MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.

TECH,MBA/AP/COMMERCE
UNIT V
MACROECONOMIC FACTORS
National income - Meaning – approaches to compute national income – Factors
determining national income. Business cycle – definition- characteristics –
phases – inflation – definition, and meaning – types – demand-pull inflation –
cost-push inflation – effects of inflation – anti-inflationary measures - deflation
- meaning – effects of deflation.
NATIONAL INCOME
Concept of National Income
National income means the value of goods and services produced by a country during
a financial year. Thus, it is the net result of all economic activities of any country during a
period of one year and is valued in terms of money. National income is an uncertain term
and is often used interchangeably with the national dividend, national output, and
national expenditure. We can understand this concept by understanding the national
income definition.
National Income

The National Income is the total amount of income accruing to a country from economic
activities in a years time. It includes payments made to all resources either in the form
of wages, interest, rent, and profits.The progress of a country can be determined by
the growth of the national income of the country

National Income Definition

There are two National Income Definition

 Traditional Definition
 Modern Definition

Traditional Definition:
According to Marshall: “The labor and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material and
immaterial including services of all kinds. This is the true net annual income or revenue
of the country or national dividend.”

For example, a product runs in the supply from the producer to distributor
to wholesaler to retailer and then to the ultimate consumer. If on every movement
commodity is taken into consideration then the value of National Income increases.
For example, In an agriculture-oriented country like India, there are commodities which
though produced but are kept for self-consumption or exchanged with other
commodities. Thus there can be an underestimation of National Income.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
Simon Kuznets defines national income as “the net output of commodities and services
flowing during the year from the country’s productive system in the hands of the
ultimate consumers.”

Following are the Modern National Income definition

1. Gross Domestic Product
The total value of goods produced and services rendered within a country during a year
is its Gross Domestic Product.Further, GDP is calculated at market price and is defined
as GDP at market prices.

Different constituents of GDP are:

1. Wages and salaries

2. Rent
3. Interest
4. Undistributed profits
5. Mixed-income
6. Direct taxes
7. Dividend
8. Depreciation
2. Gross National Product
For calculation of GNP, we need to collect and assess the data from all productive
activities, such as agricultural produce, wood, minerals, commodities, the contributions
to production by transport, communications, insurance companies, professions such (as
lawyers, doctors, teachers, etc). at market prices.It also includes net income arising in a
country from abroad.

Four main constituents of GNP are:

1. Consumer goods and services

2. Gross private domestic income
3. Goods produced or services rendered
4. Income arising from abroad.

3. GDP and GNP on the basis of Market Price and Factor Cost
a) Market Price
The Actual transacted price including indirect taxes such as GST, Customs duty etc.
Such taxes tend to raise the prices of goods and services in the economy.

b) Factor Cost
It Includes the cost of factors of production e.g. interest on capital, wages to labor, rent
for land profit to the stakeholders. Thus services provided by service providers and goods
sold by the producer is equal to revenue price.

Alternatively,
Revenue Price (or Factor Cost) = Market Price (net of) Net Indirect Taxes
Net Indirect Taxes = Indirect Taxes Net of Subsidies received
Hence,
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
Factor Cost shall be equal to
(Market Price) LESS (Indirect Taxes ADD Subsidies)

4.Net Domestic Product

The net output of the country’s economy during a year is its NDP. During the year a
country’s capital assets are subject to wear and tear due to its use or can become
obsolete.Hence, we deduct a percentage of such investment from the GDP to arrive at
NDP.
So NDP=GDP at factor cost LESS Depreciation.
The Accumulation of all factors of income earned by residents of a country and includes
income earned from the county as well as from abroad.

Thus, National Income at Factor Cost shall be equal to

NNP at Market Price LESS (Indirect Taxes ADD Subsidies)

METHODS FOR CALCULATING NATIONAL INCOME

Now that you know what national income is and have a basic understanding, you must
know the procedures for calculating it. So below are the three essential methods that
help with the calculation.

1.Product Method or Value-Added Method

National income is calculated using this technique as a flow of commodities and
services. First, we compute the monetary worth of all final products and services
generated in an economy over a year. The term “final goods” refers to items consumed
immediately and are not employed in the subsequent manufacturing process.
Intermediate products are goods that are utilized in the manufacturing process.

Because the worth of intermediate products has been used in the worth of final
products, we do not include the cost of intermediate goods; alternatively, we would be
twice calculating the cost of the goods. To circumvent the dilemma of double counting,
we could utilize the value-addition approach, which calculates value-addition at each
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
production stage and sums it up to reach GDP. Because the money value is measured
at market prices, the GDP (Gross Domestic Products) at market prices is the total
amount.

Formula: NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA, OR,

NNPfc = GDPmp – Depreciation – Net product taxes – Net production taxes + NFIA

2.Income Method
National income is calculated using this technique as a circulation of factor incomes.
There are mainly four production aspects: labor, land, capital, and entrepreneurship.
Labor is compensated with wages and salaries, money is compensated with interest,
the land is compensated with rent, and entrepreneurship is compensated with profit.

Furthermore, specific self-employed individuals, like physicians, lawyers, and CAs,

provide their own money and labor. Their income is referred to as mixed-income. All
of these factor incomes are referred to as NDP at factor costs (NDPfc).

Formula: National Income = Rent + Compensation + Interest + Profit + Mixed Income

3.Expenditure Method
Since you’re already aware of the income technique, let’s look at the expenditure
method. The expenditure approach can also be employed during the disposal phase
to determine national income. It determines national revenue by computing final GDP
spending at market prices. The amount spent on finished goods is referred to as final
expenditure.

Final products are necessary for final investment and consumption. Therefore, the
requirement for final investment and consumption is generated by all four economic
sectors, including households, enterprises, the government, and the rest of the world.

Formula: National Income: Household Consumption + Government Expenditure +

Investment expense + Net Export (Exports – Imports)

NNPfc = C + G + I + NX

FACTORS FOR DETERMINING THE SIZE OF NATIONAL INCOME

Factor # 1. Natural and Human Resources:

The quantity and quality of a country’s resources exert perhaps the most important
influence on its national income. For example, fertile soil, ready sources of power,
easily worked mineral deposits; a favourable climate, navigable rivers, etc. will have a
beneficial effect on a country’s productive capacity.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
Capital equipment may range from simple hand tools to the most up-to-date forms of
industrial machinery. Generally, the achievement of an increasing output of goods is
associated with increased investment in capital equipment. For example, a miner can
extract a greater quantity of mineral resources from the earth with the aid of
machinery than with only a pick and shovel. Thus, the effectiveness with which natural
and human resources are used depends to a large extent on the capital equipment
available.

The size of the working population is determined by factors such as the age structure
of the population and social attitudes. For example, the social attitude towards women
is important in this respect. If the community judges that ‘a woman’s place is in the
home’, then the talents of many women may be wasted.

The quality of the labour force will depend partly on the innate intelligence of the
people and partly on the skills acquired through education and training.

Entrepreneurial skill, that is, the ability to make decisions, calls for sound judgment
and some courage. The availability of the skill will affect the use of resources and,
hence, the size of the national income.

Factor # 2. Technical Knowledge:

New methods of production and new ways of utilising resources may increase the
output of goods and services. A community which is keen to try out new ideas or
inventions in industry and commerce is likely to enjoy a higher standard of living than
a country which is slow to adopt new ideas.

Factor # 3. Political Stability:

Political stability is essential for the expansion of business activities. War and internal
revolution interfere with production because they add to normal commercial risks.
Thus, peace and a stable government promote confidence and encourage production.

Factor # 4. Terms of Trade:

Trade benefits all countries which engage in it, but the degree of benefit enjoyed by a
particular country will vary according to changes in the price levels at which it sells its
exports and imports. Favourable terms of trade occur if the prices of imports fall
relatively to the prices of exported goods. This means that a larger quantity of imports
can be obtained for a given quantity of exports. Hence, more goods are available and
national income is increased.

Factor # 5. Foreign Investment:

A net income from foreign investment means that the creditor country can obtain
goods and services from debtor countries without having to give goods and services in
return. Thus, if two countries have the same Gross Domestic Products then the country
with the more favourable net return from foreign investment will have the higher
national income.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE

BUSINESS CYCLE
What is a Business Cycle?
A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)
around its long-term natural growth rate. It explains the expansion and contraction
in economic activity that an economy experiences over time.

A business cycle is completed when it goes through a single boom and a single
contraction in sequence. The time period to complete this sequence is called the
length of the business cycle. A boom is characterized by a period of rapid economic
growth whereas a period of relatively stagnated economic growth is a recession.
These are measured in terms of the growth of the real GDP, which is inflation-adjusted.

Stages of the Business Cycle

In the diagram above, the straight line in the middle is the steady growth line. The
business cycle moves about the line. Below is a more detailed description of each
stage in the business cycle:

1. Expansion

The first stage in the business cycle is expansion. In this stage, there is an increase in
positive economic indicators such as employment, income, output, wages, profits,
demand, and supply of goods and services. Debtors are generally paying their debts
on time, the velocity of the money supply is high, and investment is high. This process
continues as long as economic conditions are favorable for expansion.

2. Peak

The economy then reaches a saturation point, or peak, which is the second stage of
the business cycle. The maximum limit of growth is attained. The economic indicators
do not grow further and are at their highest. Prices are at their peak. This stage marks
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
the reversal point in the trend of economic growth. Consumers tend to restructure their
budgets at this point.

3. Recession

The recession is the stage that follows the peak phase. The demand for goods and
services starts declining rapidly and steadily in this phase. Producers do not notice the
decrease in demand instantly and go on producing, which creates a situation of excess
supply in the market. Prices tend to fall. All positive economic indicators such as
income, output, wages, etc., consequently start to fall.

4. Depression

There is a commensurate rise in unemployment. The growth in the economy continues

to decline, and as this falls below the steady growth line, the stage is called a
depression.

5. Trough

In the depression stage, the economy’s growth rate becomes negative. There is further
decline until the prices of factors, as well as the demand and supply of goods and
services, contract to reach their lowest point. The economy eventually reaches the
trough. It is the negative saturation point for an economy. There is extensive depletion
of national income and expenditure.

6. Recovery

After the trough, the economy moves to the stage of recovery. In this phase, there is
a turnaround in the economy, and it begins to recover from the negative growth rate.
Demand starts to pick up due to low prices and, consequently, supply begins to
increase. The population develops a positive attitude towards investment and
employment and production starts increasing.

Employment begins to rise and, due to accumulated cash balances with the bankers,
lending also shows positive signals. In this phase, depreciated capital is replaced,
leading to new investments in the production process. Recovery continues until the
economy returns to steady growth levels.

This completes one full business cycle of boom and contraction. The extreme points
are the peak and the trough.

CHARACTERISTICS OF BUSINESS CYCLE

The business cycle occurs periodically in a wave-like fashion with varying magnitude
affecting not only the entire economy of the country but also making its impact on
economies of other countries. Let us discuss its features / characteristics in detail.

1. Business cycle occurs Periodically

The Business cycles occur periodically in a regular fashion. This means the prosperity
and depression will be occurring alternatively. But there need not be uniformity in the
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
extent and magnitude. Though the general structure of different cycles may be the
same, it may not be perfectly rhythmical in character.

2. It is all embracing.
The business cycle implies that the prosperity or depressionary effect of the phase will
be affecting all industries in the entire economy and also affect the economies of other
countries. It is international in character. The Great Depression of 1929 is an example
of this.
3. Business Cycle is wave-like
The business cycle will have set pattern of movements which is analogous to waves.
Rising prices, production, employment, and prosperity will become the features of
upward movement. Falling prices, unemployment will become the features of the
downward movement.

4. Process of Business Cycle is cumulative and self-reinforcing

The upward movement and downward movement are cumulative in their process.
When once the upward movement starts, it creates further movement in the same
direction by feeding on itself. This movement will persist till the forces accumulate to
alter the direction and create the downward movement. When a downward movement
starts, it persists in the same direction leading to the worst depression and stagnation
till it is retrieved to gain an upward movement.

5. The cycles will be similar but not identical

Different cycles and waves in the business cycles will be similar in general features,
but they are not identical in all respects.

Besides these features, the American Economic Association stressed the following
important characteristics of the business cycle.

1. Generally, prices and production fall or rise together. The exception is agriculture in
which, during the downward phase of the cycle, prices will be falling but production will
be increasing. The reason is, with falling prices of agricultural commodities, the
farmers would try to produce more to offset the loss of falling prices of their produce
and maintain the same level of income.

2. Fluctuations in output and employment will be greater in capital goods industries

than in consumption goods Industries.

3. Phenomenal changes in employment, output and price level will be normally

accompanied by changes in currency, credit and velocity of circulation of money in the
same direction.

4. Prices of agricultural goods will be flexible while the prices of manufactured

goods will be comparatively rigid as they will be kept stable by the manufacturers.
5. Profits fluctuate by a larger percentage than the other types of income.

6. Fluctuations will spread throughout, as industries are interconnected and the

cyclical fluctuations tend to be international in the sense that the prosperity or adversity
will affect the foreign countries, through international trade.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE

INFLATION

What is Inflation?
In economics, inflation (or less frequently, price inflation) is a general rise in the price level of
an economy over a period of time. When the general price level rises, each unit of currency
buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing
power per unit of money – a loss of real value in the medium of exchange and unit of account
within the economy.

Inflation
The different types of inflation in an economy can be explained as follows:

 Cost push inflation: This inflation is caused due to an increase in the wages that
bounds business houses to increase prices to cover for high labor costs.
 Demand pull inflation: This inflation is caused owing to high consumer demand
backed by easy credit finance.

Demand-Pull Inflation
This type of inflation is caused due to an increase in aggregate demand in the economy.
Causes of Demand-Pull Inflation:

 A growing economy or increase in the supply of money – When consumers feel confident, they
spend more and take on more debt. This leads to a steady increase in demand, which means higher
prices.
 Asset inflation or Increase in Forex reserves– A sudden rise in exports forces a depreciation of the
currencies involved.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
 Government spending or Deficit financing by the government – When the government spends
more freely, prices go up.
 Due to fiscal stimulus.
 Increased borrowing.
 Depreciation of rupee.
 Low unemployment rate.
Effects of Demand-Pull Inflation:

 Shortage in supply
 Increase in the prices of the goods (inflation).
 The overall increase in the cost of living.
Cost-Push Inflation
This type of inflation is caused due to various reasons such as:

 Increase in price of inputs

 Hoarding and Speculation of commodities
 Defective Supply chain
 Increase in indirect taxes
 Depreciation of Currency
 Crude oil price fluctuation
 Defective food supply chain
 Low growth of Agricultural sector
 Food Inflation
 Interest rates increased by RBI
Cost pull inflation is considered bad among the two types of inflation. Because the National Income is
reduced along with the reduction in supply in the Cost-push type of inflation.

Built-in Inflation
This type of inflation involves a high demand for wages by the workers which the firms address by
increasing the cost of goods and services for the customers.

Types of inflation by rate of increase

Creeping inflation (1-4%)

When the rate of inflation slowly increases over time. For example, the inflation rate
rises from 2% to 3%, to 4% a year. Creeping inflation may not be immediately
noticeable, but if the creeping rate of inflation continues, it can become an increasing
problem.

Walking inflation (2-10%)

When inflation is in single digits – less than 10%. At this rate – inflation is not a major
problem, but when it rises over 4%, Central Banks will be increasingly concerned.
Walking inflation may simply be referred to as moderate inflation.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
Running inflation (10-20%)

When inflation starts to rise at a significant rate. It is usually defined as a rate

between 10% and 20% a year. At this rate, inflation is imposing significant costs on
the economy and could easily start to creep higher.

Galloping inflation (20%-1000%)

This is an inflation rate of between 20% up to 1000%. At this rapid rate of price
increases, inflation is a serious problem and will be challenging to bring under
control. Some definitions of galloping inflation may be between 20% and 100%.
There is no universally agreed definition, but hyperinflation usually implies over
1,000% a year.

Hyperinflation (> 1000%)

This is reserved for extreme forms of inflation – usually over 1,000% though there is
no specific definition. Hyperinflation usually involves prices changing so fast, that it
becomes a daily occurrence, and under hyperinflation, the value of money will
rapidly decline

FACTORS INFLUENCING INFLATION

Remedies to Inflation
The different remedies to solve issues related to inflation can be stated as:

 Monetary Policy (Contractionary policy)

The monetary policy of the Reserve Bank of India is aimed at managing the quantity
of money in order to meet the requirements of different sectors of the economy and to
boost economic growth.
This contractionary policy is manifested by decreasing bond prices and increasing
interest rates. This helps in reducing expenses during inflation which ultimately helps
halt economic growth and, in turn, the rate of inflation.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
 Fiscal Policy
 Monetary policy is often seen separate from fiscal policy which deals
with taxation, spending by government and borrowing. Monetary policy
is either contractionary or expansionary.
 When the total money supply is increased rapidly than normal, it is called
an expansionary policy while a slower increase or even a decrease of
the same refers to a contractionary policy.
 It deals with the Revenue and Expenditure policy of the government.
Tools of fiscal policy

1. Direct Taxes and Indirect taxes – Direct taxes should be increased and indirect
taxes should be reduced.
2. Public Expenditure should be decreased (should borrow less from RBI and
more from other financial institutions)

To know more about the Fiscal policy in India, refer to the linked article.

 Supply Management measures

 Import commodities that are in short supply
 Decrease exports
 Govt may put a check on hoarding and speculation
 Distribution through Public Distribution System (PDS).

Measurement of Inflation

1. Wholesale Price Index (WPI) – It is estimated by the Ministry of Commerce &

Industry and measured on a monthly basis.
2. Consumer Price Index (CPI) – It is calculated by taking price changes for each
item in the predetermined lot of goods and averaging them.
3. Producer Price Index – It is a measure of the average change in the selling
prices over time received by domestic producers for their output.
4. Commodity Price Indices – It is a fixed-weight index or (weighted) average of
selected commodity prices, which may be based on spot or futures price
5. Core Price Index – It measures the prices paid by consumers for goods and
services without the volatility caused by movements in food and energy prices.
It is a way to measure the underlying inflation trends.
6. GDP deflator – It is a measure of general price inflation.

Effect of Inflation on the Economy

The effect of inflation on the economy can be stated as:

 The effect of inflation is not distributed evenly in the economy. There are
chances of hidden costs for different goods and services in the economy.
 Sudden or unpredictable inflation rates are harmful to an overall economy. They
lead to market instability and thereby make it difficult for companies to plan a
budget for the long-term.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
 Inflation can act as a drag on productivity as companies are forced to mobilize
resources away from products and services to handle the situations of profit
and losses from inflation.
 Moderate inflation enables labour markets to reach equilibrium at a faster pace .

DEFLATION
MEANING:

Deflation is defined as an economic condition whereby the prices of goods and

services go down constantly with the inflation rate turning negative. The situation
generally emerges from the contraction of the money supply in the economy

Causes of Deflation

1. A recession struck or stagnant economy gives rise to excessive price fall when
unemployment and low wages leave less money in the hands of consumers. They
spend less, save more, reducing aggregate demand and investments which leads to
fallen prices.
2. When the central bank of a nation adopts a contractionary monetary
policy for extended periods such as interest rate hikes to curb inflation or the
excessive money supply, it can cause deflation. Credit becomes expensive with
interest hikes, hindering banks’ lending facility causing a cash crunch amongst the
public.
3. A particular segment of the economy can also experience excessive price fall.
If there is over production and not a proportionate increase in buyers, it makes the
product less expensive due to over-supply and less demand. An example is China’s
2009 crisis in which the economy experienced deflation in factory prices due to price
declines globally and over production capacity.
4. Another prominent reason is perfect competition in a particular industry or
sector, which forces entities to reduce product prices to survive the competition.
Technology sector is often battling this issue.
5. The phenomena can stem from reduced production costs as well. The cost of
production steeps down because of technological advancement, discovery of newer
and cheaper resources. Overall decline in inputs reduces pricing of goods or service.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE

What is deflation in economics?

Deflation in economics is negative inflation (below 0%) that occurs when a country or

an industrial sector experiences a decrease in the price of its products and services
due to monetary contraction.
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE
MANAGERIAL ECONOMICS LECTURE NOTES M.DIVYA,B.TECH,MBA/AP/COMMERCE