMESTIC PRODUCTION ACCRUING TO THE PRIVATE SECTOR + NET FACTOR INCOME FROM ABROAD+ CURRENT TRANSFER FROM GOVERNMENT + NET TRANSFERS FROM ROW TO THE PRIVATE SECTOR

PERSONAL INCOME

= PRIVATE INCOME - RETAINED PROFITS CORPORATE PROFIT TAX

NET FACTOR INCOME FROM ABROAD = FACTOR INCOMES PAID income generated in domestic productive activity paid to foreigners(eg repatriated profits, payment to consultants)- FACTOR INCOMES RECEIVED(domestic residents earn incomes abroad)

SIMPLE ECONOMY
WAGES&PROFITS(Y) Rs1000

PRODUCTIVE SECTOR

Y=AD Y=C

HOUSEHOLD SECTOR

PRIVATE CONSUMPTION Rs 1000 ( C)

CLOSED ECONOMY
WAGES&PROFITS(Y) Rs1000

PRODUCTIVE SECTOR

Y=AD Y=C+I S=I

HOUSEHOLD SECTOR

PRIVATE CONSUMPTION Rs 800 ( C)

INVESTMENT Rs 200

SAVING Rs 200

OPEN ECONOMY
WAGES&PROFITS(Y) Rs1000

PRODUCTIVE SECTOR

Y=AD Y=C+I+G+X Y =C+J W=J

HOUSEHOLD SECTOR

PRIVATE CONSUMPTION Rs 800 ( C)

INJECTIONS(J)=(Rs 200) INVESTMENT(I)=80 Exports(E)=60 Expenditure(G)=60

WITHDRAWALS(W)=(200)

SAVINGS(S)=100 IMPORTS(I)=50 TAXES(T)=50

GDP at Market Price Value at market prices of all goods and services during a specified period GDPmp = C+I+G+E-M
GDP at Factor Cost Income generated in the productive activities in an economy during a year GDPfc = W+INT+P+R

KEY TO FLOW CHART NATIONAL PRODUCT DOMESTIC PRODUCT = NET INCOME FROM ABROAD (NIA) GROSS VALUE NET VALUE = DEPRECIATION MARKET PRICE FACTOR COST = INDIRECT TAXES + SUBSIDIES

GNPMP -depreciation -net income from Abroad =NNPMP GDPMP -net indirect taxes -depreciation -net income from Abroad =NNPFC = NDPMP -net income from Abroad -depreciation -depreciation -net income from Abroad =GNPFC -net indirect taxes

-net indirect taxes GDPFC

-net indirect taxes

= NDPFC

SUMMARY OF THE FLOW CHART

KEY RELATIONSHIPS
GNPmp-NET INDIRECT TAXES = GNPfc

GNPmp-NET INCOME FROM ABROAD = GDPmp


GNPmp DEPRECIATION = NNPmp GDPmp DEPRECIATION = NDPmp NNPmp NET INCOME FROM ABROAD = NDPmp (SAME RELATIONSHIPS HOLD FOR NATIONAL INCOME VARIABLES MEASURED AT FACTOR COST)

CONCEPTUAL FRAMEWORK
STOCKS AND FLOWS Stocks Measured at a point of time eg. Total number of persons employed at a time in India Flows Measured over a period of time eg. No. of persons who get new jobs

Stocks
MONEY SUPPLY CPI FOREX RESERVES CAPITAL STOCK UNEMPLOYMENT

Flows
INFLATION EXPORTS / IMPORTERS INVESTMENT WAGES TAXES

Measurement of national income


The Output (Value Added) Method refers to value of all final goods and services produced during a year by different sectors of the economy or aggregating values imparted to intermediate Products at each stage of production
The agricultural and extractive industries 10

plus plus equals

Manufacturing Industries Services and construction Gross Domestic Product at factor cost

40 40 90

plus

Net factor income from abroad


(= Income received from abroad income paid abroad) 10 100 -20

equals less

Gross National Product at factor cost Capital consumption or depreciation

equals

Net National Product at factor cost or National Income

80

INCOME METHOD
MONEY PAYMENTS MADE TO ALL FACTORS OF PRODUCTION FACTOR INCOMES FOR CURRENT SERVICES TO PRODUCTION Income from employment Income from self employment Gross trading profits of cos Gross trading surplus of public cos Rent Total domestic income Stock appreciation GDPfc NFIA GNPfc 80 10 10 10 10 120 -30 90 10 100

EXPENDITURE METHOD
AGGREGATES ALL MONEY SPEND BY PRIVATE CITIZENS FIRMS AND GOVERNMENT

Consumer Expenditure (C) Govt.Expenditure (G) Gross Domestic Fixed Capital Formation (GDFC) (I) Value of Physical increase in stocks Total domestic expenditure (mp) Exports & factor income received Imports & factor income paid GNPmp Indirect Taxes Subsidies GNPfc

70 + 20
+ 20 + 10 120 + 20 - 30 110 - 20 +10 100

DIFFICULTIES IN MEASUREMENT OF NI
Non Market production Imputed values Underground economy Side effects and Economic Bads Double counting USE OF NI ECONOMIC PLANNING STANDARD OF LIVING CHANGES IN COUNTRYS ECONOMIC GROWTH COMPARATIVE ANALYSIS FACILITATED

Possible steps by the RBI to correct Rs slide- Intervention Possible steps by the Govt to correct Rs slideDemand for gold ,silver which has seen a 56% increase in demand Because it is thought of as a hedge against inflation So provide inflation indexed bonds with high returns Decontrol diesel prices, allow third party marketing to break The oil companies cartel Opening up organised retail to foreign investment and give resettlement package to deserving beneficiaries

BACKGROUND
CLASSICAL SCHOOL *Full employment - SayS Law Supply creates its own demand No room for Fiscal or M policy-Automatic equilibrium.

KEYNESIAN SCHOOL SHOT INTO PROMINENCE DURING THE GREAT DEPRESSION OF 1930

*UNEMPLOYMENT -Fiscal policy in raising AD. Use of multiplier

According to a recent CRISIL study released today, the IT and ITeS services sector has a multiplier effect on the Indian economy with every input of a rupee resulting in a 100 per cent return.

The study, conducted for NASSCOM, says, "Every rupee spent by the IT-ITeS sector translates into a total output of 2 rupees in the economy.

Nearly 58% of GDP comprises of Consumption expenditure which is a component growing in importance

Components of GDP in India(Expenditure method)


3500000 3000000 2500000 2000000 1500000 1000000 500000 0 2004-05 -500000 -1000000 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 con(pvt) Gov cons

#REF!
NX

GDP Measurement -Output method


COMM FIN/RE TRADE CON SER 2010-11 ELEC MANU MIN IND AGRI AGRI ALL 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 2009-10 2008-09

One way or another, there's really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can't spend more unless they make more The only sustainable source of consistent growth is rising median wages. The rich just don't spend enough all by themselves. Kevin seems to be arguing that as income distribution gets more tilted from the poor and middle class towards the rich, consumption as a share of national income will fall. OK, we are currently concerned about an insufficiency of aggregate demand given that the sum of net investment and net exports is barely above zero. During the transitional (perhaps defined as a couple of years) Keynesian period of weak investment demand, we have the paradox of thrift where any upwards shift of the national savings schedule will only deepen the recession.

The business climate index increased somewhat in wholesaling and clearly in retailing. The business situation is assessed more positively than previously at both levels of trade. In addition, retailers and wholesalers are more optimistic. This suggests brisk Christmas trade.

EQUILIBRIUM OUTPUT
EQUILIBRIUM OUTPUT = QUANTITY OF OUTPUT PRODUCE EQUALS AGGREGATE DEMAND

AGGREGATE DEMAND
EXPORTS

CONSUMPTION (C) + INVESTMENT GOVERNMENT PURCHASES (G) + NET (NX)

AD
Y AD

=
= =

C+I+G+NX
C+I+G+NX Y

EXANTE SENSE

ALL THE ABOVE MENTIONED VARIABLES ARE PLANNED OR DESIRED VALUES AND NOT ACTUAL VALUES

SIMPLE CONSUMPTION FUNCTION


AD=A+bY

I+G+NX
C=a+by

C Y S S

= = = =

a+by ; [ a>0, O>b<1] C+S Y-C y-a-by = -a+(1+b)y

MARGINAL PROPENSITY TO CONSUME = INCREASE IN CONSUMPTION PER UNIT IN INCOME AD = = A AD = = C+I+G+NX a+by+I+G+NX (I+G+NX) A+by

M. THAMPY MPC (1951-1979) = C = 19.60 + 0.824 Yd C/N = 91.69 + 0.733 (Yd/N)

0.82

Marginal propensity to consume India Japan West Germany Australia 0.82 0.66 0.72 0.76

SAVINGS FUNCTION
TWO SECTOR ECONOMY - INCOME IS EITHER SAVED OR SPENT Y = C+S which implies S = Y-C Substituting the consumption function we get S = Y-C = Y-a-by = -a+(1-b) Y (1-b) = MPS = Marginal propensity to save (MPS) Increase in savings per unit of income

MPC + MPS = 1

CONSUMPTION FUNCTION

C = a+by

Y
PLANNED INVESTMENT (I) GOVERNMENT PURCHASES & NET EXPORTS AD = = = = C+I+G+NX a+by+I-G+NX (a+I+G+NX) +by A+by (where A = (a+I+G+NX)

AD
AD=A+by C=a+by

DETERMINATION OF CONSUMPTION
STOCK OF WEALTH EXPECTATIONS TAXATION POLICY Wealthier economies consume more Regarding future movements in incomes and prices Taxation policy influences the Average propensity to consume and shifts the consumption function Income accruing greatly to the Higher income class is likely to Be saved Young families have higher Propensities to consume

DISTRIBUTION OF INCOME AGE COMPOSITION OF POPULATION

DETERMINATION OF EQUILIBRIUM INCOME


ASSUMPTION : CONPONENTS OF INVESTMENT, GOVERNMENT EXPENDITURE, NET EXPORTS CONSTITUTING (AD) ARE HELD CONSTANT

AD = C+I+G+NX, Substituting the consumption equation we get

AD = a+by+I+G+NX Where (I+G+NX) are AUTONOMOUS components (independent of the level of income)

GIVEN THE ABOVE FACTS EQUILIBRIUM INCOME IS WHERE (AD) CURVE EQUALS THE 45 DEGREE LINE AS SHOWN IN THE FIG(PLANNED(EXANTE) SPENDING=ACTUAL (EXPOST)OUTPUT

EQUILIBRIUM OUTPUT DETERMINATION


AD

AD=A+by
A

C = a+by
a 45o y

INPUT OUTPUT

Y = AD = A + by A = Y(1-b)

INVESTMENT FUNCTION ALLOWING FOR EFFECT OF INCOME


I f(y) I-= f(yo)

50 + 0.9 yd y-T 10+0.2y C+I+G I G

yd = T Y I G = = = =

(a) CALCULATE EQUILIBRIUM INCOME, AGG CONS,. GOVT. BUDGET DEFICIT, I = 50, G = 40
SOLUTION C = 50 + 0.9 yd y (10+0.2y) 50-+0.9 (y-10-0.2y) 50+0.9 y 9 0.18y 41+0.72y C+I+G 41+0.72y+50+40

Yd = C = = C Y Y = = =

Y-0.72Y= 41+50+40 Y= 41+50+40 0.28 C+I+G=467.86 T= 10+0.2Y =10+93.57 Yd=Y-T = 103.57

= 467.86-103.57 = 364.29

C= 50+0.9Yd = 50+0.9 x 364.29= 377.86 Budget deficit = Govt. expenditure Taxes 40-103.57

Disposable Income (y) a. b. c. d. e. 500 600 700 800 900

Consumption 400 475 540 600 650

MPC 0.72 0.73 0.71 0.70 0.68

MPS 0.28 0.27 0.29 0.30 0.32

40+byd, MPC = b, MPS 1-b


MPC C 40 400 40 360 0.72 yd 500 500

MPS =

(1-0.72) = 0.28

Multiplier effect

2.4

D Fi Fs Fo ef e M n re nc s e hin s e inin st e g g r r

trade Agri Transpo Water s Manu Constr 0 2

3.2 3.4 4.3 Series1 4.9 6.5 7.5 4 6 8

2.6 2.7 2.9 3.13 3.14 3.15 0 2 4 Series1

O th er

se rv

So c

MULTIPLIER ANALYSIS
Multiplier INCREASE IN THE LEVEL OF EQUILIBRIUM INCOME FOR A UNIT INCREASE IN AUTONOMOUS SPENDING

For e.g. If Consumption function is given as

Y=a+by (where b is MPC) then


Y-by = a (where a is the autonomous consumption component) Y (1-b) = a

Y = 1/1-b* a (where 1/1-b is the multiplier)


In case of we Include Govt. exp a can be represented as A (autonomous Component) and we can write the above as Y=A/1-b

DERIVATION M = Y*2-Y*1 A2-A1 Substituting Y*1 = A1 1-b Y*2 =A2 1-b


(Y*1 AND Y*2 ARE EQUILIBRIUM OUTPUT)

We have = A2 -A1 1-b 1-b A2-A1 M= A2-A1 1-b (A2-A1)


=1/1-b =1/MPS

SUMMARY
1.
(a)

SIMPLE ECONOMY
Y = AD = C+S = a+by y-by y (1-b) y1
1 b

= = =

a
1a (1 b)

= (Multiplier = INVESTMENT CONSIDERED (b) Y = = C+I (a+by) + (c+dy)

1 1 1 MPC MPS

=
=

1 (a+c) (1 b d ) 1 Where b = MPC , d = MPI (1 b d )

(a+c) Autonomous Spending + Autonomous investment


GOVERNMENT SECTOR

(C)

= =

C+I+G (a+by) + (c+dy) + G


1 (a+c+G) (1 b d )

GOVT. SECTOR WITH TAXES Y C yd = = = C+I+G a+byd y-T+J


1
1 b(1 t ) d

(T= Tax payment, J = Transfers)

(a+b(y-ty+j)) + (c+dy) + G
1
1 b (1 t )

*(a+G+bJ+c)

OPEN ECONOMY
Y M C I M Y

=
= = = = = =

C+I+G+X-M m(y) Imports are a function of income a+b (y-by+j) c+dy my a+b(y-ty+J) + c+dy +G + x my * (a+c+G+x+bj)
1 1 d b(1 t ) m

The following relations represent Of an open economy

simple model

Consumption function (C) = 250+ 0.75Y Investment function ( I ) = 65 + 0.15 Y Government exp (G ) = 90 Exports (X) = 125 Import function (M) = 0.15Y Due to an exogenous boost in the economy exports Increase by 25. Compute the change in equilibrium Level of income and also compute foreign trade multiplier

Y= C+ I+G+X-M Y = 250 + 0.75 Y + 65 + 0.15Y + 90 +125 - 0.15 Y Y = 530 + 0.75Y 0.25Y = 530 Y = 530/0.25 = 2120 When X increases by 25
0.25Y = (530 + 25) = 555 Y = 2220 Increase in income is 100 Foreign trade multiplier = 100/25 =4

Balanced budget multiplier 1/1-b x G 1/(1-b) (a-bt +I+G) -b/1-b x T Since G = T (1/1-b - b/1-b) G

1-b/1-b = 1
Eg. a =20, b = 0.80 , I = 50 If G = T = 10 then

2. Using the consumption function C= 40+byd If MPC is 0.8 calculate the consumption for Disposable income of a) 800 b) 90

Factory output and order book touched a six month high, RBI hinted a rate Cut . However investors are wary. Manufacturing activity rises in the first six months -8 core industries Register growth. PMI also shows growth. However growth should Remain the priority Weak Rs to encourage margins in IT companies. Companies to lower Prices to raise volumes Fiscal deficit in India 2008-09 6.4 2009-10 5.1 2010-11 5.5

INVESTMENT FUNCTION INVESTMENT DEMAND -DEMAND BY BUSINESS FOR OUTPUT WITH WHICH TO MAINTAIN OR INCREASE THE TOTAL CAPITAL STOCK

The investment function expressed mathematically as I = f(y)=n- I/r


r =rate of interest N = Autonomous component I/r is the marginal response of investment to rate of interest The following fig. Indicates the relationship between investment. Interest rate and income. I2 I0 I = f(y1) I1 I = f(yo) r0 r1

INCOME DETERMINATION MODEL (INCLUDING MONEY AND INTEREST)


INTRODUCTION IS-LM MODEL Studies the interaction of the goods & assets markets using the IS-LM curves. Interest rate is considered in determination of (AD) Illustrates how monetary and Fiscal policies can prove effective Assumption of the earlier model are done away with. E.g. Autonomous Investment concept.

Investment dependant on interest.

Interest rate I

I- i
Planned investment spending

STRUCTURE

OF THE INCOME

IS LM

MODEL

ASSETS MARKET Money mkt Bond mkt Demand Demand Supply Supply

GOODS MARKET AGGREGATE DEMAND OUTPUT

Interest rates
Monetary policy Fiscal policy

Derivation of the IS Curve(GOODS MARKET Where Agg demand =output)


First of all, we will have to modify the aggregate demand function of the earlier chapter to reflect the new planned investment spending schedule. Here we see that only I is redefined as

I- i

AD C I G NX [a b(Y tY J )] [ I i ] [G ] [ NX ]
A b(1 t )Y i (Where A a b J I G NX )
For equilibriu m in the goods market Y AD A b(1- t)Y - i A i Y 1 - b(1- t)

Solving for i
i A

[1 b(1 t )]

Y ( IS curve)

Derivation of the IS Curve(GOODS MARKET Where Agg demand =output)


First of all, we will have to modify the aggregate demand function of the earlier chapter to reflect the new planned investment spending schedule. Here we see that only I is redefined as
AD E2 AD1
A-i2

I- i
AD=Y

AD2

E1 A-i1

Y1

Y2

IS curve shows Combinations of Y i1 and i i2 Where demand for goods(AD)= Its supply

E1

E2
IS

IS curve is derived from the AD curve (same Y and i)

y1

y2

See derivation

Now, let us derive some important properties of the IS curve. The equation of the IS curve is

[1 b(l t )] Y

since the multiplier

1 1 - b(1 - t) we can rewrite the equation of the IS curve as A

From the above equation it can be seen that the steepness of the IS curve depends on the multiplier () and investment sensitiveness to change in interest rates () is large, then the IS curve would flat because 1/ would be small. It can also be inferred that larger the multiplier, the flatter would be the IS curve. Since the slope of the IS curve is dependent on the multiplier and the multiplier in turn is dependent on fiscal policy more specifically, the tax rate t we see that fiscal policy can affect the slope of the multiplier. An increase in the tax rate would reduce the multiplier, which in turn increases the steepness of the IS curve). Thus the steepness of the IS curve and the tax rate go in the same direction.

ASSETS MARKETS AND THE LM CURVE(money market where Md=Ms)


The assets markets are the markets in which money, bonds, stocks, houses and other forms of wealth are traded. There are a large variety of assets and a lot of trading takes place in the assets markets everyday. But we shall simplify matters by grouping all available assets into two groups, money and all other assets. Given the level of financial wealth, an individual who has decided how much money to hold. Our focus will be on the money market, which implicitly takes care of the other assets market. L=Ky-hi ; k,h>O

K Y

L2=kY2-hi L1=kY1-hi
Demand for money

k,h is the sensitivity of Demand for real balances to changes in income and interest rate

DEMAND FOR MONEY

Transactions demand for Money= DEPENDENT ON INCOME


PRECAUTIONARY DEMAND = DEPENDENT ON INCOME

SPECULATIVE DEMAND = DEPENDENT ON INTEREST RATE.

DERIVATION OF THE LM CURVE E2 (Combinations of interest rate and income where Md=Ms E2 i2
E1 E1 L2

i1
L1
M/P

Y1

Y2

LM

Shifts in LM Curve
E1 LM1

E1

Changes in Real Ms Shifts LM E2 curve


L1 L M1/P

E2

Income Output

M kY hi P 1 M i (kY ) h P

M/P Real Balance

E i

LM

IS

Monetary PolicyDIG1
LM E LM1 E

Fiscal PolicyDIG2

LM
E1

i0 i1
E1

i1 i0
IS

E2

IS1

IS y0 y1 y2

Y0
Income Output

Y1

Changes in money demand affect AD - TRANSMISSION MECHANISIM (1)


Change in money supply

(2)
Portfolio adjustments lead to change in asset prices to

(3)
spending adjusts changes in Output adjusts to AD change in

(4)

interest rate

and interest rates

Monetary policy(dig1) Govt. uses the monetary tool of open market operations to increase Money Supply - Shifts LM curve to the right to LM1. Initially in intersects the IS Curve at E1. In Ms with constant Md i i and also causes
a)changes in portfolio and people start holding more financial assets thereby raising its prices and reducing yields. b) Investment to pick up thereby raising AD and moving to point EWhere IS and LM1 curve intersects at i1(interest rate) and goods market and money Market are in equilibrium.(note:at E1 only money market was in equilibrium)

Fiscal Policy(dig2)

G - pushes IS curve to the right to IS1 thereby reducing i and reaching point E2 at income Y2.(Here only goods market is in Equilibrium). b)Now in Y raises Md with Ms being constant and this in turn raises i which leads to falls in private I and Y at E1 where new IS1 curve intersects old LM curve and goods and money market equilibrium is restored. However this leads to crowding out(of Private I) and reduction of Y WHICH IS CALLED CROWDING OUT CONTROVERSY

CROWDING

OUT

EFFECT

INTERACTION OF MONETARY AND FISCAL POLICY Dig3


E2

LM
INTERACTION OF MONETARY AND FISCAL POLICY

Crowding Out

i2 i0

E1

LM1

(see relationships in the next slide) y0 y2 y1

IS1
IS

POLICY PREVENTION OF CROWDING OUT

Dig 3 Shows that the only way to prevent crowding out is to Reduce i to i0 by increasing money supply so as to push LM curve to LM1.

New equilibrium is obtained at E1 where (new IS curve) IS1=(new LM curve) LM1 and both goods and money markets are in equilibrium

POLICY EFFECTS ON

INCOME AND INTEREST RAT

Monetary expansion - Increase in Money supply Fiscal expansion - Increase in G or reduction in t

POLICY

EQUILIBRIUM INCOME

EQUILIBRIUM

INTEREST RATES

Monetary exp Fiscal exp

+ +

ALTERNATIVE

FISCAL

POLICIES

INTEREST RATE INCOME TAX CUT + GOVT. SPENDING + INVESTMENT SUBSIDY +

C + + +

I +

Y (GDP) + + +

Germany US France Belgium Italy Greece

GDP

2.9 1.7 1.6 2.3 0.6 -7.5

IG

5.7 3.9 2.3 10 -2.7 -2.1

UNEM

7 9 9.9 6.7 8.3 18.4

INF

2.5 3.1 2.2 3.3 3.4 2.9

Source: Economist

The Business Confidence Index (BCI) of SACCI is a market-related index that reflects not what business is saying, but what it is doing and experiencing. It is therefore not an opinion/perception-based index. It is likely that in any one month the business mood will be influenced both positively and negatively by various developments in the economy. The BCI seeks to reflect the net results of these influences.
The BCI is a composite weighted index of thirteen sub-indices. Various economic indicators are used to compile the thirteen sub-indices. The indicators that are monitored have been judged by business to have the greatest bearing on the business mood.

Average monthly weighted exchange rate of the rand against the US dollar, the euro and the British pound as well as the volatility of the rand exchange rate Core consumer inflation rate for metropolitan and urban areas The real predominant prime overdraft rate Retail sales volumes Rate of change in real credit extension to the private sector Average weighted US dollar price of gold and platinum Merchandise import volumes Merchandise export volumes New vehicle sales Liquidations of companies and closed corporations Volume of manufacturing production Real value of private sector building plans passed, and

Results of the December 2011 Ifo Business Survey The Ifo Business Climate for trade and industry in Germany continued to improve in December after stabilising in the previous month. Survey participants responses showed that their assessment of the current business situation continues to remain favourable. Business expectations improved for the second time in succession. The German economy seems to be successfully countering the downturn in Western Europe. This bodes well for Christmas.
In manufacturing the business climate remains unchanged. Manufacturing firms may assess their current business situation as slightly less positive than in November, but there is no question of a meltdown comparable to that of 2008. On the contrary, the German economy is showing signs of stabilisation. Firms even view their six-month business outlook more favourably. They also see greater opportunities in the export business. The overhang of firms wishing to increase their staff numbers has nevertheless fallen slightly.

But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment. And if Kevin is right about the rich having a lower propensity to consume that is, a higher propensity to save the old trickle down nonsense about taking from the poor to give to the rich would at least spur more investment demand and long-term growth.

Figure 1 confirms the continuation of the long term downward trend of US savings, with inevitable oscillations in business cycles, since 1981. Each cyclical savings peak was lower than previous one 21.4% of GDP in 1981, 19.0% in 1998, and 16.4% in 2006. Each cyclical trough was also lower than the one before 14.2% in 1992, 13.6% in 2003, 10.2% in 2009.

JAPAN
30

25

20 Axis Title

15

inv sav

10

0 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000

USA
25

20

15 Axis Title INV SAV 10

0 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000

India
45 40 35 30 Axis Title 25 I 20 15 10 5 0 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 S

Components of GDP in India(Expenditure method)


3500000 3000000 2500000 2000000 1500000 1000000 500000 0 2004-05 -500000 -1000000 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 con(pvt) Gov cons

#REF!
NX

GDP Measurement -Output method


COMM FIN/RE TRADE CON SER 2010-11 ELEC MANU MIN IND AGRI AGRI ALL 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 2009-10 2008-09

Yr
1995-96 1996-97

Nominal GNP
2500 3200

GNP deflator
120 145

Base yr GNP deflator 1994 -95 =100 What is real GNP of 1995-96 What is the real GNP of 1996-97

What is the growth rate of real GNP from 1995-96 to 1996-97? What is the inflation rate in 1996-97 in relation to 1995-96 ?

Real GNP 2500 x 100/120 = 2083.33 3200 x 100/145 = 2207

Growth rate
Growth Rate = Real GNP 1996-97 Real GNP 1995-96

2207/2083.3 1

0.059 = 5.9%

Inflation rate
GNP deflator (cp- 96-97) - GNP(BP95-96) GNP def (1995-96)bp
145-120/120 x 100 = 20.83%

Following are the data relating to the national accounts Of an economy for the year 1995 in mn units of currency Capital consumption allowance Personal consumption spending Corporate income taxes Undistributed corporate profits Net exports Dividends Rent Interest Indirect business taxes Gross private investment Compensation to employees Government spending Proprietors income 1000 12500 500 250 25 750 1000 500 1250 550 8487.5 912.5 1250

Compute GNP using income method and expenditure method

(a) GNP INCOME METHOD


INDIRECT BUSINESS TAXES COMPENSATION TO EMPLOYEES RENTS INTEREST PROPRIETORS INCOME CORPORATE TAX DIVIDENDS UNDISTRIBUTED PROFITS 1250 8487.50 1000.00 500.00 1250.00 500.00 750.00 250.00 13987.50

(b)

GNP = EXPENDITURE METHOD = C+I+G+X-M = 12500+550+912.5+25 = 13987.5

From the following figures compute a) GDP at factor cost b) National income c) Personal disposable income GNP mp Personal income tax Corporate taxes Subsidies FIPA FIRFA Undistributed profit Indirect taxes Depreciation 5000 1000 800 400 800 900 200 450 350

GDP fc = GNP fc - NFIA


GNPfc = GNP mp - IT + subsidies = 5000 - 450 + 400 = 4950 GDP fc = 4950 (900-800) = 4850

National income NNPfc = GNP fc - Dep 4950 350 4600 Personal disposable income = Personal income Personal Taxes Personal income = National income - Retained earning - Corp tax 4600 -200 800 = 3600

GDP mp 6000 Corporate income tax 1200 Personal income tax 900 Subsidies 475 Factor incomes received from abroad 1500 Factor incomes paid 1200 abroad Undistributed profits 225 Indirect taxes 900 Depreciation 600 Compute Personal Disposable income, national income and GNP at market prices

GNPmp

= GDPmp +NFIA = 6000+1500 -1200 = 6300

National income = NNPfc GNPfc = GNP mp + Subsidies - Indirect taxes = 6300 + 475 -900 =5875
NNPfc = 5875- 600 5275

Personal disposable income = National income - Retained earnings - Corporate taxes - Personal txes 5275 -225 -1200 -900 = 2950

NATIONAL INCOME ACCOUNTING


INTRODUCTION MODERN ECONOMY IS VERY COMPLEX IN NATURE INVOLVES A NUMBER OF TRANSACTIONS eg
HOUSEHOLDS CONSUME GOODS AND SERVICES AND PROVIDE THEIR LABOUR SERVICES TO FIRMS THEY PROVIDE SAVINGS TO Fis WHICH ACT AS INTERMEDIARIES BETWEEN SAVERS AND INVESTORS GOVERNMENT PLAYS A ROLE IN COLLECTING TAXES AND PROVIDING PUBLIC SERVICES TRANSFER OF PHYSICAL AND FINANCIAL ASSETS TAKE PLACE WITH FOREIGNERS

NATIONAL INCOME ACCOUNTS SUMMARY PICTURE OF ALL TRANSACTIONS

NATIONAL ACCOUNTING INVOLVES A SUBSTANTIAL AMOUNT OF AGGREGATION HELPS IDENTIFY IMPORTANT ECONOMIC RELATIONSHIPS
MAJOR TYPES OF ACCOUNTS NATIONAL ECONOMY NATIONAL INCOME ACCOUNTS FLOW OF GOODS AND SERVICES IN AN ECONOMY DURING A YEAR FLOWS OF GOODS AND SERVICES BETWEEN PRODUCTIVE AND HOUSEHOLD SECTORS REFLECTS NATIONS WEALTH AT A POINT OF TIME

INPUT OUTPUT ACCOUNT

NATIONAL BALANCE SHEET

NATIONAL ACCOUNTS

NUMBER OF HOUSEHOLDS SINGLE FIRM (OWNED BY SOME HOUSEHOLDS) LABOUR IS THE ONLY SCARCE INPUT
PRODUCTION ACCOUNT Dr. Wages 90 Profits 10 Sales (to households) 100 HOUSEHOLD ACCOUNT Wages Profits Consumption Sales (to households) 90 10 100 100 Cr. --100 100

SIMPLE ECONOMY

100

CONSOLIDATED PRODUCTION ACCOUNT (WITH BUSINESS SAVING & DEPRECIATION)

Dr.

Cr.

Wages & Salaries Retained Profits Depreciation Sales Investment

1340 310 50
1700

--1200 500 1700

INVENTORY INVESTMENT
GNP IS NOT EQUAL TO GNI-ROLE OF SAVING & INVESTMENT PRODUCTION A/C

Wages & Profits Sales Households Investment

Dr. 360 360


HOUSEHOLD A/C.

Cr. -325 35 360 360

Wages & Profits Sales to Households Saving

325 35 360
SAVINGS A/C

360

Investment in inventories Saving (Household)

35 35 35 35

(ROLE OF GOVERNMENT)-PR0DUCTION SECTOR

Wages and salaries Dividends Retained profits Corporate profit tax Sales to households Sales to Government Domestic investment

1000 500 500 1000 1000 1000 1000 3000 3000

GOVERNMENT SECTOR
Wages and salaries Purchases Taxes collected 500 1000 1500 1500 1500

HOUSEHOLD A/C
Dr. Wages & Salaries Dividends Personal income tax Consumption Personal Saving Cr. 1500 500

500 1000 500 2000

2000

SAVINGS & INVESTMENT Dr.

Personal Saving Business Saving Domestic Investment

Cr. 500 500 1000

1000 1000

INDIRECT TAXES AND SUBSIDIES-PR0DUCTION SECTOR

Wages and salaries Dividends Retained profits Corporate profit tax Sales and excise taxes Sales to households Sales to Government Domestic investment

1000 500 500 500 300


1100 1100 1100 3300 3300

GOVERNMENT SECTOR
Wages and salaries Purchases Taxes collected 700 1100 1800 1800 1800

HOUSEHOLD A/C
Dr. Wages & Salaries Dividends Personal income tax Consumption Personal Saving Cr. 1700 500

500 1100 600 2200

2200

SAVINGS & INVESTMENT Dr.

Personal Saving Business Saving Domestic Investment

Cr. 800 500 1100

1100 1100

A COMPLETE PICTURE PRODUCTION A/C


Dr. Cr.

Factor Incomes
(a) Paid to domestic residents (b) Paid to foreign residents Retained Profits Corporate Profit tax Indirect taxes Imports

85
(80) (5) 8 1 6 5

Sales to households
Sales to Government Domestic Investment (a) Fixed Investment (b) Inventory Investment Exports Subsidies from Govt.

78
4 12 (10) (2) 3

105

105

EXTERNAL A/C.
Dr. Exports Transfers from foreigners Incomes from abroad Deficit on current a/c. 8 3 4 1 16 Dr. Fixed Investment Inventory 10 2 Personal Saving Business Saving Government Saving Deficit on current a/c. 12 Imports Transfer to foreigners Income paid to foreigners Cr. 5 6 5 16 CR 2 8 1 1 12

SAVINGS & INVESTMENT A/C

HOUSEHOLD SECTOR
Dr. 78 10 5 2 Consumption Personal Income Tax Transfers to foreigners Personal Saving Incomes from domestic production Income from abroad Transfers from Govt. Transfers from foreigners

Cr. 86 4 2 3

95

95

GOVERNMENT A/C.
Dr.
5 4 Wages & Salaries Purchases of goods & services Corporate profit tax Indirect Tax

Cr.
1 6

Transfers abroad
Transfers to household Subsidies to producers Surplus

1
2 3 1 17

Income Tax

10

17

12 10 8 6 4 2 0

9.8 9.5

8.5 7

8.1 6 5.8 5.3 4.5 4.5 Outlook in April Outlook in Oct

ia

na m

hi n

In d

or e ap

Si ng

S. Ko

Vi et

re a

A comparitive picture
s. Korea India Euro China Japan US 0 0.9 1 1.3 1.6 5 10 15 0.9 1.3 8.5 9.8 4.2 4.4 7.1 7.7 GDP growth 2009 GDP growth 2008

Budget deficit as a percentage of GDP


2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -2.50% -2.80% -4.00% US UK S. India Korea China Series1 1.50% 0.60%

-3.40%

Growth in industrial production 12.80% 14.00% 12.00% 9.10% 10.00% 7.10% 8.00% 6.00% 4.00% 2.40% 2.00% 0.00% -2.00% -1.50% -1.70% -4.00%

Growth in industrial production

In di a S. Ko re a

Eu ro C hi na

.S .

(39)
The following is the information from the national income accounts for a hypothetical country :
GNP MP Gross Investment Net Investment Consumption Government purchases of goods and services National Income Wages and Salaries Proprietors income + rental income of persons Dividends Government budget surplus Interest Transfer payments Personal tax and non-tax payments 2400 400 150 1500 480 1925 1460 160 50 15 60 260 300

Required to compute :
(a) NNP at market prices (d) Corporate profits (g) Disposable personal income (b) Net exports (e) Taxes Transfers (h) Personal saving (c) Net indirect taxes (f) Personal income

(39)
(a) NNP = = = = = = GNP Depreciation 2400-250 2150 Gross Investment Net Investment 400-150 250 = GNP (C+I+G) 2400-(1500+400+480) 20 = NNP National Income 2150-1925 225

Depreciation

(b)

Net Exports = = Net Indirect Profits = =

(c)

(d)

Corporate Profits = + Net Interest) = = = Taxes- Transfers = = = Personal Income = = =

NI (Wages and Salaries + Proprietors Income + Rental Income 1925-(1460+160+60) 1925-1680 245 Gross Purchases + Budget Surplus 480+15 495 National Income Corporate Profits + Transfer Payments + Dividends (1925-245) + 260+50 Rs. 1990

(e)

(f)

(g)

Personal Disposable Income = =


Personal Saving = = =

=Personal Income Personal Taxes and Non-Tax payments 1990-300 Rs. 1690
Personal Disposal Income Consumption 1690 1500 Rs. 190

(h)

2.

Given below are the accounts of a hypothetical economy


PRODUCTION A/C
GOVT. PURCHASE 30 PERSONAL SECTOR A/C. PERSONAL SECTOR PURCHASES (BF) 20 PURCHASES INCOME TAX 20 20 EXPORTS 20 40 SAVING 60 10 FIXED INVESTMENT FIXEDINVESTMENT 20 20 20 50 NET CHANGE IN I FOREIGN SECTOR A/C IMPORTS (BF) __ -1MPORTS(BF) 10 EXPORTS 40 FACTOR INCOMES 20

WAGES & SALARIES 100 DIVIDENDS( ) EXCISE TAX PROFIT TAX RETAINED PROFIT

FACTOR INCOMES TRANSFER PAYMENT(GOVT)

160 30

GOVERNMENT A/C. WAGES & SALARIES TRANSFER to HH TRANSFERS TO ROW


EXPENSES ON GOOD SAVINGS TOTAL

10

EXCISE TAX PERSONAL INCOME TAX PROFIT TAX FROM BUSINESS

20 20
DOMESTIC INVESTMENT INVESTMENT IN INVENTORIES
NET FOREIGN INVEST

IMPORTS FACTOR INCOMES PAID TRANSFERS TO ROW


SURPLUS

10

(30)

SAVING AND INVESTMENT A/C


20

10

HOUSEHOLD SAVINGS BUSINESS SAVINGS


GOVT. SAVINGS

60

10

Fill up the missing entries and compute GDP & GNPfc GDP & GNPmp Personal Disposable Income

2.

Given below are the accounts of a hypothetical economy PRODUCTION A/C

WAGES & SALARIES 100 DIVIDENDS(10) EXCISE TAX PROFIT TAX RETAINED PROFIT

GOVT. PURCHASE 30 PERSONAL SECTOR A/C. PERSONAL SECTOR PURCHASES (BF) 110) 20 PURCHASES 110 INCOME TAX 20 20 EXPORTS 20 40 SAVING 60 10 FIXED INVESTMENT FIXEDINVESTMENT 20 20 20 50 NET CHANGE IN I 10 FOREIGN SECTOR IMPORTS (BF) __-10 -1MPORTS(BF) 10 FACTOR INCOMES 20

FACTOR INCOMES TRANSFER PAYMENT(GOVT)

160 30

GOVERNMENT A/C. WAGES & SALARIES TRANSFER PAYMENT TRANSFERS TO ROW


PURCHASES(HS) SAVINGS TOTAL

eXPORTS

40

FACTOR INCOMES PAID TRANSFERS TO ROW


SURPLUS

10

10
30

30 30 10
30 -50

EXCISE TAX PERSONAL INCOME TAX PROFIT TAX FROM BUSINESS

20 20

SAVINGS AND INVESTMENT A/C


DOMESTIC INVESTMENT INVESTMENT IN INVENTORIES
NET FOREIGN INVEST

20

10

HOUSEHOLD SAVINGS BUSINESS SAVINGS


GOVT. SAVINGS

60

10
(-30)

50
-50

Fill up the missing entries and compute GDP & GNPfc GDP & GNPmp Personal Disposable Income

(45)
The following are inter-industry transactions in an economy. (The figures represent money valued of output)

Industries X Y Z Total Output

X 50 20 30 200

Y 80 60 40 240

Z 30 50 60 160

Total Output 200 240 160

Calculate the National Income in the economy and value added in industry Y

(45)
The National Income in the Economy = Total final output in the Economy - Sales to household sector. The sales to household sector by X, Y and Z industries are as follows :X Y Z = = = 200-(50+80+30) = 40 240-(20+60+50) = 110 160-(30+40+60) = 30 =40+110+30= 180 = = = = Output of Y Input from the industries 240-(80+60+40) 240-180 60

National Income

Value added in Industry Y

(14)
The following is the information from the national income accounts for a country XXX
Rs. In Crore National Income 3850 Government purchases 930 Consumption 3000 Net investment 300 Gross investment 800 GNP 4800 Personal Tax and non-tax payments 600 Transfer payments 510 Net interest 120 Government budget surplus 30 Dividends 100 Proprietors incme and rental income 320 of persons W ages and salaries 2920

Required to compute : a. Net Indirect Tax b. Taxes Transfers. c. Personal Income d. Net Exports

a.

Net indirect taxes OR Indirect taxes - Subsidies

=
=

NNP at market prices National income

(14)

(GNP at Market price Depreciation) National Income

b. Taxes Transfers

c. Personal Income

d. Net Exports

= GNP at Market Price (GI-NI) National Income [where Gross Investment (NI) = Depreciation ] = 4800-(800-300)-3850 = 4800-500-3850 = 450 = Government purchases + Budget surplus = 930+30=960 = (Wages + Proprietors income + Net Interest + Dividends + Transfer Payments) = 2920+320+120+100+510 = 3970. = GNP (C+I+G) = 4800 (3000+800+930) = 70

(20)
The following is the information drawn from the National Income Accounts for an economy

Amount (Rs. In crore) A. GNP 4850 B. Gross investment 854 C. Net investment 310 D. Consumption 3095 E. Government Spending 968
Calcutta the NNP and net export for the economy.

Item

(20)
NNP = = Net Exports = = GNP Depreciation (i.e. Gross Investment Net Investment) 4850-544=4306 GNP Domestic absorption (i.e. C+I+G) 4850-4917= -67

Note : While calculating Domestic Absorption we have to consider gross investment

PROBLEMS
(88) C I Ms = = = 120+0.6Y 150-80i 300

Mt
Ma

=
=

0.3Y
120-160i

Required to compute : a. b. c. d. e. Equilibrium Interest Rate Equilibrium Income Consumption C, Investment (I) in the Economy Transaction Demand for Money (Mt) Speculative Demand for Money (Ma)

SOLUTIONS
(a) The equation of the IS curve is :
Y or Y or Y-0.6Y or Y = = = 120+0.6Y+150-80i 270+0.6Y-80i = 270-80i (i)

675-200i

The equation of the LM curve is MS = Md or 300 or Y = = 0.3Y + 120 160i 600+533.33i . (ii)

Putting the value of Y in equation (I), we have : 675-200i = 600+533.33i

or, 733.33i
or i =

=
75 733.33

75

or, i

0.10%

(b)

675-200x0.10

or, Y

655

(c)

Consumption

120+0.6x655

=
Investment = =

513
150-80x0.10 142

(d)

Mt

= =

0.3x655 196.50

(e)

Ma

= =

120-160i 104

(107)

The following relations have been estimated for an economy :

Savings function
Disposable income Tax Function

S
Yd T

=
= =

-50+0.2 Yd
Y-T 0.25Y

Investment demand function I


Government purchases G

=
= Mt=

200-10i
400 0.25Y 125-50i 250

Transactions demand for money

Speculative demand for money Ma = Supply of money Ms =

If the Government decides to increase its expenditure(G) by 135 1)Required to compute crowding out of private investment 2)If the government does not want to crowd out private investment by increasing money supply What will the required money supply be to meet this end

IS Curve

Savings function
Consumption function Y =

=
=

-50+0.2Yd
50+0.8Yd

C+I+G

=
= 0.40 Y Y = =

50+0.8 (Y-0.25Y) +200-10i+400


650+0.8Y 0.2Y 10i 650-10i 1625-25i .. IS Curve

LM Curve Demand for money = +Speculative demand

Transactions demand Mt

0.25Y + 125 50i

Supply of money Ms

250

When money market and goods market are in equilibrium IS = LM 1625-25i = 500+200i 1625-500 = 200i + 251 1125 1125=225i 225 =5

= Investment (I) = 200 10i = 200-(10*5) = 150 When the Government increases its expenditure by 135, IS curve will change but LM curve will remain unchanged. New IS curve of IS Y = 50+0.8 (Y-0.25Y) + 200-10i+(400+135) = 50+0.8Y 0.2Y +200-10i+535 0.4 Y = 785-10i

When money market and goods market are in equilibrium

Investment (I)
= =

200-10i

200-10(6.5) 135

Crowing out of private investment on account of increase in Government expenditure is = 150-135 =15

b)Investment will not be crowded out if money supply is maintained at 5%. This can happen only when LM Curve shifts to the right
IS curve after increase in Government expenditure is

Y=1962.5-25i
Substituting i=5% in the above equation Y=1837.5