Introduction To Macro Economics

 Difference

Macro Economics Micro Economics

Concerned vth the behavior of economic aggregates such as Concerned vth the behavior of individual markets such as
total national product, total investment, exports for the entire those for the wheat, vegetables, computer or apples.
economy, average price of all goods and services rather than
prices of specific products.

These aggregates follow from behavior of diff decision makers These aggregates follow from behavior of individual agents
such as consumers, govts & firms. such as firms & consumers.

Several price indices such as WPI, RPI, IPD are calculated to

show diff sections of the economy.

Macro economics is all about aggregate phenomena such as

growth, business cycles, inflation, unemployment & balance of
payments.

 Macro economics issues in an economy

1. Economic growth- Predominant determinant of living standards in an economy

- Measured vth d help of rise in both total & per capita output over time (Long term rising trends)
- Indicator of rising living standards & serve as a major economic policy issue.

2. Business cycles- Economy tends to move in a series of ups & downs, called Business cycles

3. Inflation- Rise in level of economic activity accompanied by rise in inflation

- Purchasing power of money is eroded drastically
- Govts attempts to control high inflation bring recessions
- Balance b/w stimulus & contraction can be achieved by appropriate timing of policy interventions.

4. Unemployment- Decline in the level of economic activity causes unemployment

- Increase in govt. spendings & reduce trends to obtain desired outcomes in economy help to reduce
unnemployment ( known as fiscal policy)

5. Govt. budget deficits- Concern about potential burden of debt in d form of interest payments
- Conflict over role of govt. budget is policy issue

6. Interest rates- Monetary policy involves changing interest rates, money supply in order to influence economy
- High interest rates reduce demand, Low interest rates stimulates demand
- Exchange rates changes affect the relative prices & thereby the competitiveness of domestic & foreign
producers.
 Introduction To NIA
 Computation of GDP using value added method
OR
Problem of double counting and how to avoid that
Production occurs in various stages- some firms produce outputs that are used as inputs by other firms & these other firms
in turn produce outputs that are used as inputs by yet other firms. Eg- A maker of shirts buys cloth from a textile
manufacturer & buttons, zips thread, pins, hangers etc from a range of other producers.
Merely adding up the market value of all outputs of all firms which is greatly iin excess of value of economy’s actual
output. The error arise in estimating the nation’s output by adding all the sales of all firms is called double counting.

Problem of double counting solved by diff b/w 2 goods :-

a) Intermediate goods & services- Outputs for some firms which in turn inputs for other firms
b) Final goods & services Goods that are not used as inputs by other firms in period under consideration. These are the
commodities needed for its own sake of consumption or investment & satisfying the final demand.
Therefore, Total output = Final goods & services – Intermediate goods & services

Gross value added = sum of all value added in an economy, which is measure of economy’s total output & all final outut
produce by all productive activity in an economy.

 Computation of GDP using spending method

GDP is calculated by adding up spending/ expenditure going to purchase the final output produced in a given year.
Total spending = Consumption + Investment + Net exports
i.e. GDP = Cp + Cg + I + X – M
Here, Consumption spending is of -Govt (Cg)
-Private inviduals (Cp)

Four Imp. categories of GDP :-

a) Private consumption spending - Spending by private individuals on good & services such as fruits, vegetables, clothes,
medical services produced & sold to their final users ; final consumption expenditure of non- profit making institutions
serving households like charities. Excludes purchases of newly built houses as they are part of investment.
b) Govt. consumption spending- Spending by govt. on goods & services such as health care, roads & street lighting.
Individual govt. final consumption & collective govt. final consumption is one term i.e. govt. consumption/ govt.
spending.
c)Investment spending- Spending on d production of goods (called investment or capital goods) not for present use but
rather for future consumption. 3 categories of investment spending- changes in stocks & investments
- Gross fixed capital formation
- net acquisition of valuables
d) Net exports- Exports minus imports is net exports arises from foreign trade of the economy with rest of world.
If value of exports exceeds imports then net export is + and if value of imports exceeds exports then net export is –

 Computation of GDP using

GDP is calculated by adding value or contribution of of incomes of owners of resource inputs (land, labour, capital etc).
3 main categories of income :-
a) Operating surplus- Involves net businesss incomes after payments to hired labours & for material inputs but before
payment of direct taxes (such as corporation tax). It constitute large part of profits & surpluses of firms. Profits paid
 out as dividends to owners of firms called distributed profits & rest are retained by the firm for future use called
undistributed profits or retained earnings. Both these are use in calculation of GDP.
b) Mixed income- Involves incomes of self employed individuals who sell their services or output while running their
own sole-trader business.their incomes are called mixed incomes which are mixture of 2 parts wage or salary
income (their earnings) & profits or surplus of business.
c) Compensation of employees- Payments for services of labour i.e. wages & salaries referred to as labour income.
Wages includes total earnings of hired labour, gross of pension funds cntrbution, insurance contributions & other
benefits. NDP at factor cost prices = operating surplus + mixed incomes + employees compensation.
GDP = NDP at factor cost prices + depreciation

 What is depreciation ? & Computation of depreciation?

Depreciation is the amount by which capital stock has been used up during given period by normal wear & tear of
machinery, normal accidental damage during production & forseen obsolescence (when machines can’t be used
efficiently & completely). It is also called capital consumption expenditure. Depreciation represents charge against
current year production, calculated on the basis of expected life of the capital goods & interest rates

Why is it important to compute depreciation?

To estimate how much capital stock is used, left, will be last.
Overestimation of depreciation helps to avoid paying high dividends & taxes(that’s y depreciation laws r linked vth
tax laws)
Gross investments – Depreciation(replacement investment) = Net investment
Positive net invts increases the economy’s total capital stock while replacement invt keep d existing stock intact by
replacing what has been use or worn out.

 Difference

Nominal GDP Real GDP

GDP valued at current prices i.e. prevailing market prices GDP valued at constant prices i.e. base year prices is real
is nominal GDP. GDP.
Change in nominal income reflects combined effects of Change in real income reflects only changes in real output.
changes in quantities & prices.

If output of goods & services produced by economy remains same during year & price rises, increase in money GDP & no
increase in real GDP.
If output of goods & services produced by economy increases during year & price remained constant, increase in real
GDP.
Thus, there’s a economic growth in d economy & economic growth linked vth growth of GDP.
Implicit price deflator- comparing nominal & real GDP over same period gives price index.
Implicit deflator = Nominal GDP X 100%
Real GDP
Real GDP = Nominal GDP
Price index
National Income Determination
 Say’s law of markets
Supply creates its own demand. Main source of demand is flow of factor incomes generated from production
process. When new production process initiated & certain outputs results, demand for outputs also simultaneously
generated on account of payment of remuneration to the factor of production.
In other words, every output brought to existence injects equivalent amount of purchasing power in circulation
which ultimately leads to its sale so there’s no possibility of overproduction. This is the essence of say’s law. If
general over production is impossible, there is no possibility of general unemployment.
Assumptions :-
 Law can operate in free exchange economy where there is full freedom for buyers to buy & sellers to sell
 There is free flow of money income.
 Equality of savings & investment brought about by flexible interest rate.
 Automatic adjustment is facilitated on part of govt. by not interveningin business matters.
 Size of market limited by volume of production only then demand= supply or supply creates its own demand.

Criticism of say’s law :

