MACROECONOMICS

Module 1-2 (Introduction and National Income Accounting)

30-11-2018

Dr.B.Chatterjee
NMIMS School Of Commerce
Email: [email protected]
Mobile: 9891102177

14-12-2018 to be used only for lecture purpose at NMIMS SOC 1

Evaluation Criteria
External Exam: 50 Marks Internal Marks: 50 Marks

Internal Components Marks

Internal Written Test (20 Marks) 20
20
Assignments/ Case Study/ Class test/
Presentations/Project 10

Total 50

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• What is macroeconomics?

• What are it’s objectives?

• Is it important for managers?

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Microeconomics
Microeconomics is the study of how individuals (households) and firms
(producers/suppliers) make decisions and how they interact in markets

- Examine choice behaviors of households and firms

- How households and firms interact in different market structures

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What is macroeconomics?
• Macroeconomics is the study of the behavior of the economy as a
whole and the policy measures used to influence factors like
total output, rates of unemployment, inflation, and exchange rates, government
deficit/debt etc

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Major Macroeconomic Objectives
Growth

Employment

Price stability

Addressing inequality

Sound Government finances

External balance/Stability

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Macroeconomic Policies: Objectives

Education
Policy
Monetary Labor
Policies policies

Land
Fiscal MACRO
acquisition
Policies OBJECTIVES
policy

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Why is it important for managers?
Mr.Kapoor owns a manufacturing business which is a global supplier of
high precision components for computer games. He has to decide how
many components to produce this year. Every year he doubles his
production, so this year he decided to do the same thing again,
because he never had trouble moving inventory. He has obtained a
short term loan to finance the expansion.
In a recent effort to tame inflation, RBI did an open market operation
(OMO) by selling bonds. On the other hand, a week after RBI’s OMO,
US Fed announced loosening of monetary policy through quantitative
easing.
Would this have any implication on Mr.Kapoor’s decision to expand his
business?

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Why is it important for managers?

Two data points were released on the last day of 2012. The current
account deficit in the second quarter of the current fiscal (July-
September 2012) reached an alarming level of 5.4% of the gross
domestic product (GDP), while fiscal deficit reported to have touched
80% of the full year target by the end of November. The government is
trying hard to restrict the fiscal deficit to 5.3% of the GDP.
You are into a business of producing and exporting organic chemicals
for products like adhesives, agrichemicals, food additives.
What policy change you might expect in this situation and how would
that impact your business?

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Why is it important for managers?
A manager has to be perform within the boundaries of macroeconomic environment

Macroeconomic Environment
• Demand will be stable
• Interest rates will be stable
• Stability in prices
• Tax rates stability
• Exchange rate fluctuations will
be minimum

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 GROSS DOMESTIC PRODUCT
(GDP)

UNEMPLOYMENT INFLATION

EXPORT AND IMPORT

EXCHANGE RATE

BUSINESS CYCLES MODELS

FISCAL MONETARY
POLICY POLICY

Fiscal Stimulus,
Interest rate
Taxation

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Are these important for Managers??
A manager has to be perform within the boundaries of macroeconomic environment

• To understand how economy functions-what causes fluctuation in

demand
• Direction of government policies
• To arrive at a decision on timing of fresh investment
• To get the best return on investment

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Course Learning outcomes
Will give you a framework to understand:
How an economy works
Major macroeconomic parameters involved in the functioning of an
economy
Short run fluctuations of these parameters in an economy-Business
Cycles
Policy prescriptions (Fiscal and Monetary Policy) to stabilize these
fluctuations

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Concepts and Variables in Macroeconomics
• Gross Domestic Product (GDP)
• Unemployment
• Inflation
• Exchange rate
• Money
• Interest rate

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Concepts and Variables in Macroeconomics
Stock and Flow Variable
Flow variable
A flow is a quantity which is measured with reference to a period of
time. Thus, flows are defined with reference to a specific period (length
of time), e.g., hours, days, weeks, months or years. It has time
dimension. National income is a flow. It describes and measures flow of
goods and services which become available to a country during a year.

Other examples of flows are: expenditure, savings, investment

depreciation, interest, exports, imports, change in inventories (not
mere inventories), change in money supply, lending, borrowing, rent,
profit, etc. because magnitude (size) of all these are measured over a
period of time.
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Concepts and Variables in Macroeconomics
Stock and Flow Variable
Stock variable
A stock is a quantity which is measurable at a particular point of time,
e.g., 4 p.m., 1st January, Monday, 2010, etc. Capital is a stock variable.
On a particular date (say, 1st April, 2011), a country owns and
commands stock of machines, buildings, accessories, raw materials,
etc. It is stock of capital. Like a balance-sheet, a stock has a reference to
a particular date on which it shows stock position. Clearly, a stock has
no time dimension (length of time) as against a flow which has time
dimension.
Other examples of stocks are: wealth, foreign debts, loan, inventories
(not change in inventories), opening stock, money supply (amount of
money), population, etc.
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We are interested in
Business Cycle
The Indian economy expanded 7.3% in the year ended March, in line
with the initial forecast and marginally higher than 6.9% recorded in
the previous year.
What does “Indian economy expanded 7.3%” mean? How is this
growth rate calculated?
Understanding GDP: The Circular Flow of Income (Ref-Vanita Agarwal Chapter 2)
Injections: Govt.(G)/Exports(X)/Investment(I)

FIRMS

Land rent Payment Goods

Labor wages for and
Capital profit/i Goods Services
nterest and
Services

National
HOUSEHOLDS Expenditure/GDP
National
Income

Leakages: Taxes(T), Imports(M), Savings(S)

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Understanding GDP: The Circular Flow of Income (Two Sector Economy)
Injections: Investment(I)

FIRMS

Land rent Payment Goods

Labor wages for and
Capital profit/i Goods Services
nterest and
Services

HOUSEHOLDS

Leakages: Savings(S)

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Understanding GDP: The Circular Flow of Income (Three Sector Economy)
Government Spending
G>T
- Government follows a
taxes Budget deficit
FIRMS
- Difference is financed by
capital Market
Investment
Rent

Government
Land
Labor
Wages Payments
for final
Goods - Money flows from capital
Capital
Profit/Int
erest
Capital market goods and
and
Services market to government
services
sector
Saving

HOUSEHOLDS
taxes

Government Spending

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Understanding GDP: The Circular Flow of Income (Four Sector Economy)
Government Spending Payment for Imports

taxes Payment for

Exports
FIRMS

Investment
Rent Payments
Land Goods
GOVERNMENT Labor
Wages for final
and FOREIGN
Profit/Int Capital market goods and
Capital erest services
Services
SECTOR

Saving

M>X M<X
HOUSEHOLDS - Current Account - Current Account
taxes
Surplus
- Leakages are more
than injections - Injections are more
than leakages
Government Spending - Leads to foreign
borrowing - Leads to foreign
lending
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Gross Domestic Product
GDP is the Market Value of all Final Goods and Services Produced on
Domestic Soil During a Given Time Period
Market Value
Final
Produced
Domestic Soil
Given Time Period
 GDP measurement
Orange Inc Transactions
Wages paid to Orange Inc $15000 Expenditure Method (expenses by final users)=10k+40k=50k
Employees
Rent paid for land $5000
Oranges sold to public $10000 Value Added:
Oranges sold to Juice Inc $25000 Value Added by Orange Inc: (25k+10k)=35k
Juice Inc Transactions Value added by Juice Inc: (40k-25k)=15k
Wages paid to Juice Inc $10000 Total: 50k
Employees
Interest paid on capital used $2000
Oranges purchased from $25000 Income Method:
Wages: 15k+10k=25k
Orange Inc
Interest: 2k
Revenue received from sale $40000 Rent: 5k
of orange juice Profits: 15k+3k= 18k
Total: 50k
Using GDP calculation methods for a Bread
Economy
Let us consider this bread economy:
• The bread economy, which has Farmer, Miller, Baker, Consumers.
• The farmer grows wheat and sells it to the miller at Rs. 500. Assume
that he incurs no cost for intermediate goods. Though there is a
labour cost of Rs. 100.
• The miller buys the wheat at Rs. 500 and turns it into flour. He incurs
a labour cost of Rs. 50. He sells flour to the baker at Rs. 700.
• The baker buys the flour and employs labour at a cost of Rs. 100 to
make it into a bread which he sells to the consumer at Rs. 1000.
GDP measurement
Stage of Sales Cost of Value Added Labor Cost Factor
Production Receipts Intermediate (4) (5) Incomes
goods
(1) (2) (6)
(3)
Farmer: 500 0 500 100 W=100
Wheat P=400
Miller: Flour 700 500 200 50 W=50
P=150
Baker: Bread 1000 700 300 100 W=100
P=200

• Expenditure method/Final Demand (GDP at market price: GDPmp)=

Sales Receipt from Bread=1000.
• Value added method (GDPmp)=500+200+300=1000
• Income method (GDPfc)=W+P=250+750=1000
Expenditure method=valued added method=Income Method
Find out Nominal GDPs, Real GDPs, and GDP
growth rates using 2011 as the base year

Good or 2011 2012 2013

Services P Q P Q P Q

Apples 2 40 3 60 5 60

T-Shirts 8 90 10 150 9 170

Bicycles 80 100 90 110 110 100

Mobiles 70 120 80 130 80 180

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Exercise: GDP Measurement
Company A sells raw material worth of Rs. 1000/- to Company B who
uses this raw material to manufacture product X and sells a part to
Company C and rest to the public directly. Company B pays wage cost
of Rs. 5000/- and its total sale is Rs. 15000/-. Company C pays Rs.
10000/- to Company B for product X and converts it into product Y and
sells to the end consumer at Rs. 25000/-. Company C pays wage cost of
Rs. 7000/-. There is no wage cost in company A.

Using Expenditure, Income and Value Added Methods, estimate the

GDP of this country which has just these three production entities,
companies A, B and C.
Summarize
• To measure GDP we may use Expenditure/Final Demand method
where we add all the expenses/pending on final goods and services.
This is called GDP at market price.
• GDP can also be measured by Income Approach where we add the
incomes derived by the factors of production. This is called GDP at
factor cost.
• According to the circular flow, GDP at market price and GDP at factor
cost both are conceptually equal.
GDP vs GNP
Country and Resident Geography Factor Count in India’s GDP Count in India’s GNP
Location Status Income

Infosys in US Resident US 300 No Yes

IBM In India Non- India 500 Yes No

Resident

If India’s GDP is 1000, what would be India’s GNP?

GNP=1000+300-500=800

GNP=GDP+ Net factor income from abroad (NFIA)

GDP=GNP-NFIA

NFIA: factor incomes earned by our residents from the rest of the world minus factor incomes
earned by non-residents from our country.
Is there any difference between GDP/GNP at
market price and GDP/GNP at factor cost?
• GDP/GNP measured at factor cost is obtained when we measure
GDP/GNP using Income method- Remember!
• Let’s say there is only one final product in the economy, whose
market price is Rs.100 and has an excise duty of Rs.20.
• GDP at market price is 100, but GDP at factor cost is 80

GDPfc=GDPmp- (net indirect taxes)

GNPfc=GNPmp- (net indirect taxes)

What is Gross about Gross Domestic Product?
Suppose Rs.100 crores worth of investment goods (say machines and
tools) are added in the current year, but Rs. 25 crores of investment
goods have been used up in the production of current’s year’s output.

While calculating GDP we add 100 crores.

If we add 75 crores, what we will be calculating is Net Domestic
Procuct.
GDP- depreciation= Net Domestic Product (NDP)
GNP- depreciation= Net National Product (NNP)
From GDP to National Income
National Income: factor incomes earned by the residents of a country
Step 1: Convert GDP to GNP
GNP=GDP+NFIA
Step 2: Convert GNP at market prices (GNPmp) to GNP at factor cost
(GNPfc)
GNPfc = GNPmp - Net indirect taxes
Step 3: Convert GNPfc to NNPfc
NNPfc= GNPfc – depreciation
National Income (NI)is NNPfc
Summarize
• Expenditure method/Final demand method and value added
methods gives GDPmp
• Income method gives NNPfc which is National Income (NI)
• Conceptually these two are the same, as per the circular flow of
income.
• The only difference in NI and GDPmp is:
NNPfc/NI= GDPmp+ NFIA — net indirect taxes — depreciation

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Treatment of certain transaction in national
income accounting
Social security payments received by a retired factory worker
The services of a painter in painting the family home
The money received by Smith when she sells her economics textbook
to a book buyer
The monthly allowance a college student receives from home
The purchase of an Reliance bond

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Treatment of certain transaction in national income accounting
Social security payments received by a retired factory worker
Excluded: A transfer payment from taxpayers for which no service is rendered
The services of a painter in painting the family home
Excluded: Not a market transaction
The money received by Smith when she sells her economics textbook to a book
buyer
Excluded: Secondhand sales are not counted; the textbook is counted only when
sold for the first time
The monthly allowance a college student receives from home
Excluded: A private transfer payment; simply a transfer of income from one
private individual to another for which no transaction in the market occurs
The purchase of an Reliance bond
Excluded: A non-investment transaction; it is merely the transfer of ownership of
financial assets. (If Reliance uses the money from the sale of the bond to carry
out an investment in real physical assets, that will be counted.)
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CRISIL Economy First Cut
• GDP growth slowed to 7.0% y-o-y in Q1 FY16 from 7.5% in Q4 FY15.
• Agriculture growth rose as compared to the previous quarter. Agriculture
growth picked up to 1.9% versus a fall of 1.4% in Q4 FY15. However, in
comparison with Q1 FY15 and trend, agriculture growth was much lower.
• Industry growth rose to 6.5% in Q1 FY16 as compared to 5.6% in the
previous quarter. This was led by a rise in construction and mining and
quarrying activity while electricity, gas, water supply & other utilities and
manufacturing activity disappointed in Q1 (fell to 3.2% and 7.2%
respectively).
• Service sector grew by 8.9%, lower than versus 9.2% in Q4 FY15. This was
led by lower growth in trade, hotels, transport, communication and
services related to broadcasting (at 12.8%) and financial, real estate and
professional services. On the other hand, growth in public administration,
defence and other services picked up to 2.7% as compared to 0.1% in Q4
FY15.
• Despite slower growth, Consumption was the largest contributor to growth
in Q1
 GDP growth measurement using data from Ministry of Statistics and
Programme Implementation (MOSPI)

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Treatment of Inventories in GDP
GDP= Consumption Expenditure (C)+ Investment Expenditure (I)+ Government
Expenditure (G) + Net Exports (X-M)

Investment Expenditures: Planned Investment Expenditure (Gross fixed capital)

+ Unplanned Investment Expenditure (Change in Stocks)

Planned Investment Expenditure: new physical assets (machines, factory etc.) +

inventory maintained by businesses

Unplanned Expenditure: Changes in inventory/stock

(accumulation/decumulation to existing inventory/stock level)
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 Example
GDP $6000

Gross Investment 800

Net Investment 200

Consumption 4000

Govt. Purchases of goods and Services 1100

Govt. Budget Surplus 30

What is:
NDP, Net Exports, Govt. Taxes minus
transfers, disposable personal income,
personal saving?
Answer
• NDP= GDP-depreciation
• Depreciation=Gross Investment-Net Investment=600
• NDP=6000-600=5400
• GDP=consumption+gross investment+govt. purchases+Net Exports
• 6000=4000+800++1100+NX
• NX=100
• Budget Surplus=G+Tr-Tax
• 30=1100+Tr-Tax
• Tr-Tax=-1070
• Tax-Tr=1070
• Disposable personal income=GDP+Tr-Tax=6000+(-1070)=4930
• Personal savings=4930-4000=930