MACROECONOMICS – I

SESSION 1:Introduction &

Output

INTEGRATED PROGRAMME IN
MANAGEMENT (IPM)
BATCH:2018-23 TERM:II
AY2018-19

What this course will do?

• First course on Macroeconomics

• Focus will be on providing
foundational knowledge about the
macro-economy in a closed economy
setup
• Introduce important definitions,
measurements and interaction of
aggregate variables such as output,
inflation, unemployment, money
supply, etc.
• Basic macroeconomic models: AD-AS and
IS-LM

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 Texts

• Macroeconomics, 2nd ed., E.

D’Souza [DS]
• Macroeconomics, 5th ed., G.
Hubbard and A. O’Brien [HO]
• Macroeconomics, 12th ed., R.
Dornbusch, S. Fischer, R.
Startz [DFS]

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Topics

• Module I: Definition and Measurement of

aggregate variables
• Module II: Aggregate macroeconomic
variables and markets
• Module III: Short-run fluctuations
• Module IV: Monetary and Fiscal Policy
and issues in macroeconomics

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 Evaluation

• Quiz -> 20%

• Mid-term -> 35%
• End-term -> 35%
• Class participation -> 10%

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Class etiquette

• All cell phones and laptops switched

off unless instructed
• Social networking outside the class!
No Whatsapp! No Facebook! No
Instagram! Etc.
• If late for class, settle in quietly
without disturbing the class
• If call is urgent, step out of class
• To participate in the discussion
raise hand

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 Micro and Macro

• Microeconomics The study of how

households and firms make
choices, their interaction in
markets, and how government
attempts to influence their
choices
• Macroeconomics The study of the
economy as a whole, aggregate
variables such as inflation,
unemployment, and economic growth
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Macroeconomics

• Business cycle: Alternating periods of

economic expansion and economic
recession
• Expansion: Period of a business cycle
during which total production and
total employment are increasing
• Recession: Period of a business cycle
during which total production and
total employment are decreasing
• Economic growth: The ability of an
economy to produce increasing
quantities of goods and services (g&s)

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 Measuring Total Production and
Output

Session Outline

• Gross Domestic Product (GDP)

• Measures of Total Production
• Other Measures of Total
Production and Total Income
• Real GDP versus Nominal GDP
• Issues with GDP as a Measure

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Measuring Total Production: GDP

• Gross Domestic Product (GDP):

The market value of all final

goods and services produced in a
country during a period of time,
typically one year.

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Measuring Total Production: GDP

• GDP is measured using Market

Values, and not quantities

• We measure production by taking

the value, in rupee/dollar
terms, of all the goods and
services produced

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 Measuring Total Production: GDP

• We measure production by taking

the value, in rupee/dollar
terms, of all goods and
services produced
• GDP excludes:
– Items produced and sold illicitly
– Items produced and consumed at
home that never enter the
marketplace

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Measuring Total Production: GDP

• Final good or service

A good or service purchased by
a final user

• Intermediate good or service

A good or service that is an
input into another good or service,
such as a tire on a truck

• To avoid double counting, we do not

include the value of intermediate
goods or services in calculating GDP

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Measuring Total Production: GDP

• GDP includes goods and services

produced in a country
• GDP includes only production
that take place during the
indicated time period
– Typically, year or quarter

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Measuring GDP: Approaches

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Measuring GDP: Expenditure Approach

The BEA (CSO) divides statistics on

GDP into four major categories of
expenditures:
• Consumption (C)
• Investment (I)
• Government purchases (G)
• Net exports (NX)

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Expenditure Approach: Consumption

• Spending by households on g&s

(also, called “Personal
Consumption Expenditures”)
• Consumption expenditure by
households are divided into:
– Expenditures on services, such as
medical care, education, and
haircuts
– Expenditures on nondurable goods,
such as food and clothing
– Expenditures on durable goods, such
as automobiles and furniture

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Expenditure Approach: Investment

• Spending by firms on new

factories, office buildings,
machinery, and additions to
inventories, plus spending by
households and firms on new
houses.
• Also, “Gross Private Domestic
Investment”

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Expenditure Approach: Investment

• Spending on investment, is divided

into three categories:
– Business fixed investment is spending
by firms on new factories, office
buildings, and machinery used to
produce other goods
– Residential investment is spending by
households and firms on new single-
family and multi-unit houses
– Changes in business inventories are
also included in investment

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Expenditure Approach: Government

• Government Consumption and

Gross Investment, or
“Government Purchases”
• Government purchases:
– Spending by federal/central,
state, and local governments
on g&s

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Expenditure Approach: Net Exports

• Net Exports of Goods and

Services, or “Net Exports”
• Add exports to expenditures to
include all spending on new g&s
domestically produced and
subtract imports from total
expenditures to exclude
spending that does not result
in this production

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 Expenditure Approach

• A simple equation sums up the

components of GDP:

𝑌 𝐶 𝐼 𝐺 𝑁𝑋

• The equation says: GDP (denoted

as Y) equals consumption (C) plus
investment (I) plus government
purchases (G) plus net exports
(NX)

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Measuring GDP: Value-Added

Value added: The market value a

firm adds to a product
An example:
1. Suppose a cotton farmer sells $1
of raw cotton to a textile mill
2. The textile mill weaves raw
cotton into fabric and sells to
a shirt company for $3
3. Shirt company sells the shirt to
a retailer for $15
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 Measuring GDP: Income Approach

• GDP can be calculated as the

sum of income payments to
households is sometimes
referred to as gross domestic
income (GDI)
• Income payments:
wage, interest, rent, profit

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Measuring GDP: Income Approach

• Wages include all compensation received

by employees, including fringe benefits
such as health insurance
• Interest is net interest received by
households, or the difference between
the interest received on savings
accounts, government bonds, and other
investments and the interest paid on car
loans, home mortgages, and other debts
• Rent is rent received by households
• Profits include the profits of sole
proprietorships, which are usually small
businesses, and the profits of
corporations
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Measuring GDP: Income Approach

Two other components (non-income expense

items) to be taken into account with
actual factor payments:

1. Indirect business taxes: Non-income

taxes paid by consumers when they buy
g&s

2. Depreciation: Portion of the current

year’s GDP that is used to replace
physical capital consumed in the
production process

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Other Measures of Total

Production and Total Income

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 Other Measures of Income

• Net Domestic Product (NDP):

An estimate of the amount of GDP after
accounting for capital goods’
depreciation

NDP = GDP – Depreciation

• Gross National Product (GNP):

It is the value of final goods and
services produced by residents of a
country, even if the production takes
place outside of the country

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Other Measures of Income

• Gross National Product:

It is the total income earned by a nation’s
permanent residents
1. GNP includes income that American/Indian
citizens earn abroad
2. GNP excludes income that foreigners earn in
the United States/India

• Net National Product:

Net National Product (NNP) is the total income
of a nation’s residents (GNP) minus losses from
depreciation (wear and tear on an economy’s
stock of equipment and structures)
NNP = GNP - Depreciation

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 Other Measures of Income
• National Income (NI):
It is the total income earned by a
nation’s residents in the
production of goods and services.
1. National income differs from
NNP by excluding indirect business
taxes and including business
subsidies
2. NNP and national income also
differ due to “statistical
discrepancy”

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Other Measures of Income

• Personal Income (PI):

It is the income that households
and non-corporate businesses
receive

• Disposable Personal Income (DPI):

It is the income that households
and non-corporate businesses have
left after taxes and other
obligations to the government

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 Real GDP versus Nominal GDP

Calculating Real GDP

• Nominal GDP: The value of final

goods and services evaluated at
current-year prices

• Real GDP: The value of final

goods and services evaluated at
base-year prices

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 Does GDP Measure What We Want
to Measure?

What does GDP leave out?

When the BEA calculates GDP, it does

not include two types of production:
• Production in the home
– Household production refers to g & s
people produce for themselves that are
not bought and sold in markets
• Production in the underground economy
– Underground economy : Buying and
selling of g & s that is concealed from
the government to avoid taxes or
regulations or because the goods and
services are illegal

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GDP as a Measure of Well-Being

• The value of leisure is not included

in GDP

• GDP is not adjusted for pollution or

other negative effects of production

• GDP is not adjusted for changes in

crime and other social problems

• GDP measures the size of the cake but

not how it is divided up!

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