Introduction To

Macro
Economics
 Macro Economics
• Macro economics is concerned with the
analysis of the behaviour of the economic
system in totality.
• Macro economics studies how the large
aggregates such as total employment,
national product or national income of an
economy and the general price level are
determined.
 Macro Economics
• In the short run, macroeconomics
determine the size of the national income
and employment and fluctuations in price.

• In the long run, macroeconomics

determines the increase in productive
capacity and national income.
 History of Macro Economics

• Classical Theory – Say’s Law

• Neo Classical Theory- Keynesian Law

 Classical Theory – Say’s Law
• Assumptions to Say’s law-
1. Say’s Law “ Supply creates its own demand”
2. Full employment of labour and capital always exists.
3. Even with the deficiency of aggregate demand the
prices and wages would change in such a way that
employment, output and national income would not
decline.
4. Factors which produce goods for supply in market get
rewards (rent, wages) for their contribution to the
production of goods produced.
5. Income earned become expenditure made on goods
and services.
6. In voluntary unemployment could not occur in capitalist
economies without the interference of trade unions.
Neo classical Theory- Keynes Theory
Assumptions to Keynes theory-
• The reduction in wages throughout the economy
will result in fall in income of working classes .
• This fall in income will result in decrease in
aggregate demand.
• The fall in aggregate demand will lower the
employment .
• Lack of aggregate demand equilibrium , level of
income and employment would be less than full
employment level in free market capitalist
economy. This causes involuntary
unemployment of labour and excess productive
capacity.
 Failure Of Theory
• Classical theory-
Classical theory does not give any solution
to involuntary unemployment.

• Neo classical theory-

Problems of stagflation, inflation were not
explained in the theory
 Scope of Macroeconomics
• Determination of National income
• General price level and Inflation
• Business cycle
• Stagflation
• Economic growth
• Balance of payment & exchange rate.
 National Income
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.

Meaning of national income-

► NI measures the market value of annual output in

monetary terms.

► For calculating NI accurately all goods and services

produced in any given year must be counted only once .

► National income= National Product= National expenditure

Circular flow of Income In
two sector economy
Labour , land , capital and enterprise

Factor payments

Business
Household
firms

Consumption expenditure

Flow of goods and services

 Circular flow of Income
• If the economy is considered to have only two agent –
Household and firm.

• Firms are required to produce goods. For production

firms require services of production Factors. Factors of
production are paid the rewards for their contribution
in the form of wages, rent, interest and profits. In
return the firms give goods to society . The household
then consumes the goods by paying the price for it.
Circular Money flow with
savings and investment

Factor payments

Financial Business
Household Markets firms

Consumption expenditure
Saving Investment Identity in
National Income accounts
• In calculation of national Income the
consumers who save and the business
firms who invest are identical or always
equal to investments.
• In a simple economy the value of output
produced which is denoted by “Y” is equal
to the value of output sold.Eq-1
Y =C+ I
• Where, C= consumption expenditure, I
=Investment expenditure
 Saving Investment Identity in
National Income accounts
• The unsold outputs leads to increase in the
inventories of goods and increase in inventory
of goods is treated as part of investments.
• National income can be represented in terms of
savings and consumption.Eq-2
Y =C+S
Thus from Eq-1,2- C+I= Y =C+S
Or subtracting Consumption from both sides-
I=S
Thus in two sector economy, savings= Investments
 Circular Money flow with
Government
• Total expenditure flow in the economy is the sum of
consumption expenditure (c), investment expenditure
(I)& Govt expenditure (G). Thus-
Total expenditure (E)=C+I+G…………….(i)
• Total Income (Y) received is allocated to Consumption
(c), Savings (S) & taxes (T ). Thus
Total Income (Y)= C+S+T ………………..(ii)
Since E=Y,
C+I+G= C+S+T or I+G= S+T ,
Or G-T=S-I
Circular Money flow with
Government

Government

Factor payments

Savings Financial Business

Household Markets firms
Investments

Consumption expenditure
 Circular Money flow in four
sector open economy
• National income= C+I+G+X (Where X is
net exports, X-M)
• Since NI can be either consumed, saved
or paid as taxes to government we have,
• C+I+G+X = C+S+T or
• I+G+X= S+T
• Thus sum of private investments (I), Govt.
expenditure (G)& net exports (X) is equal
to sum of savings and tax revenue.
 Government

Savings Financial Investments Business

Household Firms
Markets

Foreign
Countries
 CONCEPT OF NATIONAL INCOME AND
NATIONAL PRODUCT
• In two sector economy the NP= NI

Value Wages
of final +
Goods Rent
National = and =
+ = NATIONAL
product INCOME
Services Interest
produced +
profits
 CONCEPT OF NATIONAL INCOME AND
NATIONAL PRODUCT
• Other than two sector economy the NI is
not equal to National product.
• The reasons for the above said equation
is-
• No assumptions of depreciation fund
• No subsidy grants.
• No indirect taxes.
 Gross National Product
GNP has following components:
• Value of final consumer and services produced in a year and
consumed by household is denote by consumption (C)
• Value of new capital goods produced and addition to the inventories of
goods such as raw material, unfinished goods and consumer goods
produced but not sold during a year. This is called gross private
investment (I)
• Value of output of general government which is taken to be equal to
the value of purchases of goods and services by the Govt denoted by
(G)
• Net exports which is equal to exports minus imports denoted by (X)
• Net factor income from abroad.
 Net Factor Income
• Net factor income from abroad is the
difference between factor income received
from abroad by residents of parent
company for rendering factor services in
other countries on the one hand and the
factor incomes paid to the foreign
residents for factor services rendered by
them in the domestic territory on the other
hand.
 Net Factor Income
Net factor income earned from abroad has
three components.
• Net compensation of employees
• Net income from property i.e. rent, interest
and income from entrepreneurship (that is
profit and dividends)
• Net retained earnings of the resident
companies working in foreign countries.
 Gross Domestic Product
Gross Domestic Product is the money value
of all final goods and services produced by
Residents as well as non residents in the
domestic territory of a country but does not
include net factor income earned from abroad.
GDP= GNP- net factor Income from abroad
or

GDP = C+I + G+X

 Net National Product
• NNP or National income at market prices
is the market value of all goods and
services after providing depreciation.

NNP= GNP- Depreciation

 Net Income At Factor Cost

• National income or national income at

factor cost = NNP at market prices –
Indirect taxes + subsidies.
 Personal Income
• Personal Income is the sum of all incomes
actually recd by all individuals or
household during a given year.
• PI= NI – undistributed corporate profit-
social security contributions- corporate
taxes+ Transfer payments.
 Disposable Income
• DI= personal taxes – personal taxes.