Segment: Macroeonomics

Topic: Macroeconomics and Some of its Measures

Macroeconomics and Some of its Measures

Table of Contents

1. Macroeconomic Ratios ........................................................................................................... 4

2. Index Numbers ........................................................................................................................ 8
3. National Income Deflators .................................................................................................... 12
4. Summary ................................................................................................................................ 13
5. Glossary .................................................................................................................................. 14

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Macroeconomics and Some of its Measures

Introduction

In the previous topic, we studied about the basic concepts of macroeconomics. This topic
covers macroeconomic ratios, index numbers and National income deflators.

Learning Objectives

At the end of this topic, you will be able to:

• define important macroeconomic ratios and examine their relevance

• explain index numbers and its practical importance

• describe national income deflators

• judge how macroeconomic measures explain the state of the economy.

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Macroeconomics and Some of its Measures

1. Macroeconomic Ratios
In this section, let us try to understand some of the important macroeconomic ratios. There
are several macroeconomic ratios and an attempt is made to explain twelve such
macroeconomic ratios. For a business firm, the knowledge of these macroeconomic ratios is
indispensable for taking microeconomic decisions.
Consumption income ratio
Y= C + S. Out of a given income (Y); people can either spend or save (S), or they can
consume (C) their entire income. Hence, C = Y – S.
The consumption income ratio explains the relationship between two variables, i.e., the
amount of income and the amount of consumption.
1. In other words, it tells us about the percentage of consumption out of a given level of
income.
This can be expressed as C = f [Y] where C = consumption, Y = income and f = function.
Consumption is an increasing function of income. Higher the income, higher would be the
consumption and vice-versa. There is a direct relationship between the two. For example, out
of Rs. 100, a person can consume Rs. 80, and save Rs 20. In this case, the consumption income
ratio is 1:0.8. This ratio helps business personnel to forecast his/her sales in the market.
2. Saving income ratio
Excess of income over expenditure is saving. The saving function can be easily derived by
subtracting spending from income. Hence, S = Y – C
where S = saving, Y = income and C = consumption. It is a function of income.
S = f [Y]. It implies that there is a direct relationship between the two. Higher the income,
higher would be the savings and vice-versa. The saving-income ratio indicates the amount of
savings made out of a given level of income. In the above example, saving income ratio is 1:0.2.
The consumption income ratio and saving income ratio enable a business to plan its production
schedule and derive sales forecasts.
3. Capital output ratio
There is a close relationship between capital investment and income-growth in any economy.
Capital is regarded as the lifeblood of all economic activities and as such, it constitutes a major

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Macroeconomics and Some of its Measures

determinant of economic growth rate in an economy. The volume of investment generally

determines the rate of growth in the real income of the people in an economy.
The concept of capital output ratio explains the relationship between the value of capital
investment and the value of output. It is a ratio of increase in output or real income to an
increase in capital. The Capital Output Ratio (COR) may be defined as “the ratio of investment
in a given economy or industry for a given time period to the output of that economy or
industry for a similar time period”. It refers to the amount of capital required to produce a unit
of output. When we say that COR is 4:1, it implies that a capital investment of Rs. 4 is required
to produce an output of Rs. 1. It is to be noted that COR would differ from one sector to
another and even from one industry to another. Generally, it would be higher in the case of
capital goods industries, and in industries using capital intensive techniques of production, and
lower in the case of consumer goods industries and industries using labour intensive
techniques of production. COR depends on several factors. However, a decrease in COR is an
indication of economic efficiency and progress of an economy.
4. Capital labour ratio
This ratio indicates the proportion of two factor inputs. It tells us the ratio between the
numbers of labourers required for a given amount of capital invested in any business. This
ratio is useful to work out the least cost combination by substituting one factor input to
another. This ratio can be expressed as

5. Output-labour ratio
The term productivity in general is defined as a ratio of what comes out of a business to what
goes in to the business, i.e., it is the ratio of ‘outcome’ to the ‘efforts’ of the business. Hence,
productivity would mean the value of output divided by the value of inputs employed. There
are different kinds of productivity ratios.
Output labour ratio expresses the relationship between the quantity of output produced and
the number of labourers employed for a specific time period. It indicates productivity of
labour. It can be obtained from dividing total output by the number of labourers employed.
Hence,

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Macroeconomics and Some of its Measures

This ratio widely varies from industry to industry. Labour productivity depends on a number of
factors like; capital endowment of labour, quality of labour, organisation of work, hours of
work, incentives to work, methods of payments, industrial climate, quality of management and
quality of raw materials used, etc. Increase in labour productivity implies increase of the ratio
of output to labour. The knowledge of this ratio would help the management of an
organisation to employ the right types of labour in the right quantity.
6. Input- output ratio
This ratio explains the relationship between two variables of inputs and outputs. Input-output
ratio indicates the quantity of inputs employed and the quantity of outputs obtained. It is also
called as production function in economics. Production is purely physical in nature and as such,
the ratio between inputs and outputs is determined by technology, availability of equipment,
labour, materials, etc. It can be expressed in the form of a mathematical equation.
Q = f [ L,N,K -------- etc] where Q = quantity of output per unit of time and, L,N,K etc are
different factor inputs like land, capital, labour, etc which are used in the production process.
Thus, the rate of output is a function of the factor inputs L,N,K etc, employed by the firm per
unit of time. The knowledge of production function would help a producer to work out the
most ideal combinations to maximise output and minimise cost.
7. Value added output ratio
Value added output is the difference between the value of output produced and the value of
inputs employed. In other words, it is a ratio of increase in the quantity of inputs employed
and the corresponding increase in the output obtained. It is very much necessary to find out
the difference between the value of inputs used and the output obtained. This will help in
deciding whether to increase the employment of additional factor input units in the production
process.
8. Cash reserve ratio
A commercial bank mobilises deposits from the general public and the entire amount of
deposits is not kept in the form of cash. An experienced banker knows that all depositors will
not withdraw their entire deposits on the same day at the same time. Hence, only a fraction of

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Macroeconomics and Some of its Measures

total deposits is kept in the form of liquid cash to honour the cheques drawn on demand
deposit by the customers. The remaining excess deposits are used for lending and investment
purposes by the bank.
Thus, each commercial bank, with a view to make profits, follows a customary cash reserve
ratio for the sake of liquidity and safety. The percentage of total deposits which the bank is
required to hold in the form of cash reserves for meeting the depositors’ demand for cash is
called cash reserve ratio. Thus, CRR indicates the ratio between the liquid cash with that of the
total deposits of the bank. For example, if CRR is 20%, in that case for every Rs.100 of deposits
collected, the bank has to keep Rs.20 as cash reserves requirement.
9. Cash income ratio
A bank is a commercial institution based on business principles. Its main objective is to make
profits. This depends on its portfolio management. A bank has to keep adequate amount of
cash in order to meet the requirements of its customers. How much deposits it will keep in the
form of liquid cash and how much money it will lend and invest on various assets will depend
on its CRR. This ratio helps the banker to know the income earning capacity during a financial
year. The cash - income ratio tells us the amount of cash, held by a bank in liquid form and the
percentage of income earned during an accounting year through its investments. This ratio
gives us information about the income–earning capacity of an institution during an accounting
year.
10. Labour’s share of income
Production is the result of combined and cooperative efforts put in by all the factors of
production in the production process. All factors of production which are involved in this
process of production are entitled to enjoy their respective rewards in the form of rent, wages,
interest and profits. If we add all factor incomes, we derive national income at factor cost.
Hence, NI at factor cost = a sum of total rent + total wages + total interest + total profits. For
example, if national income is Rs. 1000; the share of rent could be Rs. 200-00, the share of
wages at Rs. 300, the share of capital at Rs. 150 and the share of profit could be Rs. 350.
The labour’s share of income indicated by the percentage of income earned by labourers, in
the form of wages out of the total national income is called as labour’s share of income. In the
above example, the share of labourers’ income is Rs. 300. This ratio gives information about

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Macroeconomics and Some of its Measures

the contribution made by workers, in the generation of total national income of the country
and it indicates various levels of wages and their living standards.
11. Capital’s share of income
Capital is a very powerful and important input in the production process. Capital is described as
the lifeblood of all economic activities. Without adequate capital, no economic activity can be
undertaken. Capital as a factor of production is earning interest as its income in the total
national income generation.
Capital’s share of income indicated, by the percentage of income earned by capital in the form
of interest, out of total national income is called as capital’s share of income. In the above
example, the share of capital in total income is Rs. 150. This ratio gives information about the
contribution made by capital in the generation of total national income of the country. Also, it
indicates the level of interest rate and the ability of capitalists to earn their income.
12. Land’s share of income
Land is one of the primary factors of production. It is a free gift of nature. It is an immovable
factor input. The landlord supplies this factor input and earns income in the form of rent.
Land’s share of income indicated, by the percentage of income earned by the landlord in the
form of rent, out of total national income is called as land’s share of income. In the above
example, the share of land’s income is Rs. 200.This ratio gives information about the
contribution made by the landlord in the generation of total national income of the country.
Also, it indicates the level of rent and the ability of the landlords to earn their income.

2. Index Numbers
The days of barter are gone. We are living in a monetary economy where every thing is
measured in terms of money. It is to be noted that money by its substance is quite value less or
worthless. Its value to its possessor arises out of its acceptability as a means of payment. Its
value to its possessors lies in its capacity to purchase other goods and services which are useful
in themselves. Thus, the value of money and the purchasing power of money is derivative.
In a monetary economy, the exchange value of everything is measured by its price expressed in
terms of money. The purchasing power of money depends on the level of prices of goods and
services to be purchased. The lower the price level, the greater would be the value of money

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Macroeconomics and Some of its Measures

and the higher the price level, the lower would be the value of money. There is an inverse
relationship between the two. The value of money is thus inversely related with the general
price level. It is to be noted that prices of all goods and services do not change in a uniform
manner. Price of some goods may rise while price of some other goods may fall. In order to
bring an element of uniformity to price change, the concept of general price level is used.
Index numbers explain this concept.
The value of everything is measured in terms of money because money acts as a measuring
rod or measure of value. However, the value of money cannot be measured in terms of money
itself. Hence, economists have developed index numbers to measure the changes in the value
of money over a period of time.
When a number of commodities and their prices at two different periods are arranged in a
tabular form, it is called as an index schedule. Index number is a statistical measure by which
changes in the prices of the same articles at different periods are calculated and computed. It
is to be remembered that index number helps us to measure only the extent by which the
value of money has changed between two different periods of time and not the value money
itself.
There are different kinds of index numbers. Some of them are: wholesale price index,
consumer or retail price index, cost of living index, wage index numbers, industrial index
numbers, etc. Out of them, the most important ones are:
• Consumer price index (CPI)
• Wholesale price index (WPI).
Consumer price index (CPI) – In this case, we include the prices of a basket of consumption
goods and services. Generally speaking, goods and services which are commonly consumed are
included in this basket. The goods and services consumed by consumers widely differ from
group to group and place to place. It also varies as tastes and preferences of consumers
change. In order to measure the changes in prices of consumer goods and services, we take
into account prices existing at the base year and the prices in the current year. The formula to
calculate CPI is as follows-

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Macroeconomics and Some of its Measures

The consumption basket data comes from family budget surveys conducted from time to time
and price data are taken from retail outlets. The base year is changed every few years in order
to take into account changes in consumption habits, prices, etc in the market. Such updating is
required so that the usefulness is not lost.
In a simple model index number, we have assumed a total weightage of 20 units and each
commodity is given a certain weight according to its influence or importance. To get the index,
the actual price in the base year is reduced to 100, which is multiplied by the approximate
weight. For example, the price of rice in the base year is Rs.50 per quintal. The weight assigned
to rice is 8, so the index for 1960 will be equivalent to 100 x 8= 800. Similarly, the index
numbers for other items is calculated. The simple arithmetic average is used to calculate the
index. In 1976, the price of rice is Rs.125 i.e. two and half times the 1960’s price. If the 1960’s
price is 100, then the 1976’s price is equal to Rs.250. This is multiplied by the weight to get the
index for 1976.
Between 1960 and 1976, the price level has risen by 2.2 times. To state the same thing in a
different manner, what Rs.100 could buy in 1960, Rs 220 can buy in 1976. In 1976, the
purchasing power of money or the value of money has fallen to 45.5% or (100/200 X100) as
compared to 1960.
Thus, the fluctuations in prices or the degrees of inflation are measured with the help of index
number of prices. Table 1 shows a model of weighted price index number.

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Macroeconomics and Some of its Measures

Table 1: A Model of Weighted Price Index Number

Whole sale price index [WPI] – These index numbers are constructed on the basis of the
wholesale prices of certain important commodities. The items included in WPI are totally
different from those included in CPI. The items included are fertilisers, industrial raw materials,
minerals, semi- finished goods, machineries, etc. It is an index of prices paid by producers for
their inputs. Wholesale prices are published by various government agencies at regular
intervals and are collected for the purpose of calculating variations in their prices for different
periods. The method of calculating WPI is same as that of the CPI.
Practical importance of index numbers
• They help us to measure the level of changes in prices and the value of money over a period
of time.
• They help us to measure the degree of inflation and deflation which enable the government
to come out with suitable price stabilisation policies.

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Macroeconomics and Some of its Measures

• They help us to know the extent of changes, in the cost of living of different sections of
people and thus help the government, to adjust the wages and salaries of workers and avoid
strikes and lockouts.
• They help us to know the purchasing power of two currencies and thus help in the
determination of exchange rates of the currencies of two countries.
• They also help us to know the economic progress achieved in different sectors of the
economy through economic planning.

3. National Income Deflators

National income of a country can be either calculated in terms of Nominal GNP or Real GNP. If
we calculate GNP at current market prices, it is called as Nominal GNP and if we measure GNP
at constant prices, i.e., prices prevailing at the base year, it is described as Real GNP. In
economics, we give importance to Real GNP rather than Nominal GNP. This is because, GNP at
current prices depicts a misleading picture of economic performance when prices are
continuously rising or falling. For example, if prices are rising and the gross national output is
remaining the same; the nominal GNP represents an inflated estimate of the national income
and creates a sense of false economic growth in the country. In order to avoid this kind of
misleading estimates of national income; the economists use a simple adjustment factor called
GNP Deflator or National Income Deflator, to eliminate the effect of rising prices on the GNP
and to work out Real GNP at the price level of the base year.
The GNP Deflator acts as an adjustment factor which is used to convert nominal GNP into Real
GNP. The GNP Deflator is the ratio of price index number [PIN] of a chosen year to the price
index number of the base year [PIN of the base year = 100]. Hence,

We can calculate the Real GNP by dividing nominal GNP by the GNP Deflator. This can be
expressed in the following formula -

where PINcy is the price index number of the chosen year.

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Macroeconomics and Some of its Measures

Application of GNP Deflator

In order to estimate the Real GNP for the year 2005 and 2006, we can make use of the GNP
Deflator.
Nominal GNP for the year 2005-06 = Rs. 15, 00,000 WPI for the same year = 120
Base year PIN = 100.

Given the data, GNP Deflator for the year 2005-06 =

1.2 is the GNP Deflator for the 2005-06. We can now calculate real GNP for 2005-06 as follows:
Real GNP for 2005-06 = Rs 12,50,000
Deflator can also be calculated for GDP, NDP or NNP, etc.
Activity:
Examine changes in India’s National Income aggregates overtime. Analyse in terms of growth rates,
contributing factors and other dimentions.
(Hint: Time series data on National Income aggregates and related analysis is available in economic
survey of Government of India.

4. Summary
Here is a quick recap of what we have learnt so far:

• Macroeconomic concepts and macroeconomic ratios help, business managers to

understand the relationship between different macroeconomic variables and their
application in day-to-day business.
• Index numbers help us, to measure the degree of price changes or inflation, and deflation,
and point out the different price stabilisation policies to be taken by the government in
advance.
• National Income Deflator helps us to know the actual value of either GDP or GNP during a
given period of time.
• All these concepts help in business planning and business forecasting and to take
appropriate decisions well in advance.

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Macroeconomics and Some of its Measures

5. Glossary
Capital labour ratio It tells us the ratio between the numbers of labourers required for a
given amount of capital invested in any business.
Capital output It explains the relationship between the value of capital investment
ratio and the value of output
Capital’s share of Percentage of income earned by capital in the form of interest out of
income total national income.
Cash - income ratio It tells us the amount of cash held by a bank in liquid form and the
percentage of income earned during an accounting year through its
investments.
Cash reserve ratio The percentage of total deposits which the bank is required to hold
in the form of cash reserves for meeting the depositors’ demand for
cash.
Consumption It explains the relationship between the amount of income and the
income ratio amount of consumption.
GNP deflator An adjustment factor which is used to convert nominal GNP into Real
GNP
Index number A statistical measure by which changes in prices of the same articles
at different periods are calculated and computed.
Input-output ratio It indicates the quantity of inputs employed and the quantity of outputs
obtained
Labour’s share of Percentage of income earned by labourers in the form of wages out of total
income national income.
Land’s share of Percentage of income earned by the landlord in the form of rent out of
income total national income.
Output labour ratio It expresses the relationship between the quantity of output produced and
the number of labourers employed for a specific time period.
Saving-income ratio It indicates the amount of savings made out of a given level of income.
Value added output It is a ratio of increase in the quantity of inputs employed and the
ratio corresponding increase in the output obtained

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Macroeconomics and Some of its Measures

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