BASIC MACROECONOMICS

 Microeconomics is the study of human behavior and choices as

they relate to relatively small units, such as an individual, a
firm, an industry, or a single market.
 Macroeconomics is the study of human behavior and choices
as they relate to an entire economy.
 Economic analysis attempts to explain why problems arise in
the economy and how these problems can be dealt with.
 It is therefore indispensable for formulating and conducting
economic policy.
 However, before studying macroeconomic theory and policy,
one must know the macroeconomic goals of the economy.
 There is no point in formulating a policy without definite
objectives.
 Macroeconomic policy operates within a framework of goals
and constraints.
 The most important goals of economic policy are;
 BASIC MACROECONOMICS

i. Full employment – full utilization of human and non-human

resources
ii. High living standards
iii. Price Stability
iv. Reduction of economic inequality and removal of poverty
v. Rapid economic growth
vi. External balance vs overall balance in economic relations with the
rest of the world.
 BASIC MACROECONOMICS
National Income
 The most important aspects that shape the economy is the nation’s
capacity to produce goods and services and keep various factors of
production employed.
 The GNP growth rate, the most important indicator of the nation’s
income, shows whether the nation’s income is expanding or
contracting, and thus, it is the broadest statistical aggregate of our
economic output and growth.
 The estimates of GNP and national income provide the policy
makers and business community with the most useful tool for
analyzing an economy’s economic performance, both in the short
term and long term periods.
 However, it is crucial to prepare the accurate and reliable estimates
of the nation product for purposes of meaningful economic analysis
and reliable forecasting.
 In simple terms, GNP is the sum of all final goods and services
produced during a specified time period usually a year, with each
class of goods services measured at its market value i.e. at price
usually paid.
 BASIC MACROECONOMICS
 If the same is estimated in terms of factor cost i.e. at the sum of all
income earned by factors of production (i.e. wages and salary, rents,
interest and profits), then the aggregate is GNP at factor cost.
 In the definition stated above the term ‘final’ is used to avoid the
possibility of double counting and to ensure that only the value of
final goods and services is counted in GNP. Why?
 Because of the value of an intermediate class of goods is embodied
within the value of final goods and services.
 The term ‘gross’ refers to the fact that depreciation (or capital
consumption) of structures and equipment is not deducted from the
value of output.
 Moreover, the aggregate GNP is a ‘flow’ concept. It is typically
measured in terms of an annual rate i.e. over a period of time. For
instance, India’s GDP was Rs 14, 13,200 crore in 1997-98.
 This means that Rs 14, 13,200 crore worth of final goods and services
were produced during 1997-98.
 Thus GDP is a device designed to measure the market value of
production that flows through countries various industries and shops
per year.
 BASIC MACROECONOMICS

 When measuring GNP, or any other aggregate of nation product, we

are interested in final value of goods and services.
 In other words, we are only interested in value added in each stage of
production process.
 Value added is difference between the value of goods and services as
they leave one stage of production and their cost when they entered
that stage.
 We will consider one example- production of bread- to explain the
concept clearly.
 As shown in the figure below, there are many stages in production of
wheat by the farmer to milling of wheat into the flour, the baking of
bread by the baker and its final sale to the customer by the retail shop
owner.
 BASIC MACROECONOMICS
 Value added in different stages of bread production
 Stage:1 Stage:2 Stage:3 Stage:4 Stage:5
 Value added value added by value added by value added final value
 by farmer= by Miller = by baker= by retailer= baked
bread=
 Rs 0.80 Rs. 1.50 Rs. 1.80 Rs 0.20 Rs. 4.30

 The final value of the bread is the sum total of value added at each
stage.
 If we add up all the prices at each stage, it would be a gross mistake of
double counting.
 This will distort the actual value of the product in a specified period.
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 Relationship among eight variants of national product

 The distinction between national product at market prices and national
product at factor cost, based on whether or not net indirect taxes have
been included and there is also a distinction between gross or net
national product according to which whether investment is inclusive
of capital consumption or not.
 Further, a distinction has been drawn between domestic and national
product, according to whether we are measuring net factor income
from abroad or whether we are measuring what is produced within the
domestic economy.
 This implies that there are eight combinations of national product
aggregates as shown below.
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 Gross Domestic Product (GDP) at Market Price (MP)
 at Factor Cost (FC)
 Gross National Product (GNP) at Market Price (MP)
 at Factor Cost (FC)
 Net Domestic Product (NDP) at Market Price (MP)
 at Factor Cost (FC)
 Net National Product (NNP) at Market Price(MP)
 at Factor Cost (FC)

 The way that these national product aggregates are related to each
other be understood from the figure given below.
 =GNPMP
-net indirect
- Depreciation taxes
=NNPMP =GNPFC
- net income from Abroad

- Depreciation
=GDPMP
-net indirect
taxes
- net income from
Abroad
- net income from
Abroad

- Depreciation -net indirect

=NNPFC taxes

=NDPMP - net income from Abroad =GDPFC

-net indirect - Depreciation

taxes
=NDPFC
 BASIC MACROECONOMICS
 We can sum up the differences between gross and net marketing prices
and factor cost and national and domestic concepts in the following
way:
 Gross = Net + Depreciation
 Market Prices = factor cost + [indirect taxes – subsidies]
 National = Domestic + Net factor income from abroad.
 There are some national product aggregates that are more frequently
met with and we have several ways to ordering them. One of these is as
follow:
 Gross domestic product at market price + net factor income from
abroad
 equals
 Gross national product at market price – net indirect taxes (indirect
taxes- Subsidies)
 equals
 Gross national product at factor cost – capital consumption
(depreciation)
 equals
 Net national product at factor cost, which is popularly known as
national Income
 BASIC MACROECONOMICS
 Real Vs. Nominal GNP
 It’s important to distinguish between real and nominal values of
macroeconomics aggregates.
 When comparing data at different points in time, economists often use
terms such as real wage, real income or real GNP.
 The “real” refers to the fact that data have been adjusted for change in
level of prices.
 Thus real GNP is the GNP in current rupees deflated for changes in
the prices of the items included in the GNP.
 In contrast, nominal GNP (or money GNP, as they are often called) is
expressed in current rupees.
 It measures the value of output in given period in the price of that
period, or as it is some times put, in current rupees.
 Over time, nominal values reflect changes both in a) the real size of
an economics variable and b) the general level of prices.
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 In contrast, real values eliminate the impact changes in the price level.
Stated another way, real economic data are adjusted for changes in
purchasing power of the rupee.
 Perhaps an example will clarify the difference between real and
nominal values.
 In 1998-99 the nominal GNP in India was Rs 16, 01,065 crore,
compared to only Rs. 7, 69,265 crore in India was 1993-94.
 Does this mean we produce two times as much output in 1993-94?
Not hardly.
 In 1998-99 the general level of price was higher than the level of
prices in 1993-94.
 Measured in terms of price level in 1993-94, real GNP in 1998-99
was worth Rs. 10, 71,073.
 Nominal GNP will increase either if a) more goods and services are
produced or if b) prices rise. Often both a) and b) contribute to an
increase in GNP.
 Since we are really interested in comparing only the output or actual
production during two intervals, GNP must be adjusted for the
changes in prices.
 BASIC MACROECONOMICS
 A price index called GNP deflator is constructed to a price index to
reveal the cost of purchasing the items included in GNP during the
period relative to the cost of purchasing those same items during a
base year (say 1993-94).
 Since the base year is assigned the value of 100, as the GNP deflator
takes on values greater than 100, it indicates that prices have risen.
 The central statistical organization (CSO) estimates how much of
each item included in GNP has been produced during a year.
 This bundle of goods will include automobiles, houses, office
buildings, medical services, bread and all other goods included in
GNP, in qualities actually produced during the current year.
 The agency then calculates the ratios of a) the cost of purchasing this
representative bundle of goods at current price divided by b) the cost
of purchasing the same bundle at the prices that were present during a
designated base year.
 The base year chosen is given the value 100. The GNP deflator is
equal to the calculated ratio multiplied by 100.
 If prices are, on average, higher during the current period than they
were during the base year, the GNP deflator will exceed 100.
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 The relative size of the GNP deflator is measure of the current price
level compared to price level during the base year.
 A change in nominal GNP tell us nothing about what is happening to
rate of real production unless we also know what is happening to
prices.
 Money income could double while production actually declines, if
prices more than double.
 On the other hand, money income could remain constant while real
GNP increases, if prices fall during a time period.
 Data on money GNP and price changes are both essential for a
meaningful duration a time period.
 Data on money GNP and price changes are both essential for a
meaningful comparison of real income between two time periods.
 So we look at real rather than nominal GNP as basic measure for
comparing output in different years.
 BASIC MACROECONOMICS
 The measurement of national income: output, expenditure and
income methods of measurement
 There are three methods of calculating national income, and they are
all conceptually equivalent to each other.
 These are: the output method, the income method and the expenditure
method.
 These three measures give rise to several different ways of describing
the various macro-aggregates employed in compiling the national
accounts and these are described and illustrated in tables.
 The output method: The output method is followed either by valuing
all final good and services produced during a year or by aggregating
the value imparted to the intermediate products at each stage of
production by the industries and productive enterprises in the
economy.
 The sum of these values added gives the gross domestic product at
factor cost which after a similar adjustment to include net factor
income from abroad gives gross national product at factor cost.
 BASIC MACROECONOMICS
 This approach is used to estimate gross and value added in the
primary sector- Ex. Agriculture and allied activities, forestry and
logging, fishing, registered manufacturing, etc.-of the Indian
Economy.
 The output (value added) method
 The agricultural and extractive industries 10
 Plus Manufacturing industries 40
 Plus Services and construction 40
 ----------------------------------------------------------------------
 Equals Gross Domestic Product at factor cost 90
 Plus Net factor income from abroad
 (=income received from abroad- income paid abroad) 10
 ---------------------------------------------------------------------
 Equal Gross National Product at factor cost 100
 Less Capital consumption or depreciation -20
 ----------------------------------------------------------------------
 Equals NNP at factor cost or national income 80
 BASIC MACROECONOMICS
 The Expenditure method: The expenditure method
aggregates all money spent by private citizens, firms and the
government within the year, to obtain total domestic
expenditure at market prices.
 This includes consumer spending and investment i.e. total
domestic spending.
 It aggregates only the value of final purchases and excludes
all expenditures on intermediate goods.
 However, since final expenditure at market price includes
both the effects of taxes and subsidies and our expenditures
on imports while excluding the value of our exports, all these
transactions have to be taken into account before we obtain
gross national product by this method.
 For instance, in case of private consumption expenditure,
qualities of goods and services entering private consumptions
are estimated by deducting from qualities produced, qualities
used up in intermediate uses, purchased by government, etc.
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 Similarly several items of machinery and equipment are identical and market values
of their output are together to estimate capital in from of machinery and equipment.
 The Expenditure Method 
 Consumer’s expenditure(C) 70
 Plus Government current expenditures on goods and services (G) 20
 Plus Gross domestic fixed capital formation (I) 20
 Plus Value of physical increase in stocks and work in progress (I) 10
 ----------------------------------------------------------------------------------------------
 Equals Total domestic expenditure at market prices 120
 Plus Exports and factor income from abroad (E) 20
 Less Imports and factors income paid abroad (M) -30
 -----------------------------------------------------------------------------------------------
 Equals GNPMP 110
 Less Indirect taxes -20
 Plus Subsidies 10
 -----------------------------------------------------------------------------------------------
 Equals Gross national product at factor cost 100
 BASIC MACROECONOMICS
 The Income Method: The income approach to measuring national
income does not simply aggregate all incomes.
 It aggregates only those of those residents of the nation, corporate and

individual, that obtain income directly from the current production of goods
and services.
 It aggregates money payments made to the different factors of production

i.e. factors income and excludes all incomes which cannot be concerned as
payment for current services to production (i.e. Transfer incomes and
which therefore do not enter national income).
 What is factor payment for the producers is factor income for factor

owners. It includes wages and salaries (W), rent (R), interest (I) and
profits (P).
 The last includes the profits of companies and surpluses of public

corporations.
 Thus, the total of all factor income gives total domestic income which once

adjusted stock appreciation gives gross domestic product at factor cost.

 If we then add on net factor income from abroad we have obtained one

measure of gross national income or more properly known as gross

national product.
 BASIC MACROECONOMICS
 The Income Method
 Income from employment 50
 Plus Income from self-employment 10
 Plus Gross Trading profits of companies 10
 Plus Gross Trading surplus of public corporations 10
 Plus Rent 10
 ---------------------------------------------------------------------------------
 Equals Gross domestic product at factor cost 90
 Plus Net factor income from abroad 10
 ----------------------------------------------------------------------------------
 Equals Gross national product at factor cost 100
 According to above table, conceptually whatever may be the method
followed for the measurement of national income, with appropriate
adjustments all three methods will give the same result.
 Hence, the three methods give rise to estimates of GNP which once
adjusted to take account of capital consumption (depreciation) provides the
measurement of national income by different methods, the consistency and
accuracy of the national income estimates can be cross checked.
 BASIC MACROECONOMICS
 Other measures of national output
 There are five alternative measures of national product and income:
 i) Gross national product
 ii) Net National income
 iii) National income
 iv) Personal income
 v) Disposable income
 The alternatives range from GNP, which is the broadest measures of
measure of output, to disposable income, which indicates the funds
available to households for either personal consumption or saving.
 GNP’s measured through expenditure method is the sum of consumption
(C), Gross Private Domestic Investment (I), Government Purchases (G),
and Net Export (E-M).
 Exports include factor income received from abroad and factor income paid
abroad is included in imports. Therefore, net exports include net factor
income from abroad (NFIA). By deducting depreciation from abroad net
indirect taxes from NNPMP, we get NNPFC, widely known as National
Income.
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 Through income method, national income can also be

calculated by summing up payments to all factors production:
Land, Labor, Capital and Entrepreneurship.
 Factor payments to land are rents, to labor wages, to capital
interest payments and to entrepreneurship profits.
 Therefore national income computed through income method is
equally to sum of rents, wages, interests and profits.
 Total profits can be either from incorporated business or
unincorporated business.
 Profits of incorporated are corporate profits and profits of
unincorporated business (like self-employment, small scale
industries, etc.) are proprietors’ income.
 BASIC MACROECONOMICS
 Personal income is the total income received by individuals that
is available for consumptions, saving and payment of personal
taxes.
 When we subtract income that is earned but not directly
received from and add income that is received but not earned
during the current period to national income we get personal
income.
 Thus, corporate profits which are equal to corporate profit
taxes plus retained earnings plus dividends and social insurance
taxes are deducted and transfer payments, net interest and
dividends are added to national income to get personal income.
 Disposable income is the income available to individuals after
personal taxes i.e. Disposable income = personal income minus
personal taxes.
 It can be either spent on consumption or saved.