Lesson briefly describing features of Macro Ecos, trade cycles and national income concepts.

1. Prof. Prabha Panth,
Osmania University

2. Definition of Macroeconomics
• Macroeconomics is the study of the Aggregate
Economy.
• It studies the behaviour of the economy as a
whole and
• The policy measures that the government uses to
influence it.
• Based on Normative Economics – to correct
imbalances and disequilibrium situations.
• Macro economics includes the analysis of growth
of total output, income, employment, inflation,
fiscal measures, banking, and trade.
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3. • Examines the economy in the short and long
run,
Short run: movements in the business
cycle
Long run: economic growth
• Macroeconomics and Microeconomics:
– Macro examines the aggregate economy, national
income, inflation, recession, growth.
– Microeconomics examines the behaviour of
individual economic units and the determination
of prices in individual markets
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4. Components of Macro Economic
system
1. Households: or consumers – provide the
demand, and supply the factors of production to
firms. Factors include: Land, Labour, Capital and
Organisation (Entrepreneurs).
2. Firms: or producers – produce and supply the
final products to other sectors in the economy.
They use the factors of production in their firms.
3. Government: includes government
investment, subsidies, taxes, monetary, fiscal and
trade policies.
4. Trade: or External Sector. Export goods and
services from said economy, and imports goods
and services from Rest of the World.
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5. Circular Flow
• Assuming a closed economy (no international
trade), the macro system shows the flow of
goods, services and incomes from one sector
to another.
• The physical flows are matched by money
flows in the opposite direction.
• All sectors balance out – i.e. Income of one
sector = expenditure of another sector.
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6. Two sector
Circular Flow Factors of production
Model
HH Firms’
Income Factor payment: Expenditure
Wages, rent, intere
st and profits
Households Firms
Product payment
HH Firms’
Expenditure Income
Final products
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7. Five sector circular flows
• The two sector flow model shows that Y = C.
• Actually all Y is not consumed, some of it is saved,
• This constitutes a “leakage” out of the Y stream
• Similarly, investment is an input from outside, it is
an “injection” in the Y stream.
• Also there are other sectors in the economy: the
government, the foreign sector, and the financial
sector.
• These can be included in a Five sector circular
flow diagram, showing an “Open Economy” i.e.
with international trade.
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8. 1.Households
Firms pay
HHs
taxes, Gov
save, bo
buys from
rrow
firms
5. Financial 2.Firms
4. Government Sector Firms
Government save, borrow, i
saves/ nvest
Foreign sector
borrows/
saves, borrows
invests
, invests
3. Foreign
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9. National Income Concepts
1. Gross Domestic Product: GDP: The total value
of all final goods and services accruing to an
economy in one accounting year
GDP = C+ GI + G + (X – M), where
C = Consumption expenditure of HHs.
GI = Gross Investment by Firms,
G = Government expenditure,
X – M = Value of exports – value of imports.
It includes the value of all expenditure within the
economy regardless of who earns it.
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10. 2. Gross National Product or GNP:
GNP = GDP + FA
FA is Net foreign income from abroad. Includes income
earned by Indians from other countries, and deducts
income earned by foreign nationals working in India.
3. Net National Product at market prices:
NNP = GNP – Depreciation
Depreciation = investment to replace and repair wear
and tear of capital, buildings and other assets.
NNP at market prices, since the value of all goods and
services is taken at the ruling price in the market.
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11. 4. NY = NNP at factor cost
NY = NNP at market prices – indirect taxes +
subsidies.
Subsidies reduce the market price, undervalue
output.
Indirect taxes such as excise duties and sales
taxes, increase the market price, over value
output.
These have to be adjusted to arrive at the cost
price of total value of production in the
economy.
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12. 5. Personal Income: PY = NY + transfer payments –
(SS payments + undistributed profits + corporate
taxes)
Transfer payments:
gifts, bequeaths, bonus, dividends, pensions, sch
olarships (income received but not earned).
SS payments life insurance, provident fund (income
earned but not received)
Undistributed profits: Firms do not distribute all
their profit to shareholders, but save part of it.
Corporate Profit Taxes: Distributed profit is net of
corporate profit taxes.
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13. 6. Disposable Income: DY = PY – direct personal
taxes
Households have to pay income tax, and this has
to be deducted, to get DY. DY = C + S
7. Per capita income: PCY = NY/Population
The size of PCY is taken as an index of the
standard of living of the population, and the level
of development of an economy.
8. Real Income or NY at constant prices = NY at
current prices/Price Index
Inflation raises the money value of all goods and
services. To show real increase in output, NY has
to be deflated with the price index.
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14. Business or Trade cycle
• The macro system of capitalist economies is
seldom in equilibrium.
• It has been noticed that NY keeps fluctuating in
regular cycles over time,
• In some periods of time, prices, employment, and
profits increase, and reaches a peak called Boom.
• In other times prices, employment, profits all
fall, called Recession or Deflation, and reaches a
minimum called Depression.
• Again there is revival, called Recovery.
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15. Phases of the Business cycle
NY
Years
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16. Recession
• What is a recession?
– Generally, 2 or more quarters (6 months) of
declining real GDP, negative growth of GDP.
• Investment falls, involuntary unemployment
increases, incomes fall.
• Demand for goods/services falls.
• Reduces incomes of those providing them. Reduces
profits. Industries start retrenchment and closures.
• Again Y and consumption fall.
• And it goes on till the entire economy reaches a state
of depression.
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17. Unemployment during Depression
• During the Great Depression (1929) in USA,
unemployment grew from 3 percent before the
1929 stock market crash, to 25 percent in 1933
• U. S. GDP fell by nearly half, from $103.8 billion to
$55.7 billion.
• 2008 collapse due to sub prime lending by
investment companies in US, such as Lehman
brothers.
• Keynes, Lerner and others had said that
Government investment must increase to revive
the economy.
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18. Inflation
• Persistent increase in prices.
• Inflation occurs due to disequilibrium in the
economy, when D > S.
• Rising prices increase costs of production.
• Reduces real consumption of the population.
• Those with fixed incomes, small
traders, farmers, daily wage earners, suffer the
most.
• Government has to either increase supply (food
grain inflation in India), or reduce demand.
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19. Economic Growth
A central concern of macroeconomics is what
determines long-run growth.
Long-run growth is the sustained increase of
aggregate output or income over several decades.
Growth rate = ∆Y/Y,
i.e. annual rate of increase in NY
The health of an economy shown by a steady rate of
growth of its output.
More output, means more employment, more
incomes, and increase in the standard of living of its
citizens.
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20. Government’s Economic Policy
• Imbalances such as
inflation, recession, unemployment, poverty –
have to be corrected by Government Economic
Policy.
• Market will not take up such corrections.
• Government’s Economic Policy includes:
– Planning policy – economic
growth, distribution, infrastructure, public sector
industries,
– Fiscal policy – taxation, public expenditure, public
debt
– Monetary policy – Central Bank policies
– Trade policy - exchange rates, Balance of Trade and
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Balance of Payments, international aid, loans, tariffs.