UNIT IV Performance of an

Economy - Macroeconomics

- Macro economics
-Aggregates
-Circular flow of Macroeconomic activity
-Components of aggregate demand
-Multiplier effect
-Fiscal policy
 Nature of macroeconomics
Short run nature of macro economics
Short run period which refers to the time period
Study of economy as a whole
Deals mainly with national income or national output.
Macro economics
Studies all conditions of inflation and deflation
Reformed capitalism
Changed conditions of the present day world.
Monetary economics
Main function of money was medium of echange
 Institutional economics
As a guide to politicians and economists all over
State intervention
Public investments are regarded as most desirable.
Crucial role of investment
Addition to the stock of goods and creation of new capital assets
Comparative static analysis
Static, comparative static and dynamic.
Theory of shifting equilibrium
Position of equality between demand and supply.
 Macro economic Aggregates
Constitute a set of policies and programs that
are formulated and implemented by the
national government.
Real sector policies
Objective of boosting domestic investment
demand by expanding the participation
Fiscal policies
These policies renew commitment to
consolidation.
 Agriculture policy
Initiating measures for the development of the agricultural
sector.
Policy on manufacturing infrastructure and services
Policy initiatives to be taken under the economic
liberalization.
Trade policies
Sets out a road map for the export sector.
Export and import policy
A farm to port approach for the export of agricultural factors.
Evaluation of Macroeconomic aggregate

It ignores the structural changes in the

aggregates.
Aggregates are not a reality
Intellectual attraction
Heterogeneous Units
Composition or structure of the aggregate is
more important than the aggregate itself.
Circular flow of Macroeconomic Activity

Real flows flow of the factors of production

and goods and services
Money flows this includes the monetary
flows between the different sectors.
Types of Circular flow
Product flow
Income flow
Circular flow of Macroeconomic Activity
Activity 2 sector Three Sector Four Sector
Economy Economy Economy

FIRMS FIRMS FIRMS

HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS

Macro
Economic
Activity
GOVERNMENT GOVERNMENT

FOREIGN
SECTOR
 Significance of Circular flow of
Macroeconomic Activity

Knowledge of interdependence
Awareness on the interdisciplinary investments
Identification of injection and leakages
Fund filling and fund leakages.
Estimation of national income
Investment and expenditure across the nation.
 National income accounting
Magnitude of flow determination
Level and structure of economic activity
Offers information on various macro variables.
Fiscal and monetary policies
Flow of income and expenditure highlights the
importance of both the fiscal and monetary
policies
 National Income
What is its meaning ?
Money value of all the final goods and services
produced by a country during a period of one year.
Define National Income.
The national dividend or income consists solely of
services as received by ultimate consumers,
whether from their material or from their human
environment.
 Features of National Income
Excessive dependence on agriculture
27.8 percent of the national income is being contributed
by the agricultural sector.
Poor growth rate of GDP and per capita income
It is another important feature of national income of the
country.
Unequal distribution and poor standard of living
Highly skewed pattern of distribution and income
Growing contribution of tertiary sector
Contribution of tertiary sector has been increasing
continously.
 Unequal growth of different sectors
Different growth statistics shown by different sectors
Regional disparity
Different per capita income with respect to different states.
Urban and rural disparity
Level of income with rural and urban areas.
Public and private sector.
Major portion of national income generated by private
sector.
 Component of National Income
Compensation of employees
Wages and salaries paid to employees.
Proprietors income
All forms of income earned by self employed and owners.
Corporate profits
All the income earned by stockholders of corporations.
Rental income of persons
Income received by individuals for the use of their non monetary
assets.
Net interest
Interest income received by households and governments minus
the interest they paid out.
 Concepts and Measures of National
Income
Gross Domestic Product (GDP)
Money value of all final goods and services
Gross National Product (GNP)
Sum of the gross domestic product and net factor income
from abroad.
Net Domestic Product (NDP)
GDP will not reveal complete flow of goods and services.
Net National product (NNP)
Derived by subtracting depreciation allowance from GNP
 NNP at market prices
Net value of final goods and services evaluated at
market prices
NNP at factor cost or National Income
Net output evaluated at factor prices.
GDP at Factor Cost
Sum of net value added by all producers within the
country.
 Concepts and Measures of National
Income
GNP at market prices
Total output produced in one year by their market prices
prevalant during the year in the country.
Domestic income
Income generated by factors of production within the country
from its own.
Private income
Average income of the people of a country in a particular year.
 Per capita income
Average income of the people of a country in a
particular year.
Personal income
Sum of all incomes actually received by all
individuals
Disposable income
After paid to government what remains of personal
income is disposable income.
 Determination of National Income
Output or production method
Problem of double counting
Value addition in particular year
Stock appreciation
Production for self consumption
Depreciation
Income method based on the individuals in the
country.
Expenditure Method
 Aggregate Demand
Aggregate demand is the total demand for
final goods and services in the economy at a
given time and price level.
Y = C+I+G+(X-
M)
Where, C=Consumption, I = Investment
G=Government Spending,
NX=X-M=Net Export,
X=Total Exports, M=Total Imports
Aggregate Demand Curve
 Components of aggregate demand
Consumption
Durable goods
Purchased with the intention of keeping them for a sustained duration of time
Non durable goods
Which has a shorter life span
Services
Services include banking, finance, insurance, medical.
Investment
It is a business investment capital
Government Spending
Government expenditure on final goods and services
Net Exports
Formulated from the way income generated from Goods and Services.
 Aggregate Supply
The total money value of goods and services
produced in an economy in a year.
Y = (N, K,
T)
Y = National Output
K = Constant amount of capital stock
T = Constant state of Technology
N = Labor Employed
Aggregate Supply Curve
 Macroeconomic Equilibrium
The model for aggregate supply-aggregate
demand model is referred as AS/AD model.
Useful for evaluating factors and conditions.
Aggregation of the elementary micro
economic supply and demand model.
Macroeconomic equilibrium also determines
the national inflation rates.
Macroeconomic Equilibrium Graph
 Multiplier Effect
Concept relates to change in income as a result
of change in investment.
Consumption expenditure of one person is an
income of the other.
Change in consumption leads to change in
income.
Change in
Change in Change in Change in
Consumptio
Investment Income Income
n

C
I Y Y
 Assumptions of Multiplier
Change in autonomous investment
Marginal propensity to consume
Consumption is a function of current income
No time lags
 New level of investment
Net increase in investment
Effective demand
Surplus capacity
Industrialized economy
 Leakages from Multiplier
Savings
Whole increment on income is not spent in consumption
Undistributed profits
Not distributed to the shareholders
Excess stocks of consumption goods
Increased demand from consumption goods is met
Public investment programmes
Increase in income as a result of increased investments
Debt cancellation
A part of income received by people may be used for
pay off.
 Imports
Part of the increased income resulting from increased investments
Price inflation
An increase in investment has expansionary effects.
Hoarding
Tendency of the people to hold idle cash balances
Purchase of stocks and securities
A part of newly created income
Taxation
Not necessary to spend all the money raised through taxation is
spent by the government.
Assumptions of Demand side Management

Labor is the only variable factor of production

Changes in prices proportionate to changes in
the wage rates
Money illusion and the supply of labor
Rigid or inflexible prices
Effective demand
Savings and investment determinants.
FISCAL POLICY
 Fiscal Policy
Part of governmental economic policy
Deals with taxation, expenditure, borrowing.
Instrument of modern public finance.
All about public expenditure and tax policy
Approach towards the objective of National
Income.
Paves way to production and employment.
 Nature of Fiscal Policy
Rationalization of product classification codes
Adoption of a rationalized standard product code
Common accounting year for income tax
Taxation policy has adopted standard accounting year
Long term fiscal policy
Provide greater certainties
Impact on rural employment
New rural employment schemes are introduced by the
government.
Black money
Unaccounted money dampens the future of the country.
 Reliance on indirect taxes
Large dependence on indirect taxes like excise duty
Inadequate public sector contribution
Public continues to be a drain on the resources of the
government.
Introduction of VAT
Manufacturer while charging full rate of excise duty on his
output gets credit for tax paid on inputs.
Inflationary Potential
Fiscal policy instead of curing the inflation has become the cause
of the inflation.
 Objectives of fiscal policy
Fiscal policy for full employment
Effective instrument for reducing unemployment
Fiscal policy and economic stabilization
Implies maintenance of full employment
Fiscal policy and economic growth
Rapid economic growth is the fundamental
objectives of fiscal policy.
Fiscal policy and social justice
Equitable distribution of income and wealth.
 Role of fiscal policy
Capital formation
Raising the rate of capital formation in the country
Resource mobilization.
Helps to mobilise resources through taxex, savings,
public debt etc.
Incentives to private sector
Encouraged under fiscal policy for investment and
production
Encourages savings
Raise the rate of savings in household
 Poverty alleviation and employment generation
Providing full employment allocation of huge
amount has been made in fiscal policy.
Reduction in inequality of income and wealth
Making constant Endeavour to reduce inequality
Export promotion
Encouraged by the way of providing subsidies,
concessions.
 Limitations in fiscal policy
Dependence on the size of measures and their
timing
Dependence on the redistribution of income
Flexibility of the government revenue
Effects on private investment
Changes in balance of payment
Dependence on the supply of human efforts
Lack of coordination and integration
Limitations of budgetary policy