S.

SIVA KUMAR

MACRO ECONOMICS
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MEANING OF MACRO ECONOMICS
Study of aggregate, covering the entire economy  also known as theory of income and employment  Concern with problem of unemployment, economic fluctuations, inflation and deflation, international trade and economic growth  Importance realized after great depression of 1929  Keynes named as depression born economist

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MAJOR ISSUES AND CONCERNS
Employment and unemployment  National income  Price level and inflation  Business cycle  Stagflation  Economic growth  Balance of payment and  Exchange rate

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change in wages and price  Keynes suggested – aggregate demand an aggregate supply  4 .EMPLOYMENT AND UNEMPLOYMENT What determines level of employment  What causes involuntary unemployment  Classical economist suggested .1.

 National income or GNP shows the performance of the economy and standard of living  In developing countries like India. resources.2. NATIONAL INCOME Value of final goods and services produced in a country in a year. human capital. technology etc.  5 . not only the aggregate demand determines level of national income but also the supply side factors like physical capital.

3. PRICE LEVEL AND INFLATION Continuous and constant increase in price of various goods and services in an economy  Too much of money chasing too few goods  Increase in price and level and fall in value of money  Classical economist viewed – quantity of money determine price level and inflation  Keynes – inflation is due to aggregate demand named demand pull inflation.  6 .

4. BUSINESS CYCLE Fluctuations in economic activities – output and employment  Boom and depression  Concern is causes of business cycle  Objective of macro policy is to achieve economic stability  7 .

STAGFLATION High unemployment and recession co-existed with high inflation  To explain this supply side economics emerged  Important issue in modern macro economics  8 .5.

6. human capital and progress in technology  Development of these requires savings and investment  9 . ECONOMIC GROWTH Means sustained increase in national income (GNP) or per capita income over a long period of time  Depends on availability of growth of physical capital.

BALANCE OF PAYMENT & EXCHANGE RATE Record of economic transactions of the residents of a country with the rest of the world during a period  May be surplus or deficit  Exchange rate is the rate at which a country‟s currency is exchange for foreign currencies  Instability in exchange rate is the major problem which leads to balance of payment problem  10 .7.

SCOPE AND IMPORTANCE To understand the working of the economy  In economic policies  In macro economic issues  In economic growth  In business cycle  In individual decision making  In Business decisions  11 .

WORKING OF THE ECONOMY Knowing main economic problems relating to income. general price etc  To analyze the effect of these  12 . output. employment.

ECONOMIC POLICIES To solve various economic problems like inflation and recession  Factors determining economic growth like saving and investment  Monetary and fiscal policies  13 .

inflation.  Such as unemployment.  14 .MACROECONOMIC ISSUES Macro economics is concerned with the study of issues and problems which affects well being of the people. instability of foreign exchange rate  Macro economics explains causes of such problems and formulating economic policies to tackle them.

 15 .ECONOMIC GROWTH Helps in raising standard of living  Solving problem relating to unemployment and poverty  Increase in rate of saving and investment and improvement in technology determine economic growth  Helps to explain factors which determine and what causes slowdown of economic growth.

BUSINESS CYCLE Biggest problem of macro economics  Fluctuation in economic activities  Macro economics helps in analysing the causes of business cycle  Providing remedies to check fluctuations with the help of monetary and fiscal policies  16 .

INDIVIDUAL DECISION MAKING Helps individuals take better decisions regarding.  How to protect from rising prices (inflation).  buying decision of assets (whether to buy or not to buy)  Helps to assess the impact of governments economic policies  17 .

BUSINESS DECISIONS Helps in solving business decision making  Forecasting future demand and investment decisions  To understand factors affect business firms like inflation and employment  18 .

National Income is a flow and not a stock. National income is the measure of aggregate money value of all goods and services produced by the nation in any given time period. 19 .NATIONAL INCOME      Means aggregate money income of a country during a definite period. A National Income estimate measures the volume of commodities and services turned out during a given period. usually a year. According to National Income Committee. counted without duplication „. National income measures the flow of goods and services in an economy. usually a year.

GROSS DOMESTIC PRODUCT (GDP) The GDP refers to the value of the goods and services produced with in the nation‟s geographical territory.  Gross Domestic Product is the money value of all final goods and resources produced by normal residents as well as non residents in the domestic territory of a country.  20 . irrespective of the ownership of the resources.

NET DOMESTIC PRODUCT (NDP) The total value of all final goods and services produced in an economy during a particular year minus depreciation allowances is called NDP.  NDP = GDP – depreciation or CCA  21 .

income received from foreign investment and from other services rendered abroad (=X).e. GNP = GDP +X –M 22 . Again we must deduct from Gross domestic product (GDP). the amount of the same country i.GROSS NATIONAL PRODUCT (GNP)    We must add with the gross domestic product (GDP). the amount of income generated by foreign nation within the country(-M).

which is known as capital consumption allowance or depreciation charges. NNP = GNP – CCA or Depreciation 23 . machinery.NET NATIONAL PRODUCT (NNP)       While producing the gross national product of a year. the capital stock of the country. It is also known as national income at market prices. equipments etc is being used or consumed in the production process. the capital goods of the country wear out or depreciate in its value due to its use In order to arrive at the actual output we must deduct the amount of capital consumed in the production process from the gross national product. i. NNP we mean the market value of all final goods and services after making provision for capital consumption allowance or depreciation.e.

NATIONAL INCOME AT FACTOR COST (NI) The total income received by land. capital and organization (factors of production) in one year is called the national income at factor cost. subsidies should be added to and indirect taxes are to be subtracted from NNP. labour.  NIfc = NNP .  To obtain income at factor cost.indirect taxes + subsidies  24 .

 PCI = NI of India in 2011 / Population of India.PER-CAPITA INCOME (PCI) When the national income is divided by the total population of the country.  Therefore.  25 . it is known as percapita income or average income per head. the per capital income of India for the year 2011 can be estimated by.

PERSONAL INCOME (PI)
Personal income denotes the aggregate money payments received by the individuals or household in the county during one year.  PI = NI – undistributed corporate profits – social security contribution + Transfer payments.

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DISPOSABLE INCOME (DI)
Disposable income is the income left with the people to meet their personal expenditure after the payment of personal direct taxes.  Entire amount of disposable Income is not spent on consumption. A portion of it is saved.  DI = PI – personal direct taxes

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MEASUREMENT OF NATIONAL INCOME

National income

Net product method Output method Net income method Value added method

Net expenditure method

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forestry and logging. fishery. livestock.NET PRODUCT METHOD Contribution of GDP from various sectors like agriculture. mining and quarrying is estimated  Estimate the gross value of product. biproducts and ancillary activities  Deduct the value of inputs (raw materials and services) from gross value  In respect of industrial activities the computation of GDP are done only for the manufacturing industrial units  29 .

service sector is estimated  Process involves the measurement of aggregate factor income in the form of wages and salaries.e. interest. profits and dividends  Small enterprises (total number of workers employed X their average earnings)  Banking and insurance (balance sheet)  House property (imputed value of net rental)  Finally. by adding up the contribution of all different sectors to national income of the country  30 . rent.NET INCOME METHOD Income from rest of sectors i..

Private Consumption Expenditure (C) + Gross Domestic Private Investment (I) + Net Foreign Investment (X.M) + Government Expenditure on goods and services (G) = C+I+(X-M)+G.  31 .NET EXPENDITURE METHOD GNP is the sum total of expenditure incurred on goods and services during one year in a country  It includes.

SLOW GROWTH OF NATIONAL INCOME High growth rate of population  Excessive dependence on Agriculture  Occupational structure  Low level of technology  Poor industrial development  Poor infrastructural facilities  Poor rate of saving and investment  Socio-political conditions  32 .

LIMITATIONS OR DIFFICULTIES Non-monetized sector  Non-availability of information  Lack of reliable data  Unreported illegal income  Difficulty in the classification of working population  33 .

CIRCULAR FLOW OF INCOME INTRODUCTION Refers to process whereby the national income and expenditure of an economy flow in a circular manner.  Modern economy is a money economy – facilitates process of exchange.  34 .  There is a flow of money corresponding to flow of economic resources and the flow of goods and services.

TWO SECTOR ECONOMY        Household sector and business sector Household owns factors of production Business sector produces goods In product market – household sector purchases goods and services from business sector. In factor market – household sector receives income by selling services Thus payment flow from one to another These two flows give GNP = GNI 35 .

Leakages Firms obtain investment funds from capital market – i..CONT…       With saving and investment Capital market coordinates saving and investment activities of the household and the business firms.e. injection Equals saving and investment 36 ..e.TWO SECTOR ECONOMY . Inflows and leakages in an economy Household supply saving to capital market – i.

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unemployment relief. are injection to an economy 38 .THREE SECTOR MODEL       Including government sector along with household and business sector Government impose taxes and spend money on public Taxation is a leakage and expenditure is injection to an economy Circular flow between household and the government Taxes in the form of income tax and commodity taxes are leakages Transfer payment by the government like old age pension. sickness benefit.

THREE SECTOR MODEL.CONT…        Circular flow between business sector and the government Taxes paid by business sector – leakages Government purchases. subsidies and transfer payments – injection in to the economy All three sectors together – circular flow of income and expenditure remain in equilibrium Household expenditure in the form of taxation is compensated in the form of transfer payment Business expenditure in the form of taxation is compensated by government purchase and payments Thus equals income and expenditure in an economy 39 .

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FOUR SECTOR MODEL         Including foreign sector along with household.creates income to domestic firm leakages – Imports from other countries – expenditure on household sector Flow between household and foreign sector Household sector – buy imported goods and makes paymentleakage from circular flow Receives transfer payment for service rendered . business and government sector Also called balance of payment sector There are injections and leakages injection – Exports from the country .injection 41 .

machinery. raw materials.leakages from circular flow Flow between government and foreign sector Government – exports goods and services. lend money and receives payment from abroad – injection Imports and borrows from foreign sector and makes payment – leakages Equation Y=C+I+G. which shows equilibrium condition among all sectors in an economy 42 . .FOUR SECTOR MODEL – CONT…        Flow between business sector and foreign sector Business sector – exports goods and receive payment – injection to circular flow Imports capital goods.

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Represented as C = f(Y) It measures not only the amount spent on consumption but also the amount saved. It is an increasing function of income When income is zero during depression. people spend out of their past savings on consumption because they must eat in order to live. 44 . It indicates a functional relationship between C and Y.CONSUMPTION FUNCTION       Consumption function or propensity consume refers to income consumption relationship.

APC decline as income increases because the proportion of income spent on consumption decreases. It is found by dividing consumption expenditure by income i. APC = C/Y It is expressed as the percentage or proportion of income consumed..e. 45 .AVERAGE PROPENSITY TO CONSUME      It is the ratio of consumption expenditure to any particular level of income.

APS = S/Y APS increases with increase in income 46 .AVERAGE PROPENSITY TO SAVE     It describes the relationship between income an saving. It is the proportion of disposable income that is saved.

MARGINAL PROPENSITY TO CONSUME       MPC is the rate of change in APC When income increases. MPC = change in C / change in Y 47 . Keynes concerned mainly with MPC MPC is lower in the case of rich people and high in the case of the poor MPC is lower in advanced countries and high in underdeveloped countries . the MPC falls but more than the APC.

Is the change in saving induced by a change in the disposable income. MPS = change in S / change in Y 48 .MARGINAL PROPENSITY TO SAVE    MPS represents how much of the additional disposable income is devoted to saving.

DETERMINANTS OF CONSUMPTION FUNCTION         Changes in general price level Fiscal policy Rate of interest Stock of wealth Availability of Credit Income distribution Windfall gains and losses Change in expectations 49 .

buildings etc. It means making an addition to the stock of goods in existence 50 . roads.INVESTMENT FUNCTION    Investment refers to real investment which adds to capital equipment. Includes new plant and equipment. construction of public works like dams.

TYPES OF INVESTMENT  Induced investment  Is profit or income motivated  It is income elastic  Demand also determines 51 .

weather changes war. growth of population an labour force. social and legal institutions.TYPES OF INVESTMENT • Autonomous investment  It is independent of the level of income  It is income inelastic  Influenced by innovations.  Not influenced by change in demand  Investment in social and economic overheads by government or the private enterprise is autonomous 52 . researches. inventions. revolution etc.

FACTORS INFLUENCING INVESTMENT          Level of income Consumer demand Liquid assets Inventions and innovations New products Growth of population State policy Political climate Existing stock of capital goods 53 .

EFFECTIVE DEMAND    Effective demand represents that aggregate demand or total spending (consumption expenditure and investment expenditure) which matches with aggregate supply (national income at factor cost). In other words. 54 . This equilibrium position (effective demand) indicates that the entrepreneurs neither have a tendency to increase production nor a tendency to decrease production. it is the signification of the equilibrium between aggregate demand (C+I) and aggregate supply (C+S).

firms and the government is undertaking on consumption and investment in an economy. depends directly on the level of real national income and indirectly on the level of employment. thus. The aggregate demand price is the amount of money which the entrepreneurs expect to receive as a result of the sale of output produced by the employment of certain number of workers. The aggregate demand (C+l).AGGREGATE DEMAND      Aggregate demand refers to the sum of expenditure. households. thereby increasing of aggregate demand (C+l) for goods. the level of output also increases. The aggregate demand curve AD (C+I) would be positively sloping signifying that as the level of employment increases. An increase in the level of employment raises the expected proceeds and a decrease in the level of employment lowers it. 55 .

The aggregate supply curve.AGGREGATE SUPPLY       The aggregate supply refers to the flow of output produced by the employment of workers in an economy during a short period. In other words. thereby. the aggregate supply (C+S) depends upon the level of employment through the economy's aggregate production function. 56 . the aggregate supply is the value of final output valued at factor cost. The aggregate supply price is the minimum amount of money which the entrepreneurs must receive to cover the costs of output produced by the employment of certain number of workers. The aggregate supply is denoted by (OS) because a part of this is consumed (C) and the other part is saved (S) in the form of inventories of unsold output. increasing the aggregate. the level of output also increases. Thus. (C+S) is positively sloped indicating that as the level of employment increases. supply.

the level of employment also decreases. As a result. When effective demand falls. As effective demand increases employment also increases. According to the concept of effective demand whatever is produced in the economy is not automatically consumed. the gap between income and expenditure is large. The principle of effective demand makes clear that in a rich community.IMPORTANCE OF EFFECTIVE DEMAND     Determinant of employment. unless investment expands. Say's Law falsified. Role of investment. 57 . It is partly saved. If required investment is not made to fill this gap. The employment cannot expand. it will lead to deficiency of effective demand resulting in unemployment. the existence of full employment is not possible. Capitalistic economy.

The equilibrium level of income determined by the equality of AD and AS does not necessarily indicate the full employment level. The equilibrium position between aggregate demand and aggregate supply can be below or above the level of full employment as is shown in the curve below.DETERMINATION OF EMPLOYMENT AND INCOME    According to Keynes. the equilibrium levels of national income and employment are determined by the interaction of aggregate demand curve (AD) and aggregate supply curve (AS). 58 .

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intersects the aggregate supply curve (OS) at point E1 which is an effective demand point. the aggregate demand curve (C+l). The OY is now the new equilibrium level of income along with full employment. We further assume that due to spending by the government. At point E1. the equilibrium of national income is OY1. 60 . the economy moves from lower equilibrium point E1 to higher equilibrium point E2. Thus E2 denotes full employment equilibrium position of the economy.DETERMINATION OF EMPLOYMENT AND INCOME      In figure. the aggregate demand curve (C+I+G) rises As a result of this.

and vice versa.e. change in Y = K change in I. 61 . income will increase by an amount which is K times the increment of investment – i.THE CONCEPT OF MULTIPLIER        First developed by R. Khan named employment multiplier. Relating to an increment of investment to an increment of income. The value of multiplier is determined by the MPC. higher the value of multiplier.F. The relationship between the multiplier and MPC is – K=1/1-c. When there is an increment of investment.. Higher the MPC. Keynes took the idea and developed investment multiplier.

IMPORTANCE OF MULTIPLIER       Investment: Trade cycle: Saving and investment equality: To achieve full employment: Public investment: Deficit financing: 62 .

IMPORTANCE OF MULTIPLIER       Investment: Importance in income and employment theory. Trade cycle: Fall in investment leads to fall in income and employment . An increase in investment leads to revival and boom. A fall in investment leads to cumulative decline in income and employment by the multiplier process and vice versa. 63 . leading to recession and depression.

64 . If there is a divergence. To achieve full employment: How much investment to be injected to remove unemployment. an increase in investment leads to rise in income via multiplier process and brings equality between saving and investment. If single dose of investment is insufficient.IMPORTANCE OF MULTIPLIER       Saving and investment equality: Helps in bringing equality between saving and investment. then state can inject regular doses of investment till full employment is reached.

65 . Deficit financing: Highlights the importance of deficit budgeting During depression. deflationary pressure and achieving and maintaining full employment.IMPORTANCE OF MULTIPLIER       Public investment: Refers to state investment on public works to increase public welfare. To overcome inflationary. increase in public expenditure through public investment helps in increasing income an employment by multiplier times the increase in investment.

LEAKAGES OF MULTIPLIER          Savings Strong liquidity preference Purchase of old stocks an securities Debt cancellation Price inflation Net imports Undistributed profits Taxation Excess stock of consumption goods 66 .

LEAKAGES OF MULTIPLIER       Savings : higher the propensity to save. leads to leakage from income stream. Strong liquidity preference: For transaction. 67 . consumption expenditure will fall and its cumulative effect on income. Purchase of old stocks an securities: If increased income is used in buying old stocks and securities instead of consumer goods. smaller the size of multiplier and greeter the amount of leakage out of the income stream an vice versa. precautionary and speculative motives.

real consumption and income fall.LEAKAGES OF MULTIPLIER        Debt cancellation: If part of income is used to repay debts to banks instead of spending it for further consumption – there is a leakage from income stream. Price inflation: A rise in prices of consumption goods implies increased expenditure on them. affect the consumption of domestic goods. Net imports: Increased income spent on purchase of imported goods. 68 . As a result.

LEAKAGES OF MULTIPLIER       Undistributed profits: Undistributed profits of joint stock companies reduces income and expenditure on consumption. 69 . reduces income and consumption and weakens multiplier effect. Taxation: Increased taxation both income and commodity tax. multiplier process will come to a halt. Excess stock of consumption goods: Consumption requirements are met out of old stocks. thereby weakens multiplier process.

ACCELERATION AN INTRODUCTION     T. Based on the fact that the demand for capital goods is derived from the demand for consumer goods which the former help to produce.N. Carver – earliest economist who recognized the relationship between changes in consumption and the net investment in 1903. 70 . Further developed by Hicks. Clark in 1917.M. Samuelson and Harrod in relation to the business cycles. Acceleration principle first introduced by J.

According to Kurilara.MEANING OF ACCELERATION    It explains the process by which an increase or decrease in the demand for consumption goods leads to an increase or decrease in investment on capital goods. Symbolically. v = change in I / change in C 71 . “ the accelerator coefficient is the ratio between induced investment and an initial change in consumption expenditure”.

It is worked out by combing both induced consumption (MPC) and induced investment (MPI). Also called as leverage effect. In order to measure the total effect of initial investment on income. 72 . Leads to very high or low level of income propagation in the economy. It is the combination of multiplier and accelerator .SUPER MULTIPLIER       Introduced by Hicks.

SUPER MULTIPLIER It tells us that if there is an initial increase in autonomous investment. income will increase by Ks times the autonomous investment.  Ks = 1/1-c-v = 1/s-v  73 .

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