Macroeconomics: The study of how the national economy as a whole grows and

changes, that occur over time

Macro Environment: It is the major external and uncontrollable factors that
influence an organization's decision making and affects its performance and
strategies. It consists of political, economic, social, technological, environmental
and legal aspects.
Impact on Business: GDP, Inflation, Fiscal Policy, Monetary Policy
National Income: The total income earned within a country.
Aggregates:
a) GDP: market value of all final goods and services produced in a country
during a period of time.
Current GDP value = $2.264 trillion
Current GDP growth rate = 7.3%
GDP = C+I+G+(X-M)
C = Consumer Goods
I = Investment in Capital Goods
G= Government Expenditure
X = Exports
M = Imports
 Nominal GDP: The total GDP calculation based on the current rates
and the current production.
 Real GDP: The total GDP calculation based on the rates at a set
base year and the current production. Real GDP eliminates the rise
in prices due to inflation.
 GDP Deflator: The GDP deflator is a tool used to measure the level
of price changes over time so that current prices can be accurately
compared to historical prices. These price changes are caused by
inflation and deflation.
GDP Deflator = (Nominal GDP/Real GDP) * 100
b) GNP: Gross market value of all the final goods and services produced by
the citizens within a country during a period.
GNP = GDP + (R-P)
R = Receipts from abroad
P = Payments to abroad
c) NNP: The net market value of all the Final goods and services produced by
the citizens within a country during a period of time.
 NNP = GNP – Depreciation.
d) Personal Income: The sum of all incomes received by all individuals or
households during a given period of time.
e) Disposable Income: The income remaining after deduction of taxes from
Personal Income.
DI = PI – Taxes.
Circular Flow of Income: An economic model which describes the circulation/flow
of income between producers and consumers.
Two sector economy: The following are the assumptions
 Households spend all their income on goods & services-no savings
 Firms produce goods & services demanded by households-no inventories
 Firms distributes all its earnings from sale of goods as wages, salaries, rent
interest and profits-no retained earnings

The firm hires factor services from households, who are owners of factors of
production (land, labor, capital and enterprise), for producing goods and services
and pays them remuneration (or compensation) in the form of money for
rendering the productive services. For the factors of production, these are factor
incomes known as rent, wages, interest and profit which have been generated in
the production process. Thus money income flows from firms to the households.
With this money the households purchase from the firms, manufactured goods
and services to satisfy their wants with the result, the same money flows back
from households to the firm sector. Thus entire income of economy comes back
to firms in the form of sales revenue.
A leakage is the amount of money which is withdrawn from income whereas
injections are the amount of money that is added to the flow of income in the
economy Thus, (i) savings, (ii) taxes by households and firms and (iii) import
spending constitute a leakage from the circular flow of income (money).On the
other hand, (i) investment spending, (ii) government spending and (iii) export
earnings become injection into the circular flow of income (money)

Three sector economy: Household sector pays income tax and commodity tax to
the government. On the other hand, the government also makes transfer
payments to the household sector in the form of various benefits and services
like pension funds, relief, sickness benefits, health, education, and other services.

The flow of income and expenditure between the business sector and the
government is similar. Business firms pay taxes to the government, the
government, on the other hand, provides subsidies, makes transfer payments,
and pays for the goods and services it purchases from the business sector.
Flow of income between government sector & capital market can also exist: If
government expenditure > Revenue, the difference is financed from loans from
capital market. If government expenditure < Revenue, money will flow to capital
market from government sector.
 Four Sector Economy

When a country imports goods & services, the expenditure incurred by the
residents of the domestic country leads to an increase in the income of factors of
production of the country which is exporting the goods & services. Here, imports
lead to an outflow of income leading to decrease in circular flow of income.
When a country exports goods & services, the expenditure incurred by the
residents of the foreign country leads to an increase in income of factors of
production of domestic country (exporting goods & services). Here, exports lead
to an inflow of income leading to increase in circular flow of income.
Transfer Payments: Payments are made but services are not rendered. Ex: Old
age pension, scholarships
1. Consumption: The process in which a substance is completely used up or
transformed into something else.
2. Investment: An asset or an item which is purchased so that it will generate
income in future.
3. Savings: A process of setting aside a portion of current income for future use.
4. Methods to measure National Income.
 (a) Output Approach/Product Method/ Value Added Method: The total
value of all final goods and services produced in an economy during a
given period of time are estimated.
Double Counting: When the costs of intermediate goods used by a
business to produce a finished good are included in the computation of a
nation's gross domestic product. Since the final price of a good already
includes the value of all the intermediate goods used to produce it,
including the price of intermediate goods when calculating gross domestic
product would involve double counting.

(b) Income Approach: The total sum of payments received in a country

during a given period is estimated.
(c) Expenditure Approach: It is a measure of the economy’s total output
produced within a country, by both local and foreign firms.
Issues in measurement of National Income:
a) Cost of environmental damage
b) Non-Monetized sector
c) Valuation of government service.
d) Non availability of statistical data.
Macro-Economic Aggregates in Business and Cross-Country Analysis:
By comparing the GDP value among different countries, one can assess the
financial status of a country and its growth with respect to that of the world
economies. Differentiating and segregating countries as “Developed, Developing
or Under developed” can be made possible with this data.
(d) Classical Theory of Employment is based on “Say’s Law”, which
states that: Supply Creates its own demand. From which, the
following is derived.
 There is demand always.
 There is need for supply always.
 There is full employment always.
 Any unemployment is ‘only voluntary’.
(e) Keynes’ Theory of Employment is based on the concept that
“People make savings & do not spend all their income on
consumption”. From which, the following is derived.
 As savings are made, consumption is lesser.
  As consumption is less, the demand is less.
 As demand is less, production is less.
 As production is less, there is less need of labor.
 As there is less need of labor, there is High level of unemployment.
(f) Keynes’ Theory of Consumption: There is a direct relationship
between Income and Consumption. According to this theory,
consumption increases with increase in income and vice versa,
but not at the exact same rate.
Average Propensity to Consume: That part of the income which
is devoted for consumption.
Marginal Propensity to Consume: The change in consumption
due to a unit change in income.
Three theories were summed up for deviation from Keynes
Theory.
(1) Relative Income Hypothesis: Consumption of an individual is
not a function of absolute income but of his relative position
in the income distribution in the society. (consumption
depends on his income relative to incomes of other
individuals in the society)
Demonstration Effect: Individuals try to copy consumption levels
of neighbors/other families in a community.
Ratchet Effect: When income of individual falls, consumption
expenditure does not fall much.
(2) Permanent Income Hypothesis: A person’s consumption is
determined not just by current income but by expected future
income.
(3) Life Cycle Hypothesis: Consumption in any period is not a
function of current income of that period but of the whole
lifetime expected income.
(g) Keynes’ Theory of Multiplier: This was the main driver to bring
USA out of recession in 1930s. He famously quoted,
“Government should dig some holes and fill them up with
sand”.
When an economy is in recession, and the government undertakes
extensive public welfare projects, for example, construction of dams, thus
 giving tenders to raw-material suppliers,
 income to contractors, sub- contractors, and
  employment to laborers.
This way, the government is pumping money into the economy and is
setting into motion a continuous flow of currency. The money earned as
income by these people is spent by them for their needs and necessities.
Thus, one level’s expenditure is another level’s income. This keeps
happening many times, over and over again.
“The Final Income is many times more than the Initial
Investment”.
Paradox of Thrift: It states that individuals try to save more during an
economic recession, which essentially leads to a fall in aggregate demand
and hence in economic growth. Such a situation is harmful for everybody
as investments give lower returns than normal.
(h) IS-LM Curves: The IS-LM Model is a macroeconomic model that
graphically represents two intersecting curves.
A. IS Curve represents the ‘goods-market’ equilibrium, where
Investment (I) equals Savings(S). It is an Income-Expenditure
model.
B. LM Curve represents the ‘money-market’ equilibrium, where
Demand for money (L) equals the Supply of money (M). It
represents the amount of money available for investing.
(i) Marginal Efficiency of Capital: It is the net rate of return that is
expected from the purchase of additional capital. A comparison
of these rates with the current rate of interest is used to indicate
the profitability of investment.
(j) Liquidity Preference Theory: It refers to the demand for money,
considered as liquidity. Having money as cash, in a liquid form
as against depositing in a bank which might earn interest, is a
choice made by the customer to cater to his immediate needs, or
in other words, has a preference for liquidity of money.
(k) Business Cycles: It is cycle of events that occur repeatedly, for a
business or a trade. It consists of 4 stages, namely,
 Boom/Prosperity – A phase where there is high business optimism
and there is high level of demand, high level of output, high
employment.
  Recession – A period of temporary economic decline during which
trade and industrial activity are reduced. It is identified by a fall in
GDP in 2 successive quarters.
 Depression – It is more severe economic downturn than a recession,
which is a slowdown in economic activity. There is a low level of
demand, output and employment.
 Revival – It is a phase in which economy undergoes change from
depression to prosperity.
(l) RBI Interest Rate: 6.00%
Inflation: It is a persistent rise in the general price level of goods
and services, rather than a once-for-all rise in it. The purchasing
power of currency is falling. It can be categorized as,
i. Cost Push Inflation – When inflation occurs due to increase in the
costs of the inputs of production like labor, raw materials, etc. It can
be further classified into
(a)Wage Push Inflation: It is an inflation caused by increased costs
as a result of higher wages. In such situations the increasing wages
are not offset by increasing productivity. Therefore, the costs rise,
which results in higher prices for goods produced.
(b) Profit Push Inflation: This type of inflation is caused when
producers in their drive for greater profits raise prices of goods and
services more than the required and hence it leads to inflationary
conditions.
ii. Demand Pull Inflation – When inflation occurs due to increase in
demand for a product or service, even when the production is
occurring at the maximum level.
Causes of Inflation:
 Demand Supply mismatch
 Improper demand elasticities
 Collusion among producers (Collusion occurs when rival firms agree
to work together, e.g. setting higher prices in order to make higher
profits)
 Budgetary policy of the government
The Competition Commission of India is the watchdog of India to
look after collusion among producers.
(Competition Commission of India is a statutory body of
the Government of India responsible for enforcing The Competition
 Act, 2002 throughout India and to prevent activities that have an
appreciable adverse effect on competition in India.)
Effects:
 Accentuates inequalities of income
 Adverse impact on capital formation
 Unfavorable impact on balance of payments
 Inflation is a hidden tax
CPI (Consumer Price Index) and WPI (Wholesale Price Index): WPI
represents wholesale price of a basket of goods over time. It is an
indicator or price changes in wholesale market. CPI represents price
index which represents average price of a basket of goods over time. It
measures the changes at retail level.
CPI has been adopted as an anchor of inflation since 2014, till that time
WPI was used. The reason for having WPI all these years is because there
was no single CPI hence making it complicated for calculations.
However, now CPI has been simplified and available with a shorter time
lag.
Balance of payments: It is the country’s or economy’s record of
transactions of exports and imports with the rest of the world. If the
exports exceed imports, then it is favorable balance of payments, and
unfavorable on the other hand.
Current Account Deficit: If there is adverse balance of payments (imports
exceed exports), then it is called CAD
Fiscal Deficit: The difference between total revenue and total expenditure
of the government is termed as fiscal deficit.
Primary Deficit: Primary deficit is one of the parts of fiscal deficit. While
fiscal deficit is the difference between total revenue and expenditure,
primary deficit can be arrived by deducting interest payment from fiscal
deficit. Interest payment is the payment that a government makes on its
borrowings to the creditors.
Twin Deficit: Economies that have both a fiscal deficit and a current
account deficit are often referred to as having twin deficits.
Revenue Deficit: A mismatch in the expected revenue and expenditure can
result in revenue deficit. Revenue deficit arises when the government’s
actual net receipts is lower than the projected receipts
Hyperinflation: It is generally defined as inflation at the rate of 50% per
more per month. Some economists also say that hyperinflation is when the
inflation rate is at 1000% or more in a year.
Stagflation: is a situation in which the inflation rate is high, the economic
growth rate slows, and unemployment remains steadily high.
Deflation: It is the continuous fall in prices wherein producers have no
incentive to produce more goods, because of which they cut down on
employment, leading to rise in unemployment.
Fiscal Policy: An important instrument to stabilize the economy, overcome
recession and control inflation in the economy. The government’s policy
regarding

 government expenditure,
 taxation and
 public borrowing.
Monetary Policy: Concerned with changing the supply of money stock and
rate of interest for the purpose of stabilizing the economy. It is formulated
by the apex central bank of a country. The main objectives of Fiscal Policy
are:

 Control Inflation
 Encourage economic growth
 Control money supply.
Monetary Policy Tools:
Repo Rate: It is the rate at which RBI lends money to commercial
banks against securities in case commercial banks fall short of funds.
Higher the repo rate higher the cost of short-term money Higher repo
rate may slowdown the growth of the economy. If the repo rate is low
then banks can charge lower interest rates on the loans taken by us.
Reverse Repo Rate: Rate at which RBI borrows money from
commercial banks. If reverse repo rate is increased, bank will give more
loan to RBI to gain profit, Liquidity will be squeezed out from the
market hence inflation will likely to come down
Cash Reserve Ratio(CRR): CRR is the minimum percentage of
deposits with commercial banks that they need to deposit with the
central bank of RBI.
Impact of increased CRR: Less money with Commercial banks →
Less money with people → Lower demand for goods and services →
Lower prices
Impact of decreased CRR: More money with Commercial
banks → More money with people → Higher demand for goods
and services → Higher prices
Statutory Liquidity Ratio(SLR): This is the percentage of liabilities
and time deposits that commercial banks need to keep with them in
form of cash, gold or government approved securities.
Impact of increase in SLR: Commercial banks need to keep more
liquid funds → Provides less loans to people → Lower demand for
goods and services → Lower prices
Impact of decrease in SLR: Commercial banks need to keep less liquid
funds → Provides more loans to people → Higher demand for goods
and services → Higher prices
Open Market Operations(OMO): Buying and selling government
securities and bonds in order to manage liquidity in the economy.
Impact of purchasing securities: More money in economy → More
demand → Higher growth rate
Impact of Selling: Less money in economy → Less demand → Lower
prices