S.

SIVA KUMAR

MACRO ECONOMICS
1

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

MAJOR ISSUES AND CONCERNS

Employment and unemployment National income Price level and inflation Business cycle Stagflation Economic growth Balance of payment and Exchange rate

1.EMPLOYMENT AND UNEMPLOYMENT

What determines level of employment What causes involuntary unemployment Classical economist suggested - change in wages and price Keynes suggested aggregate demand an aggregate supply

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

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.

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

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

6. 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, human capital and progress in technology Development of these requires savings and investment

7. 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 countrys currency is exchange for foreign currencies Instability in exchange rate is the major problem which leads to balance of payment problem

10

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, output, employment, general price etc To analyze the effect of these

12

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

13

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

14

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.

15

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

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

GROSS DOMESTIC PRODUCT (GDP)

The GDP refers to the value of the goods and services produced with in the nations geographical territory, irrespective of the ownership of the resources. 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

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

GROSS NATIONAL PRODUCT (GNP)

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

22

NET NATIONAL PRODUCT (NNP)

While producing the gross national product of a year, the capital stock of the country, i.e, machinery; 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, which is known as capital consumption allowance or depreciation charges. NNP we mean the market value of all final goods and services after making provision for capital consumption allowance or depreciation. It is also known as national income at market prices. NNP = GNP CCA or Depreciation

23

NATIONAL INCOME AT FACTOR COST (NI)

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

24

PER-CAPITA INCOME (PCI)

When the national income is divided by the total population of the country, it is known as percapita income or average income per head. Therefore, the per capital income of India for the year 2011 can be estimated by; PCI = NI of India in 2011 / Population of India.

25

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.

26

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

27

MEASUREMENT OF NATIONAL INCOME

National income

Net product method Output method Net income method Value added method

Net expenditure method

28

NET PRODUCT METHOD

Contribution of GDP from various sectors like agriculture, livestock, fishery, forestry and logging, 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

NET INCOME METHOD

Income from rest of sectors i.e., service sector is estimated Process involves the measurement of aggregate factor income in the form of wages and salaries, rent, 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

NET EXPENDITURE METHOD

GNP is the sum total of expenditure incurred on goods and services during one year in a country It includes, 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

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. There is a flow of money corresponding to flow of economic resources and the flow of goods and services.

34

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

TWO SECTOR ECONOMY - CONT

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

37

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, unemployment relief, sickness benefit, are injection to an economy
38

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

40

FOUR SECTOR MODEL

Including foreign sector along with household, business and government sector Also called balance of payment sector There are injections and leakages injection Exports from the country - 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 - injection
41

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, 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

43

CONSUMPTION FUNCTION

Consumption function or propensity consume refers to income consumption relationship. It indicates a functional relationship between C and Y. 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

AVERAGE PROPENSITY TO CONSUME

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

AVERAGE PROPENSITY TO SAVE

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

46

MARGINAL PROPENSITY TO CONSUME

MPC is the rate of change in APC When income increases, the MPC falls but more than the APC. 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 . MPC = change in C / change in Y
47

MARGINAL PROPENSITY TO SAVE

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

48

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

INVESTMENT FUNCTION

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

50

TYPES OF INVESTMENT

Induced investment Is profit or income motivated It is income elastic Demand also determines

51

TYPES OF INVESTMENT

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

52

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, it is the signification of the equilibrium between aggregate demand (C+I) and aggregate supply (C+S). This equilibrium position (effective demand) indicates that the entrepreneurs neither have a tendency to increase production nor a tendency to decrease production.

54

AGGREGATE DEMAND

Aggregate demand refers to the sum of expenditure, households, firms and the government is undertaking on consumption and investment in an economy. 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. An increase in the level of employment raises the expected proceeds and a decrease in the level of employment lowers it. The aggregate demand curve AD (C+I) would be positively sloping signifying that as the level of employment increases, the level of output also increases, thereby increasing of aggregate demand (C+l) for goods. The aggregate demand (C+l), thus, depends directly on the level of real national income and indirectly on the level of employment.
55

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, 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. The aggregate supply curve, (C+S) is positively sloped indicating that as the level of employment increases, the level of output also increases, thereby, increasing the aggregate, supply. Thus, the aggregate supply (C+S) depends upon the level of employment through the economy's aggregate production function. 56

IMPORTANCE OF EFFECTIVE DEMAND

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

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). 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.

58

59

DETERMINATION OF EMPLOYMENT AND INCOME

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

THE CONCEPT OF MULTIPLIER

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

61

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. A fall in investment leads to cumulative decline in income and employment by the multiplier process and vice versa. Trade cycle: Fall in investment leads to fall in income and employment , leading to recession and depression. An increase in investment leads to revival and boom.
63

IMPORTANCE OF MULTIPLIER

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

IMPORTANCE OF MULTIPLIER

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

65

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

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. As a result, real consumption and income fall. Net imports: Increased income spent on purchase of imported goods, affect the consumption of domestic goods.

68

LEAKAGES OF MULTIPLIER

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

69

ACCELERATION AN INTRODUCTION

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

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. According to Kurilara, the accelerator coefficient is the ratio between induced investment and an initial change in consumption expenditure. Symbolically, v = change in I / change in C

71

SUPER MULTIPLIER

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

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