Macroeconomics

Ganesh Kumar N.
 Agenda
■ Course administration
■ Scope of macroeconomics
■ Observed facts of economies
■ Long run, short run, medium run
models
■ Business cycles
■ National income accounts
TEXT BOOK:

Dornbush, R., Fischer, S. & Startz, R. (2018),

Macroeconomics, 12th Edition. New Delhi:
Tata McGraw-Hill.
Course Evaluation

Component %age

Quizzes 20

Mid Term 35

End Term 35

Class 10
Participation
Scope of Macroeconomics
■ Macroeconomics is concerned with economy
as a whole
– Booms and recessions
– Consumption and investment
– Rate of inflation, wages
– Interest rates–
– Unemployment
– Exports, Imports, Balance of payments
– Budget deficits
– Monetary policy and Fiscal policy
Observed facts about economies
■ Over long periods of time economy grows at
steady rates – Long run behaviour of the
economy
■ In some periods inflation rates are much
higher – 1970s; Medium run behaviour of the
economy.
■ In bad year unemployment rate rises – short
run behaviour – year to year fluctuations
■ Macroeconomics help us understand the
reasons for these observed facts
Aggregate demand & aggregate
supply
■ Aggregate supply: amount of output an
economy can produce with the given
resources and technology
■ Aggregate demand: Total demand for goods
& services (consumption, investment, govt.
purchases, net exports)
Economy with fixed productive
capacity
■ Why in some countries prices are stable
for many years while in some prices
double every month?
■ In the long run output is determined by
supply side (productive capacity)
■ Price level is determined by demand
relative to the output economy can
supply.
 Economy with fixed productive
capacity
Level of output
P
AS
is determined by
productive
capacity
Price level

Inflation (price
rise) is due to
changes
AD in AD
and AS; mainly
due to changes in
AD
Output, Y
Y0
 AS in the long run
P AS

Price level
Output (Y)

Time
Output, Y
Short run

■ Fluctuations in output around the potential output

■ Flat AS: Any level of output can be produced at a
given price
Underlying assumption is output does not affect
prices in the short run
Short run
P

Fluctuations in output are

due to fluctuations in AD
Price level

AS

AD

Output, Y
Y0
Medium run Positively
sloping AS:
P
When AD
demand pushes
AS output beyond
Price level

sustainable level
as per the long
run model, firms
AD start raising
prices

Y0 Output, Y
Business cycles

■ Inflation, growth and output are related

through business cycles
■ Business cycle is a regular pattern of
expansion (recovery) and contraction
(recession) in economic activity around
the path of trend growth
 Pea Recess
Output

k ion

Recov
ery
Trou
gh

Time

A recession (technical) is a decline in output that persists

for two or more consecutive quarters in a year.
 Duration of Cycles and
Recession in USA
Average of all cycles No. of months of
recession
1854-1919 (16 cycles) 22
1919-1945 (6 cycles) 18
1945-2001 (10 cycles) 10

Great Depression: 43
August 1929(III)-
March 1933(I)
Mother of all recessions - Great
depression
Between 1929 and 1933 in USA:
■ The stock market fell by 85%
■ GNP fell by nearly 30%
■ Unemployment rose from 3% to 25%
■ Consumer price index fell by 25%
■ Investment collapsed.
Inflation and business cycle

■ Output gap =actual output – potential output

■ Inflation rates are positively related to output gap
■ During recession inflation comes down
■ During boom inflation rate picks up
USA: Rate of Inflation in Consumer Prices,
1960-2002
 National Income Accounts:
Agenda
■ National income accounts
– Circular flow of income, GDP,
components of aggregate demand
■ Inflation & its measurement – WPI,
CPI, GDP deflator
■ Some important identities
■ Data sources
 CIRCULAR FLOW OF INCOME

Consumption Exp.

Goods and Services

Household
FIRMS Sector

Factor
Payment Services
of Factor Income
(Wages, Profit, Interest,
Rent)
 Govt.
Purchases Govt Tax

Investment Capital Mkt Saving

Consumption Exp.

Goods and Services

Household
FIRMS Sector

Factor Services
Payment of Factor Income
CIRCULAR FLOW OF INCOME
Gross Domestic Product (GDP)
Economic performance of country is measured
in terms of GDP growth

India’s GDP growth at current prices

2013-14 2014-15
--------- ----------
Growth rate % 13.58 10.54

In which year India has done better?

 Gross Domestic Product (GDP)
GDP is the market value of all final goods and
services produced within a country in a given
period of time

Measuring GDP
1.Production approach
2.Income approach
3.Expenditure approach
 Govt.
Purchases Govt Tax

Investment Capital Mkt Saving

Expenditur Consumption Exp.
e
approach
Goods and Services

Production
Household
FIRMS approach Sector

Factor Services
Payment of Factor Income
Income
approac
Nominal GDP (GDP at current Prices) –
Product approach
2011-12
Items Price (Rs.) Quantity Market Value

Oranges 20 10,000 2,00,000

Apples 30 5,000 1,50,000

Total 3,50,000
2019-20
Items Price (Rs.) Quantity Market Value

Oranges 25 20,000 5,00,000

Apples 55 10,000 5,50,000
Total 10,50,000
Real GDP (GDP at const. prices)

2019-20
Items Price (Rs.) Quantity Value at
2011-12 2019-20 2011-12 prices

Oranges 20 20,000 4,00,000

Apples 30 10,000 3,00,000

Total 7,00,000
 GDP indicators

GDP 2011-12 2012-13 2013-14 2014-15

Current prices 88,32,012 99,88,540 113,45,056 125,41,208
(Rs.Cr)
2011-12 prices 88,32,012 92,80,803 99,21,106 106,43,983
(Rs.Cr)
Growth (current
prices) - 13.09 13.58 10.54
Growth (2011-12
prices) - 5.08 6.90 7.29

Source: http://statisticstimes.com/economy/gdp-of-india.php
Components of Aggregate demand
■ We look at different purposes for which
domestically produced goods and services
are demanded.
■ Aggregate demand is the total demand for
goods and services in the economy.
■ AD= Consumption (C), Investment (I), Govt.
spending (G), and net exports (NX).
■ AD= C+I+G+NX
Consumption
■ Consumption is spending by household on
food, clothing, education etc.
Components of Aggregate
demand
Investment
■ Investment (I) means addition to physical
stock of capital. It also includes inventories
with firms.
Govt. Spending (G)
■ It refers to govt. purchases of goods and
services.
■ It includes such items as national defence
expenditure, costs of roads, salaries of govt.
employees etc.
Components of Aggregate
demand
Net exports (NX)
■ Spending by foreigners on domestic
goods [ export, X] minus spending by
domestic residents on foreign goods
(import, Q)
■ NX = X-Q
 Problems of GDP Measurement

✔Productive Vs. Non-productive activity: In

general activities resulting in marketable goods
and services should be included in national
income.
✔Non-market transactions are generally
excluded- Example: Contribution of home
makers. However, there are exceptions.
Example: Produce consumed by farmers also
included in India’s GDP
 Problems of GDP Measurement

Excluded from GDP

✔Underground economy
✔Change in the quality of goods
✔Effect on Environmental pollution/ degradation
✔Distributional aspects & quality of life: Healthcare,
schooling, distribution of income, happiness
GDP deflator

■ GDP deflator: Measure of price index

■ (Nominal GDP/Real GDP)*100
■ Our example for 2019-20 GDP deflator:
(10,50,000/7,00,000)*100 = 150.00
■ This means that prices have risen by
50% over the base year (i.e., over
2011-12 to 2019-20).
Nominal & Real GDP– Product approach
2019-20
Items Price (Rs.) Quantity Market Value

Oranges 25 20,000 5,00,000

Apples 55 10,000 5,50,000
Nominal GDP 10,50,000

Items Price (Rs.) Quantity Value at 2011-12

2011-12 2019-20 prices
Oranges 20 20,000 4,00,000

Apples 30 10,000 3,00,000

Real GDP 7,00,000

GDP and related indicators (Source: Economic Survey
2018-19)

2015-16 2016-17 2017-18 2018-19

GDP current prices
(Rs.Cr) 13771874 15362386 17095005 19010164
GDP Const. Prices
(Rs. Cr) 11369493 12298327 13179857 14077586

Questions:

1.What is the GDP deflator for 2015-16 to 2018-19?

2.What is the inflation rate for 2016-17 to 2018-19?
 WHOLESALE PRICE INDEX

New WPI (2011-12 base) tracks 697 products

 Consumer Price Index (CPI)
(2011-12 base)
Basket:
Food, Beverages : 45.86%
Tobacco and intoxicants: 2.38%
Fuel and light: 6.84 %
Housing: 10.07%
Clothing and foot wear: 6.53%
Misc. (Education, healthcare etc.): 28.32 %

Inflation rate is the % change in price index.

 Correlation
coeff
FOOD & WPI 0.037535
FOOD & CPI 0.639387
 Some important identities

Y=C+I+G+NX (income/output = expenditure)

YD=Y+TR-TA (disposable income)
YD=C+S
■C+S=(C+I+G+NX)+TR-TA
■S-I=(G+TR-TA)+NX
■S-I= (G+TR-TA)+(X-Q) . Twin deficits
 Other National Income Concepts
GVA (FC) = Factor income earned by factors of production
(Wage + Profit + Rent + Interest)
GDP = GVA (FC) + Prod. Taxes – Prod. Subsidies
GNP = GDP + Net Factor Earnings from abroad (NFI)
NNP= GNP – Depreciation
National Income =
NNP – Prod. Taxes + Prod. Subsidies
= GVA (FC) –Dep. + NFI
PI = National income - Ret. earnings - Corporate taxes +
Transfer payments
Disposable Income (DI)= PI - Personal Taxes
DI = Consumption + Savings
Sources of Data
Government of India, Ministry of Statistics and
programme Implementation Web site:
http://mospi.gov.in/
CSO:The Central Statistical Organisation is
responsible for coordination of statistical activities
in the country, and evolving and maintaining
statistical standards.
Data: National accounts, CPI, WPI etc.f NSSO
The National Sample Survey (NSS), initiated in the
year 1950, is a nation-wide, large-scale, continuous
survey operation conducted in the form of
successive rounds. Surveys on consumption,
employment.