Macro economics introduction

T.J. Joseph: 

T.J. Joseph Introduction to Macroeconomics

Contents: 

Contents National Income Accounting Aggregate Demand and Aggregate Supply Macroeconomic Equilibrium Money and Banking Integration of Goods and Money Markets (IS-LM) Fiscal and Monetary Policies Business Cycles Inflation and Unemployment International Trade and Balance of Payments

Distribution of Marks: 

Distribution of Marks Component Marks Group Assignment 05 Presentations 10 News Analysis and Class participation 10 Attendance 05 Mid-Term Examination 20 End-term Examination 50 TOTAL 100

Introduction: 

Introduction Managers have to cope with economic environment at two levels ( i ) Firm level (Microeconomics) Depend on market structure: More competitive market → less influence on price → reduce cost or differentiate product (ii) Macro level (Macroeconomics) Assumption of stability in demand, prices, interest rates, wages, taxes, and exchange rates.

Why to study Macroeconomics?: 

Why to study Macroeconomics? To understand the functioning of an economy What causes fluctuations in demand? What leads to instability in interest rates, prices (inflation rates), exchange rates? To understand the direction of govt. policies To take a decision on timing of fresh investments, takeovers, enter new markets, etc. To get best return on investment

Macroeconomic – An Introduction: 

Macroeconomic – An Introduction Macroeconomics – study of the behavior and performance of the economy as a whole Study of factors or forces determining the level and growth of macroeconomic aggregates Macroeconomic aggregates (macroeconomic variables) – output, income, employment , price level, balance of payment positions, etc . Aggregate behavior refers to the behavior of all households and firms together.

Concepts in Macroeconomic Analysis: 

Concepts in Macroeconomic Analysis Stock and Flow Variables Stock : quantity of a variable at a point in time Eg : Capital stock, money supply, unemployment level, foreign exchange reserve, etc. Flow: quantity expressed for a period of time Eg : GDP, inflation, exports, consumption, etc.

Concepts in Macroeconomic Analysis: 

Concepts in Macroeconomic Analysis Aggregate Demand and Aggregate Supply Aggregate Demand: sum of demands for all consumer goods and services and for capital goods Sum of consumption, investment, government expenditure and net export. Aggregate Supply: sum of the supplies of all consumer goods and services and of capital goods The amount of output the economy can produce given the resources and technology available

The Roots of Macroeconomics: 

The Roots of Macroeconomics The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s. A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession. A prolonged and deep recession becomes a depression .

The Roots of Macroeconomics: 

The Roots of Macroeconomics Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems Main argument: ‘Supply creates its own demand’ - Say’s law No intervention by the government (Laissez faire). Economy should be left to market forces (‘invisible hand’) The failure of classical models to explain the prolonged existence of high unemployment during the Great Depression led to the development of macroeconomics

The Roots of Macroeconomics: 

The Roots of Macroeconomics In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money . Keynes arguments: The level of output and employment in an economy is determined by the aggregate demand (AD) Governments could intervene in the economy and affect the level of output and employment Two important objectives of macroeconomic policies : (a) Sustained growth in GDP, and (b) Price stability

Functions of an Economy: 

Functions of an Economy An economy is a complex arrangements of many different buyers and sellers – households, businesses, government, and the rest of the world – and of their interactions with each other An economy employs various resources to produce a variety of goods and services for domestic and world consumption, and provides income for the resources Ref: MB p.91-92

The Components of the Macro Economy: 

The Components of the Macro Economy An economy can be pictured as a schematic of closely linked sectors – households, businesses, financial institutions, governments, and foreigners A change in one sector’s transaction with another sector will trigger changes in the entire schematic The circular flow of income and output diagram shows the income received and payments made by each sector of the economy

Two-sectors Circular Flow: 

Two-sectors Circular Flow Households Business/ Firms Product Market Factor Market Wages, rent, interest, profit Spending Revenue Labor, land, capital, entrepreneurship Inputs for production Goods & Services sold Goods & Services bought Income Financial Sector Saving Investment

Three-sectors Circular Flow: 

Three-sectors Circular Flow Households Business/ Firms Product Market Factor Market Wages, rent, interest, profit Consumption Spending ( C ) Financial Market Saving = Investment ( S=I ) Government Govt. expenditure ( G ) Direct taxes Direct/Indirect taxes Govt. expenditure ( G )

Four-sectors Circular Flow : 

Four-sectors Circular Flow Households Business/ Firms Wages, rent, interest, profit Consumption Spending ( C ) Saving = Investment ( S=I ) Government Govt. expenditure ( G ) Direct taxes Direct/Indirect taxes Govt. expenditure ( G ) External Sector Export of services Payments for imports Receipts from exports Remittances

The Three Market Arenas: 

The Three Market Arenas Households, firms, the government, and the rest of the world all interact in the goods-and-services , labor , and money markets . Who create demand and supply in these markets?

Leakages and Injections: 

Leakages and Injections Leakage/Withdrawal: is the amount that is set aside by the households, firms, and governments and is not spent on the domestically produced goods and services over a period of time They reduce the size of the circular flow Ex: savings, taxes, imports Injection/Addition: is the amount spent by households and firms in addition to their regular incomes and receipts Injections increase the size of the circular flow Ex: investments, govt. expenditures, exports

National Income – Concepts and Measurement: 

National Income – Concepts and Measurement National Income Accounting

Why National Income Accounting?: 

Why National Income Accounting? Provides common standards of measurement of the size of an economy Helps to evaluate the economic condition of a country and to compare conditions across time and across countries Ref: MB p.97

National Income – Concepts: 

National Income – Concepts Different concepts of NI - The Criteria ( i ) Items included in or excluded from the NI concept (ii) Method of estimating NI Gross Domestic Product ( GDP ) The sum of market value of all final goods and services produced in a country during a specified period of time , generally one year . Also called GDP at market prices ( GDP MP ) Ref: MB p.100

National Income – Concepts: 

National Income – Concepts Market values of final goods and services are taken Includes net indirect taxes Considers only final goods and services Intermediate goods are excluded to avoid the problem of double-counting Considers output produced in a year The year of production , not the year of sale Inventory as such is not included, but changes in inventory * is considered * Changes in inventory count output that is produced but not sold in a given year Ref: MB p.100

National Income – Concepts: 

National Income – Concepts GDP at factor cost ( GDP FC ) is the sum of all factor payments (wages, interest, rent, profits and depreciation) GDP FC = GDP MP – Net indirect taxes (Net indirect taxes = Indirect taxes – Subsidies ) Gross National Product (GNP) The concept of GNP is similar to GDP, but with a significant difference. Ref: MB p.103, 105

GDP vs. GNP: 

GDP measures the total value of goods and services that are produced within a country’s geographical borders Example: An Indian MNC in China will actually contribute to Chinese GDP GNP measures the total value of all final goods and services that a country’s citizens produce regardless of where they produce them Example: Profits of Indian MNCs earn in overseas market is included in India’s GNP GNP = GDP + NFIA (Net Factor Income from Abroad) (NFIA=income earned by residents abroad – income earned by non-residents from our country) GDP vs. GNP Ref: MB p.105

National Income – Concepts: 

Net National Product (NNP) GNP included final consumer goods + capital goods Depreciation: part of capital goods that is used up or consumed in the process of production Usually covered under Gross Investment (Gross Investment = Net Investment + Replacement Investment/Depreciation) NNP = GNP – Depreciation NNP FC = NI (the actual measure of National Income ) Per Capita Income = (NNP FC = NI ) / Total Population National Income – Concepts Ref: MB p.106

National Income – Concepts: 

Personal Income (PI) The sum of all kinds of income received by the individuals from all sources of income The share of NI actually received by the HH sector Personal Income (PI) = National Income (NI) Minus – Income earned but not received (undistributed corporate profits, social security contributions by the HHs (PF, pension funds), etc.) Plus + Income received but not earned now (transfer payments by business and govt. to HHs, dividend income, etc.) Disposable Personal Income (DPI): the income at the disposal of a person DPI = PI – Direct taxes National Income – Concepts Ref: MB p.107

National Income – Concepts: 

Nominal and Real GNP GNP is estimated at current and constant prices Nominal GNP: market value of all final goods and services measured in current year prices Real GNP: market value of all final goods and services measured in the price of a base year (constant prices) Why do we estimate GNP at constant prices? How to convert the nominal (current) values into real (constant) values ? National Income – Concepts Ref: MB p.108

National Income – Concepts: 

GNP Deflator An index of price changes for goods and services included in GNP Used to deflate the nominal GNP to eliminate the price effect to find real GNP for any year Real GNP = Nominal GNP / GNP Deflator GNP Deflator = Nominal GNP / Real GNP x 100 National Income – Concepts

PowerPoint Presentation: 

National Income Accounting GDP (Gross Domestic Product) (Rs. crore ) 2006-07 2007-08 2008-09 2009-10 2010-11 At current prices 4283979 4947857 5582623 PE 6550271 QE 7877947 AE Growth rate 15.6 15.5 12.0 17.3 20.3 At 2004-05 prices 3564627 3893457 4162509 PE 4493743 QE 4879232 AE Growth rate 9.7 9.2 6.8 8.0 8.6

National Income Measurement: 

National Income Measurement

Measurement of NI - Methods: 

Measurement of NI - Methods A complex process Product flows (Real flows) and Money flows (factor payments and payments for goods and services) Three approaches of measuring NI: Product Approach Factor Income Approach Expenditure Approach

Measurement of NI - Methods: 

Measurement of NI - Methods The Product Method Also known as Output Method or Value Added Method Either by valuing all the final goods and services during a year OR By aggregating the values imparted ( value added ) to the intermediate products at each stage of production (to avoid Double Counting ) ( Value added is the difference between the value of output and the value of the intermediate goods used in the production of that output) Ref: MB p.101

Measurement of NI - Methods: 

Measurement of NI - Methods Method Classification of output under various categories (15 sub-categories are currently used in India) Computation of gross value of output of each category by multiplying the output of each category by their respective market prices and adding them together OR by summing up the value added at each stage of production This gives GDP at market prices

Measurement of NI - Methods: 

Measurement of NI - Methods Product Method – An illustration Sectors Total value in Rupees Crores Agriculture & allied activities 1000 plus Manufacturing industries 3000 plus Services & construction 4000 equals GDP at market prices 8000 plus Net factor income from abroad 1000 equals GNP at market prices 9000

Measurement of NI - Methods: 

Measurement of NI - Methods The Income Method Also known as factor share method Sum of the incomes accruing to the basic factors of production used in producing the national products Rent + wages + interests + profits + depreciation = GDP at factor cost Plus net income from abroad = GNP at factor cost Ref: MB p.105

Measurement of NI - Methods: 

Measurement of NI - Methods Factor Income Method – An illustration Sectors Total value in Rupees Crores Income from employment 1000 plus Gross profits of companies 2000 plus Gross profits of public sector 2000 plus Rent 2000 equals GDP at factor cost 7000 plus Net factor income from abroad 1000 equals GNP at factor cost 8000

Measurement of NI - Methods: 

Measurement of NI - Methods The Expenditure Method Measures NI at final expenditure stage Excluded all expenditure on intermediate goods Sum of all money spend by individuals, firms and government within a year = GDP at market prices (Y) = ) Consumption (C) + Investment (I) + Government Expenditure (G) + Exports and factor income from abroad (X) - Imports and factor income paid abroad(M) Y = C + I + G + X - M Ref: MB p.103

Measurement of NI - Methods: 

Measurement of NI - Methods Expenditure Method – An illustration Sectors Total value in Rupees Crores Consumer expenditure (C) 2000 plus Gross business spending (investment) (I) 3000 plus Govt. expenditure (G) 2000 equals Domestic expenditure at market prices (C + I + G) 7000 plus Exports & factor income from abroad (X) 3000 minus Imports & factor income paid abroad (M) 1000 equals GNP at market prices (C + I + G + X - M) 9000

GDP Omissions: 

There are three types of omissions in the measurement of GDP 1) Activities that are not part of GDP by definition Transfer payments & gifts received, second-hand sales (except brokerage), increase in share prices, etc.. 2) Items left out because of measurement problem All non-market transactions, unorganized sector, income through illegal means (black money), etc.. 3) Items related to the welfare of the people Quality of life, distribution of income, environmental damages, etc.. GDP Omissions

Problems of measuring GNP: 

Determining what is ‘ final ’ and what is not ( problem of double counting ) Evaluation of non-marketed goods and services Example : - The goods and services produced and consumed at home, that never enter the market place The services of housewives, women at HHs. Many economic activities by unorganized sector Black money, black market items, income from illegal activities and professions, etc . Does not consider certain factors affecting people’s welfare (like income distribution, environmental damages) Problems of measuring GNP Ref: MB p.100

Exercise - 1: 

Exercise - 1 Particulars Rs. In crore GNP at factor price 95,000 Indirect taxes 14,000 NDP at market prices 1,00,422 NNP at market prices 1,00,000 GNP at market prices 1,07,000 Personal income taxes 10,000 Corporate profit tax 6,500 Retained profit 30,000 The following information is extracted from the National Income Accounts of an economy for the year 2008-09 Compute (a) the value of depreciation; (b) the value of net factor income from abroad; (c) the value of subsidies; (d) the value of NDP at factor cost; (e) the value of national income; (f) the value of personal income; and (g) the value of personal disposable income

Exercise - 2: 

Exercise - 2 Particulars Rs. In crore NNP at factor price 4,73,246 Depreciation 61,809 Subsidies 19,431 Net Factor Income from abroad -6,833 Indirect taxes 87,043 Personal income taxes 9,759 Corporate taxes 7,300 Retained profit 6,758 The following information is extracted from the National Income Accounts of an economy for the year 2008-09 Compute (a) the value of GNP at market price; (b) the value of NNP at market price; (c) the value of NDP at market prices; (d) the value of NDP at factor cost; (e) the value of GNP at factor cost; and (f) the value of personal disposable income

Web References for Data (India): 

Web References for Data (India) http://indiabudget.nic.in http://finmin.nic.in http://eaindustry.nic.in http://www.rbi.org.in http://planningcommission.nic.in http://mospi.nic.in

References: 

References Chapter 4 & 5, ‘Principles of Macroeconomics ’ by Michael Melvin and William Boyes . Chapters 1 & 2, ‘Macroeconomic Policy Environment’ by Shyamal Roy. Chapter 2, ‘Macroeconomics’ by R. Dornbusch , S.Fischer , and R. Startz .