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introduction

Chapter 1

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• Economics is the study of the allocation of scarce

resources. Unlimited wants and scarce resources to
satisfy these desires.
• The British economist Adam Smith “Wealth of Nations”
the first treatise on economics (published in 1776),
famously phrased this discussion in terms of whether a
country should produce guns or butter.
• Economics studies the best way to allocate the
resources that are available across these competing
needs. Not all these needs can be satisfied, but
economics should be able to help an individual (and
society) meet as many as possible

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• Economies allocate resources through prices.

Prices tell producers what the demand will be for
a particular product,-the market ensures that
society produces more of the goods that people
want and less of those that they do not.
• By studying prices, consumers decide which
goods to purchase and which to avoid.
Economics focuses so much on the determination
of market prices and how prices help to allocate
resources effectively. Prices are thus determined
jointly by both consumers and producers.

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COMPONENTS OF ECONOMICS
• Microeconomics and Macroeconomics.
• Microeconomics examines how individual units,
consumers or firms, decide how to allocate resources
and whether those decisions are desirable.
• Macroeconomics studies the economy as a whole. It
looks at the aggregate outcomes of all the decisions
that consumers, firms and the government make in an
economy, the overall levels of output, consumption,
employment and prices—and how they move over
time and between countries.
•
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• Example 1
• In terms of prices,
• microeconomics focuses on the price of a
particular firm’s product, whereas
macroeconomics focuses on the exchange rate
(the price of one country’s money in terms of
that of another country) or the interest rate .

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• Another way of outlining the differences
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between microeconomics and macroeconomics.

•

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• EXAMPLE 2
• Should a firm should adopt the latest developments in
information technology (IT), which may increase labor
productivity by say, 20%. Microeconomic analysis would
focus mainly on the costs faced in adopting this technology
and the likely productivity and profit gains that it would
create.
• Macroeconomics would consider this IT innovation in the
context of the whole economy.--examine how if many firms
were adopting this technology, then costs in the whole
economy would fall, and the demand for skilled labor would
rise. Increase in labor productivity, would lead to an increase
in wages and the firm’s wage bill. It might also shift demand
away from unskilled towards skilled workers, causing the
composition of unemployment and relative wages to change.
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• The microeconomic analysis is one where the firm alone is

contemplating adopting a new technology, and the emphasis
is on the firm’s pricing and employment decisions, probably
holding wages fixed or the analysis assumes that the firm’s
decisions do not influence the background economic
environment.
• In contrast, the macroeconomic analysis examines the
consequences when many firms implement the new
technology and investigates how this affects economy-wide
output, wages, and unemployment.
• Both forms of analysis have a role to play, and which is more
appropriate depends on the issue to be analyzed and the
question that needs answering.
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 DIFFERENCE BETWEEN
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MACROECONOMICS AND
MICROECONOMICS
• Macroeconomics-Large economy-wide aggregate
variables such as indicators of total economic
activity an economy’s banking and monetary
system, and how national income
,unemployment, inflation and economic growth
are determined. Macro economic policy analysis
considers the effects of changing taxes and
government spending or growth in the money
supply. And normative goals of macro economic
policy include high employment, price level
stability, economic growth and economic
security.
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• Micro economics - an economy’ s components the

study of individual decision making, resource allocation
and how prices, production and the distribution of
income are determined. focuses on interaction among
individual households, firms and specific government
agencies.
• Macro goals can be achieved only with micro policies.
Other than that there are 3 major goals for micro
policy like efficiency, equity, and freedom where
maximum freedom requires the range of choices
available to people to be as wide and deep as possible

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 EVOLUTION OF MACRO ECONOMIC
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and MICROECONOMIC ANALYSIS

• Greek words for “large“ and “small” . the tools of
macro economics are telescopes, while those of
microeconomics are microscopes -coined by Ragnar
Frisch of Oslo University during the twenties From the
very earliest times, the term Economics was
understood to mean macro economics dealing with the
entire economy and not with any particular segment of
the economy.- The mercantilists were the early
pioneers in economic thinking and were concerned
with the functioning of the whole economy.
Historically, therefore, economics was macro
economics dealing with 'large aggregates'.

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• The physiocrats - economic philosophy flourished

in France for about two decades beginning from
1758 also looked at the economy as a whole.
Although micro economics owed its origin to
Smith, a part of the classical economic literature
was a mixture of micro and macro economic
analysis. Adam Smith and his followers assumed
full employment and aggregate output as given
and believed in the 'invisible hand' which
managed the whole economy

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• . However, T R Malthus a classicist and Karl Marx

disagreed with the classical thesis of self adjusting'
economy. --denied the existence of invisible hand to
bring about smooth functioning of the economy.
• T R Malthus laid the foundation of the theory of the
behaviour of the economy as a whole.
Hence,considered as the founder of modern macro
economics, the first to point out that aggregate
demand might prove insufficient to absorb the total
production. His theory of market glut forerunner of
Keynes Theory

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• However, the neoclassical economists were

interested in micro economics and therefore
they neglected the macro economic elements.
Alfred Marshall's analysis was primarily micro
economics. Sometimes stray attempts were
made to develop macro economics.

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• The development of macro economics started

in the thirties of this century with the onset of
the 'Great Depression' when the free
economy failed to work smoothly. Keynes
pointed out that full employment could not
exist under all circumstances. Hence, Keynes
studied the forces which determined output
and employment.

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• Besides Keynes, the French economists Leon

Walras, the Swedish economist Knut Wicksell and
the American economist Irving Fisher were some
of the prominent economists who contributed to
the development of macro economics.
• The hyper inflation after the First World War and
the Great Depression of the thirties exposed the
fallacy of the self adjusting nature of the
economic system -the chief factors contributing
to the development of macro economics.

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MACRO ECONOMICS—GENERAL
INTRODUCTION
• Discipline of macroeconomics composed of three
interrelated components:
• 1 the key attributes that characterize a macro
economy;
• 2 the key macroeconomic theories that explain
how these attributes behave over time;
• 3 the key macroeconomic policy
recommendations that emerge from the
macroeconomic theories.
•

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The key characteristics of an economy
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(macro economic variables)

• 1 Output and income.
• Economy's overall economic activity i-
summarized by a measure of aggregate
output. Production or output of goods and
services generates income, so aggregate
output measure closely associated with an
aggregate income measure. The GDP is a
measure of all currently produced goods and
services valued at market prices.

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• , only currently produced goods (produced

during the relevant year) are included. only
final goods and services are counted. In order
to avoid double counting, intermediate
goods—goods used in the production of other
goods and services—do not enter the GDP
• Several other measures of output and income
are derived from the GNP.
• NNP= GNP - depreciation

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• Other measures of output and income derived from

the GNP.
• NNP= GNP – depreciation (CCA) or national income at
market price
• NI or national income at factor cost =NNP- indirect
taxes + subsidies(given to business ,factors get)
• PI =income received by persons from all sources
• PI= NI-security contributions –undistributed profits +
old age pensions
• DI = PI-Ptaxes
• Di=C+S

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• Aggregate income/output measures are

usually quoted both in current prices (in
"nominal" terms) and in constant prices (in
"real" terms).
• In real terms quotes are adjusted for inflation
and are thus most widely used since they are
not subject to distortions introduced by
changes in prices

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2 Unemployment.
• The unemployment rate defined as the fraction of
labor force not working .but seeking work. Thus, it
leaves out people who are not working but also not
seeking work—ie "voluntarily" unemployed. For
purposes of government macroeconomic policies,
only people who are "involuntarily" unemployed are
of primary concern.
• Not possible to bring down the unemployment
rate to zero in the best of circumstances.
Realistically, economists normally expect a fraction
of labor force to remain unemployed. In effect, if the
unemployment level is at 6 percent, the economy is
considered to be at fullFrom
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3 Inflation rate.
• The inflation rate -the rate of change in the price level. Most
economies face positive rates of inflation year after year. The
price level, in turn, is measured by a price index, which
measures the level of prices of goods and services at given
time.
• The number of items included in a price index vary depending
on the objective of the index. Usually three kinds of price
indexes,
• 1 consumer price index (CPI), measures the average retail
prices paid by consumers for goods and services bought by
them.a thousand items, bought by an average household,
included in this index.
• 2 Producer price index (PPI or WPI). much broader measure
than CPI .measures the wholesale prices of approximately
3,000 items. usedFileby producers (manufacturers and
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• 3Broadest measure of inflation the implicit

GDP price deflator. measures the prices of all
goods and services included in the calculation
of the current output of goods and services in
the economy, the GDP.
• In general, if one hears about the inflation rate
number in the popular media, it is most likely
to be the number based on the CPI.

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4 Interest rate.
• The interest rate - quoted in nominal terms—
that is, not adjusted for inflation. or nominal
interest rate. Egs of Hundreds of nominal
interest rates. : savings account rate, six-
month certificate of deposit rate, 15-year
mortgage rate, variable mortgage rate, 30-
year Treasury bond rate, 10-year bond rate,
and commercial bank prime lending rate. the
nominal interest rate has two key attributes—
the duration of lending/borrowing involved
and the identity of the borrower.
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• The nominal interest rate does not represent the

real cost of borrowing or the real return on
lending.
• To understand the real cost or return, one must
consider the inflation-adjusted nominal rate,
called the real interest rate. Tax and other
considerations also influence the real cost or
return. Nevertheless, the real interest rate is a
very important concept in understanding the
main incentives behind borrowing or lending.

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5 Economic growth
• Central macro economic goal is a healthy rate of
economic growth. Economic growth occurs when
more goods may be produced and alongside
economic development entails improvement in
the quality of life, in the quality of goods available
or in the ways production is organized.
• The concept of growth involves the study of
factors determining it, why some economies grow
faster than others and factors like population that
stands in the way of growth of less developed
countries
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6 Business cycles
• The Great depression of the 1930’s actually
gave an impetus to Keynes to bring out his
General theory which signaled the significance
of macro economics. Thereafter
macroeconomics grew with new theories
analyzing the causes of business cycles.

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7 International trade and finance

• It deals with an open economy and considers

how international trade and finance affect
standards of living everywhere. - studies trade
policies, the gains from trade, the different
means available to pay for imports and be
paid for exports

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 MACROECONOMIC THEORIES AND
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ASSOCIATED POLICY
RECOMMENDATIONS
• Macroeconomics examines the factors that lead to
changes in the main characteristics of the
economy—output, employment, inflation, and the
interest rate.
• A set of principles that describes how the key
macroeconomic variables are determined is called a
macroeconomic theory.
• Typically, every macroeconomic theory comes up
with a set of policy recommendations that
hopefully the government will follow.
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• Currently, there are four competing

macroeconomic theories:
• Keynesian economics,
• monetarism,
• the new classical economics,
• and supply-side economics.
• All four theories are based, in varying degrees, on
classical economics, which preceded the advent
of Keynesian

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The classical economics

• The macroeconomic theory that dominated capitalist

economies prior to the advent of Keynesian economics
in 1936 "classical macroeconomics.“
• Believed in free markets— the economy would always
achieve full employment through forces of supply and
demand.
• No role for government in economic policy.
• Did not recommend use of monetary policy or fiscal
policy by the government. This hands-off policy
recommendation is known as the laissez faire policy.

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Keynesian economics.
• born during the Great Depression of the 1930s -
followed in most capitalist countries ever since. English
economist John Maynard Keynes (1883-1946) argued
that self-adjusting market forces would take a long
time to restore full employment.
• government should intervene to increase aggregate
demand through the use of fiscal policy, involves
government spending and taxation. - jobs will be
created - increase income levels, - increase the
aggregate demand for goods and services and thus
create new jobs.

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• Modern Keynesians (also, known as neo-

Keynesians) recommend monetary policy, in
addition to fiscal policy, to manage the level of
aggregate demand. An increase in the money
supply, for example, leads to a decrease in the
interest rate which increases private
investment and consumption, boosting the
aggregate demand in the economy.

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Monetarism.

• Monetarism attempt by conservative economists to

reestablish the classical laissez faire recommendation.
Proposed by Milton Friedman (1912—) in the 1960s,
monetarism not possible to have full employment of
the labor force all the time, it is better to leave the
macro economy to market forces.
• government's use of monetary and fiscal policies to
stabilize the economy around full employment leads to
greater instability in the economy.
• Under monetarism, the only policy recommendation is
that the money supply should be allowed to grow at a
constant rate.

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The new classical economics

• The 1970s further push to revive classical orthodoxy. New
classical economists (also known as proponents of rational
expectations) provided a theoretical framework and
empirical evidence to show that neither fiscal nor
monetary policy can be effective in altering the output and
employment levels in a systematic manner.
• The concept of rational expectations - considered the use
of all available information by economic agents
(consumers, businesses, and others). Proponents of the
new classical economics argue that if economic agents used
rational expectations regarding government policies, they
would frustrate any anticipated policy action by the
government by altering their own behavior. Thus, there was
no point in conducting monetary and fiscal policies—
market forces are not amenable to such manipulation.

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Supply-side economics.
• popular during the Reagan era, been a part of
U.S. macroeconomic policies for some time. also
rooted in classical economics, even though it
accepts some Keynesian demand management
policy. Basically, supply siders emphasize
enhancing economic growth by augmenting the
supply of factors of production (such as labor and
capital). done through increased incentives like
reducing taxes and regulatory burdens. Reagan
used a major tax cut as part of his fiscal policy.
The supply siders, want a greater role for market
forces and a reduced role for government.
•

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DEFINITION AND SCOPE OF
MACROECONOMICS
• macro economic analysis is an aggregative or
general approach and defined by K E Boulding
as , "Macro economics deals not with
individual quantities but with aggregate of
these quantities - not with individual income
but with the national income, not with
individual prices but with general price level,
not with individual outputs but with the
national output".
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RECENT DEVELOPMENTS IN
MACROECONOMICS
• Followers of New Classical Economics further built on
the rational expectations concept – developed "real
business cycle models." Assuming that output is
always at its natural level, they attempt to explain
movements of the natural level of output.
• New Keynesian Economics, on the other hand, is the
result of the effort by the followers of neo-Keynesian
economics, who further refined Keynesian
Economics by explaining imperfections in different
markets.
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• New Growth Theory is the third component of

recent developments in macroeconomics. It
further refines growth theory, the intellectual
basis of supply-side economics.

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• G Ackley says "Macro economics concerns

with such variables as the aggregate volume
of the output of an economy, with the extent
to which its resources are employed, with the
size of national income and with the general
price level".

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 TYPES OF MACRO ECONOMIC
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ANALYSIS
• a Simple Macro Statics
• It studies the aggregative relations in a
Stationary state. It does not throw light on the
path of final equilibrium but analyses the
economy at a particular time.

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• b. Comparative Macro Statics

• It involves the comparative study of different.
equilibria attained by the economy due to
changes in various macro variables like total
consumption, total investment, total income
etc. does not tell the process of the
adjustment but only gives a still picture of the
various equilibria reached. This is Keynes
theory of "Shifting Equilibrium".

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c. Macro Dynamics
• Eminent economists like R Frisch, D. H Robertson, J R Hicks, M
kalecki, J Tinbergen . etc., contributed Macro dynamics
shows how equilibrium in the economy is reached as the
result of changes in the macro variables and aggregates. It
explains the process of adjustments which come into
operation due to changes in macro variables.
• For example, suppose a disturbance takes place due to
sudden change in the volume of investment in the economy.
This will in turn set off a series of adjustments through the
multiplier and accelerator effect and will bring the economy
to a new point of equilibrium at a higher level of income,
output and employment. Thus, this analysis is very realistic,
comprehensive and a complete method.

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• 6 To understand the problems faced by

various countries
• 7 To comprehend monetary problems
• 8 Study of National income
• 9 In Economic Growth
• 10 In General Unemployment
• 11 In Business Cycles:

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SIGNIFICANCE OF MACRO ECONOMIC
THEORY
• 1. Helps government in policy framing
• 2. Aggregate approach necessary to study the
entire field
• 3. Facilitates. the building of micro economics
• 4 Helps in analyzing the behaviour pattern of
variables
• 5 Working of the economy

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LIMITATIONS OF MACRO ECONOMICS

• 1. Danger of excessive generalization

• 2. Aggregates not homogeneous
• 3. Aggregate tendency influences sectors
differently
• 4. Implies that new policies not required

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 MACRO ECONOMICS AND ITS
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INTERFACE WITH BUSINESS AND

INDUSTRY
• Types of business enterprise
• 1 sole proprietorship
• 2 partnership
• 3 corporate
• whatever the type macro economics is
interfaced to it

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• 1 Impact of trade cycles -changes in demand

during booms and depressions
• 2 Sales and marketing strategies –based on
macroeconomic factors like inflation,booms
and recessions—reduce prices ,cheaper
alternatives etc
• 3 Influence of governmental policies on the
businesses. –heavy taxes, rules and regulation
affect business

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• 4 Facet of prediction—principles of macro economics helps

to predict markets, monetary policy and employment rates
,to predict economic growth and anticipate periods of
decline or recession. critical for policymakers and business
leaders; knowing what to expect or anticipate usually leads
to stronger and more effective long-term planning
• 5 Evaluating Employment Rates
• To get a grip on a region’s true rates of
unemployment. The true percentage of unemployed
workers is derived by calculating the number of those
actively seeking employment in the labor force. Excludes
those staying home to look after aged or children.Business
can anticipate changes by studying employment statistics
and govt provide welfare packages

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• 6 Understanding National Business Cycles

• macroeconomics in collecting statistics regarding
the business cycle of a given country. This
involves a periodic review quarterly of the rate of
demand for finished goods and services an
important component of the GDP. Is crucial
because when the demand for goods and
services increases within a business cycle, it is
also reflected in the GDP level — which also
usually increases as a result.

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• 7 Formulating Monetary Policies

• Macroeconomic principles to study the growth of the
GDP when Govt formulates monetary policies. like budgets
for government divisions; set out rules about how money
should be spent, and also include accountability measures to
be sure that money coming in and going out is being both
recorded and transparently disclosed.
• The monetary policy serve as a means for reducing the GDP
level or as a means for encouraging consumer behavior that
will lead to a decrease in the GDP level. particularly
necessary since GDP that is too low or too high could have a
negative effect on the economy. In particular, a GDP that is
substantially higher than normal could be a precursor to a
depression in the economy of a nation. Business will keep
track of all developments
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• 8 Predicting Economic Growth and Stagnation

• Government leaders use macroeconomics to
guide fiscal policies to prevent calamities and
spur growth in the free market. to increase
interest rates as a means of forcing consumers to
scale back on the rate of spending, for instance.
When the consumers save more and spend less,
this will be reflected in a lower GDP, which in
many cases will help stabilize the economy.
Business and industry will have to take note of
this

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• 9 Drawing up independent business policies

• Businesses and various organizations also
study macroeconomic trends with the aim of
using the results as a guide toward formulating
independent business policies. For instance, an
increase in the consumption of goods could be an
indication of increased consumer confidence,
influencing the decision of a company to either
increase or reduce production until the
consumption rates increase.

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Grasping economic issues at the global level

• Senior management in any international

company also needs to understand the institutional
structure of the global economy. Government policy
and the structure of government provide the
framework of rules within which firms operate.
• Any firm that wants to succeed must understand the
behavior of other organizations that affect its
market., and work for which the prizes are profits.
The other players in the game include governments
(whether it be a national government or an
international organization like the International
Monetary Fund and other firms.

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• For each firm, success in the marketplace

requires not just understanding the products and
strategy of the opposition but also the policy
stance of European and American governments
as well as the attitude of international
organizations like the World Trade Organization.

• Understanding the interests and behavior of the

government and its policies is therefore an
important part of corporate strategy, and this
requires a firm understanding of macroeconomics

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11 Macro economics and health of companies
• The health of a company depends on the macro
economy. Macroeconomic events like changes in
interest rates, fluctuations in exchange rates, and
shifts in the overall level of stock market prices affect
individual companies. More local events—like a rise in
the wages of the company’s workforce or the
bankruptcy of a competitor—are also important. Both
factors—the localized and the general—are uncertain.
• Aggregate uncertainty affects all firms and sectors in
the economy. Macroeconomics is essentially about the
aggregate sources of uncertainty that affect firms. like
aggregate Income tax changes, national elections,
exchange rate fluctuations and shifts in interest rates
•

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 ECONOMIC SYSTEMS
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• A system of production and exchange of goods and services

as well as allocation of resources in a society. -includes the
combination of the various institutions, agencies, entities or
even sectors and consumers that comprise the economic
structure of a given community. An economic system
resolves what, how and for whom questions.
• Some criteria used to distinguish among economic systems
are a) who owns the resources, b) what decision making
process is used to allocate resources and products, and c)
what type of incentives guide economic decision makers..
• The study of economic systems includes how these
various agencies and institutions are linked to one another,
how information flows between them, and the social
relations within the system (including property rights and
the structure of management).
• Today the dominant
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• CLASSIFICATION OF SYSTEMS
• It is threefold as below
• 1 Capitalist economic system
• 2 Socialist Economic system
• 3 Mixed economic system

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Capitalist economic system
• Private ownership of the means of production and
the market distribution of products.
• private property, freedom of enterprise capital
accumulation, wage labour and competitive markets.
, investments determined by private decision and
the parties to a transaction typically determine the
prices for exchange of assets, goods, and services.
• The entrepreneur plays a vital role. Producers free to
make and sell for profits
• consumers are free to buy whatever goods they can
afford. Consumer is the king
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• The price system is predominant. markets answer

the what, how and for whom questions. Hence
the term market system for capitalist system.
Markets transmit information about relative
scarcity, provide individual incentives and
distribute income among resource suppliers.
Market forces according to Adam smith allocate
resources as if by an invisible hand where each
individual while promoting his self interest
promotes the general welfare.

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 Flaws in capitalism or market failures
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• 1 Rules of the game not followed as no central authority to

protect property rights, enforce contracts,
• 2 People lacking resources become poorer widening the gulf
between the rich and the poor
• 3 Monopolies may result as some producers monopolise
markets by eliminating competition
• 4 All types of goods can be produced or consumed- may
produce side effects that can harm or benefit people not
involved in the market transaction.
• 5 Private firms lack the incentive to produce public goods like
national defence as they do not want non payers to enjoy the
benefits of public goods.
•
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• Economists, political economists, and historians

adopted different perspectives in analyses of
capitalism recognized various forms of it in practice.
-laissez-faire or free market capitalism, welfare
capitalism and state capitalism. Each model has
employed varying degrees of dependency on free
markets, public ownership, obstacles to free
competition, and inclusion of state-sanctioned social
policies. Capitalism has shown adaptability to
changing circumstances.The welfare state has
emerged as an aspect of capitalism. .
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•
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• capitalism as their dominant economic

system includes USA, Canada and all the
countries that are part of the European Union.
Even China has vast output coming from
private property or in other words have some
features of capitalist system. Many states have
a mixed economy, which combines elements
of both free markets with state
interventionism, and in some cases, with
economic planning.
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Socialist economic system

• A socialist economy is a system of production
where goods and services are produced directly
for use, the sole object of production would be
to meet human needs.
• Goods and services would be produced for use-
value, eliminating the need for market-induced
needs to ensure a sufficient amount of demand
for products to be sold at a profit. Production is
therefore "planned" or "coordinated", and does
not suffer from the business cycle inherent to
capitalism.

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• Webbs definition "A socialised industry is one in which the

national instruments of production are owned by public
authority or voluntary association and operated not with a
view to profiting by sale to other people, but for the direct
service of those whom the authority or voluntary association
represents". This definition does not correspond to the
present notion of socialism, because it does not imply any
idea of planning.
• Dickenson defines it as an economic organisation of society
in which the material means of production are owned by the
whole community and operated by the organs
representative of, and responsible to the community
according to general plan, all members of the community
being entitled to benefits from the results of such socialised
planned production on the basis of equal rights
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• Socialism in different forms –

• Authoritarian Socialism State ownership
covers all the means of production and
allocates them by planning for the production
of various goods- generally called communism
prevalent in countries like Russia and China.

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• Liberal Socialism,- the government takes up

the ownership of the means of production,
but the price system or market mechanism is
retained
• Other forms - Collectivism, or State Socialism ,
believing in parliamentary democracy and
nationalisation of the means of production.
etc

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• Merits of socialism
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• 1assures social justice.

• 2 Ensures better allocation of resources. central planning
authority determines the .allocation of resources ‘to promote
social welfare and social security.
• 3 Improves productive efficiency.
• National output significantly increases. iimproved techniques
of producton and scientific research freely available to all
organisations that may need them.
• 4 avoids all wastes of competition
• 5 provides social security for all citizens. , social insurance
covering unemployment, accidents, sickness, old-age
pensions, death grants, etc.
• 6 ensures economic stability. eliminates trade cycles which
cause a great hardship to the people.
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Criticisms

• 1 Bureaucracy and Red Tapeism.

• 2 Misallocation of Resources
• 3 Loss of Consumer's Sovereignty.
• 4 No incentive to hard work and stimulus
• too much power is concentrated in the State-
loss of personal liberty

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examples
• The former Soviet Union
• Cuba –health care and education managed by
govt
• North korea-economy state run
• Vietnam’s economy - socialist policy
• China has elements of socialism Venezuela,
Laos, Sweden, Belarus also state run

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• Mixed economic system‘

• characteristics of both capitalism and
socialism. A mixed economic system allows a
level of private economic freedom in the use
of capital, but also allows for governments to
interfere in economic activities in order to
achieve social aims

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Features
• (i) Co-existence of the Public and Private Sectors
• (ii) Role of Price System and Government
Directives
• (iii) Government Regulation and Control and
Private Sector
• iv) Consumers' Sovereignty
• (v) Government Protection of Labour.
• (vi) Reduction of Economic Inequalities
• (vii) Control of Monopolies
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Advantages of Mixed Economies

• Most business and industry can be left to private

firms. more efficient than government controlled
firms- can reduce the amount of government
regulation
• Can enable some government regulation in areas
where there is market failure -Taxation and
regulation of goods with negative externalities,
e.g. pollution,
• Subsidy etc public goods, like police and national
defence, and merit goods like education and
health care.

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• Can create greater equality and provide a

‘safety net’ to prevent people living in
absolute poverty
• Government can pursue policies to provide
macro-economic stability, e.g. expansionary
fiscal policy in times of a recession.

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Disadvantages of Mixed Economies

• Difficult to know how much governments

should intervene
• Too much market forces, leading to inequality
and an inefficient allocation of resources.
• Too much government intervention.

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• Examples of mixed economic countries

• “Mixed Economy” applied to a variety of nations
with a hybrid system of socialist and capitalist
policies Western Democracies such as the United
States, Canada and various Western European
nations, as well as Nordic Social Democracies,
which have high taxation and greater wealth
redistribution for social aims; even a Communist
nation like Cuba is considered to have a mixed
economy by some economists

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• Share of Government Spending as a % of GDP

• Iceland (57%)
• Sweden (52%)
• France (52.8%)
• United Kingdom 47.3%
• United States 38.9
• Russia 34.1
• China – 20% of GDP
• Hong Kong 18.6%

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GOALS OF ECONOMIC SYSTEMS

• (1) Economic efficiency,
• achieved when society is able to get the
greatest amount of satisfaction from available
resources
• (2) Economic growth
• achieved by increasing the economy's ability
to produce goods and services

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• (3) Economic freedom,

• It is the freedom to prosper within a country
without intervention from a government or
economic authority

• 4 Economic security
• Economic security -the condition of having a
stable source of financial income that allows for
the on-going maintenance of one's standard of
living currently and in the near future

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• 5 An equitable distribution of income,

• Equity achieved when income and wealth are
fairly distributed within a society.
• 6 Full employment,
• achieved when all available resources (labor,
capital, land, and entrepreneurship) are used to
produce goods and services. This goal is
commonly indicated by the employment of labor
resources (measured by the unemployment rate).
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• 7 Price level stability,

• achieved by avoiding or limiting fluctuations in
production, employment, and prices. Stability
seeks to avoid the recessionary declines and
inflationary expansions of business cycles
• 8 A reasonable balance of trade.
• Trade, in general connotation, means the
purchase and sales of commodities. In
International Trade, purchase and sale are
replaced by imports and exports
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Trade offs

• . Greater employment is typically better than less.

Stable prices are better than inflation. Economic
growth is better than stagnation. Efficiency is
better than inefficiency. An equitable distribution
is better than inequality.
• However, the pursuit of one goal often restricts
attainment of others. For example, policies that
promote efficiency might create unemployment
or policies that improve equity might limit
economic growth.

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• Full Employment and Stability, Economic Growth and

Full Employment in conflict So establish priorities
• Adam Smith in the Wealth of Nations (1776) describes
the basic characteristics of capitalism (this book marks
the birth of capitalism). Smith suggests that there are
three legitimate functions of government in a free
enterprise economy. (1) provide for the national
defense, (2) provide for a system of justice, and
(3)provides those goods and services that cannot be
effectively provided by the private economy because of
the lack of a profit motive.

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RESOURCES OF ECONOMIC SYSTEM

• In economics a resource is defined as a service
or other asset used to produce goods and
services that meet human needs and wants.
Economics itself has been defined as the study
of how society manages its scarce resources.
Classical economics recognizes three
categories of resources, also referred to as
factors of production: land, labour, and capital

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• Land
• Land is a free gift of nature. -economic
resource encompassing natural resources
found within a nations economy. includes
timber, land, fisheries, farms and other similar
natural resources. Land is usually a limited
resource for many economies

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• The classical economist David Ricardo in

defining rent which is the payment for the use
of land pointed to the fact that land has
original and indestructible powers not found
in other factors

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• He assumes that land differs in quality. There

are various grades of land, differing from each
other in respect of fertility and location. Some
pieces of land are more fertile than others
and, as compared to others, some are more
well located or near to the market centres. He
also assumes that there is perfect competition
in the market for land. Far superior grades of
land will give rise to differential rents.
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• Labor represents the human capital available to

transform raw or national resources into
consumer goods. Human capital includes all able-
bodied individuals capable of working in the
nation’s economy and providing various services
to other individuals or businesses
• Human capital can also be improved through
training or educating workers to complete
technical functions or business tasks when
working with other economic resources.

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• Most serious issue related to labour at the

macro level is the problem of unemployment
• Types of unemployment
• Demand Deficient Unemployment
• Structural Unemployment example due to:
• Occupational immobility
• Geographical immobility

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• Technological change
• Frictional unemployment
• Voluntary Unemployment
• Institutional unemployment Government
interference
• Seasonal Unemployment
• Disguised / Hidden unemployment

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• Natural Rate of Unemployment. is the level

of unemployment when the labour market is
in equilibrium. It is the difference between the
labour force and those willing and able to
accept a job at going wage rate.
• Under Employment

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capital
• 1The monetary resources companies use to purchase natural
resources, land and other capital goods. Monetary resources
flow through a nations economy as individuals buy and sell
resources to individuals and businesses.
• Capital also represents the major physical assets individuals
and companies use when producing goods or services. -
buildings, production facilities, equipment, vehicles and
other similar items in business operations Individuals may
create their own capital production resources, purchase
them from another individual or business or lease them for a
specific amount of time from individuals or other businesses.
• 2 Human capital

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Entrepreneur
• . Entrepreneurship also a factor of production
since someone must complete the managerial
functions of gathering, allocating and distributing
economic resources or consumer products to
individuals and other businesses in the economy
• Entrepreneurs are frequently thought of as
national assets to be cultivated, motivated and
remunerated to the greatest possible extent.

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• The following are the reasons why

entrepreneurs are important to the economy.
• Entrepreneurs Create New Business.
• Entrepreneurs Add to National Income
• Entrepreneurs Also Create Social Change
• Entrepreneurs regularly nurture
entrepreneurial ventures—CSR

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• The Other Side of Entrepreneurs

• Unregulated entrepreneurship may lead to
unwanted social outcomes including unfair market
practices, pervasive corruption, financial crisis and
even criminal activity.
• Findings from United Nations University also
indicate the possible implications of “over
nurturing" entrepreneurship. Wim Naudé argues
that “while entrepreneurship may raise economic
growth and material welfare, it may not always
result in improvements in non-material welfare (or
happiness). Promotion of happiness is increasingly
seen as an essential goal.”

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 FREE MARKETS AND MIXED
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ECONOMY
• A free market is a market economy system in which the
prices for goods and services are set freely by consent
between vendors and consumers, in which the laws
and forces of supply and demand are free from any
intervention by a government, price-setting monopoly,
or other authority. .
• In a free-market economy, prices for goods and
services are set freely by the forces of supply and
demand and are allowed to reach their point of
equilibrium without intervention by government policy,
and it typically entails support for highly competitive
markets and private ownership of productive
enterprise
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Concepts

• Supply and demand

• The point at which the supply and demand curves
meet is the equilibrium price of the good and
quantity demanded. Sellers willing to offer their
goods at a lower price than the equilibrium price
receive the difference as producer surplus.
Buyers willing to pay for goods at a higher price
than the equilibrium price receive the difference
as consumer surplus.

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• The model applicable to wages in the market for

labor. The typical roles of supplier and consumer
are reversed. The suppliers are individuals, who
try to sell (supply) their labor for the highest
price. The consumers are businesses, which try to
buy (demand) the type of labor they need at the
lowest price. As more people offer their labor in
that market, the equilibrium wage decreases . If
fewer people offer their wages in the market the
equilibrium wage increases.

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• Government intervention in the free market

can hamper economic growth,
entrepreneurship and a healthy economy by
disrupting the natural allocation of resources
according to supply and demand. Milton
Friedman pointed to failures of central
planning, price controls and state-owned
corporations, particularly in the Soviet Union
and Communist China.
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• Economic equilibrium
• General equilibrium theory has demonstrated, that under
certain conditions of competition, the law of supply and
demand predominates in this ideal free and competitive
market, influencing prices toward an equilibrium that
balances the demands for the products against the
supplies.
• At these equilibrium prices, the market distributes the
products to the purchasers according to each purchaser's
preference (or utility) for each product and within the
relative limits of each buyer's purchasing power. This result
is described as market efficiency, or more specifically a
Pareto optimum.
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• This equilibrating behavior of free markets

requires perfect Competition, with
assumptions , such as complete information,
interchangeable goods and services, and lack
of market power.
• Failures in competition generate overall
market failures due to asymmetric information

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• Low barriers to entry

• A free market requires a framework that allows new
market entrants. Hence, in the lack of coercive barriers,
and in markets with low entry cost it is generally
understood that competition flourishes in a free-
market environment. neither a profit motive or profit
itself are necessary for a free market.
• All modern free markets are understood to include
entrepreneurs, both individuals and businesses.
Typically, a modern free market economy would
include other features, such as a stock exchange and a
financial services sector, but they do not define it.

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• Spontaneous order-invisible hand

• Friedrich Hayek popularized the classical liberal view
that market economies promote spontaneous order
which results in a better "allocation of societal
resources than any design could achieve." According to
this view, in market economies are characterized by the
formation of complex transactional networks which
produce and distribute goods and services throughout
the economy. due to decentralized individual economic
decisions. The idea of spontaneous order is an
elaboration on the invisible hand proposed by Adam
Smith in The Wealth of Nations.

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• Critics, such as political economist Karl Polanyi,

question whether a spontaneously ordered market can
exist, completely free of "distortions" of political
policy; claiming that even the ostensibly freest markets
require a state to exercise coercive power in some
areas – to enforce contracts, to govern the formation
of labor unions, to spell out the rights and obligations
of corporations, to shape who has standing to bring
legal actions, to define what constitutes an
unacceptable conflict of interest, etc.

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General principles
• The Heritage Foundation, a right-wing think tank, tried to identify the key
factors necessary to measure the degree of freedom of economy of a
particular country. In 1986 they introduced the Index of Economic
Freedom, which is based on some fifty variables. This and other similar
indices do not define a free market, but measure the degree to which a
modern economy is free, meaning in most cases free of state intervention.
The variables are divided into the following major groups:
• Trade policy,
• Fiscal burden of government,
• Government intervention in the economy,
• Monetary policy,
• Capital flows and foreign investment,
• Banking and finance,
• Wages and prices,
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• INDIAN ECONOMY – A MIXED ECONOMY

• The Industrial Policy Resolutions passed in 1948 and 1956 gave a concrete
shape to the concept of mixed economy. According to the Industrial Policy
Resolution of 1948, industries in India were broadly divided into four
categories: (i) Exclusive government monopoly; (ii) Government-controlled
sphere; (iii) Industries subject to State regulation and control: and (iv) the
rest of the industrial field which was to be the sphere of private enterprise
under general control of the State. In other words, the whole industrial
field was split up into two broad sectors viz., public sector which was
exclusively reserved for the government and the private sector in which
private enterprise could operate freely. The Industrial (Development and
Regulation) Act, 1951 was the main instrument by which the Government
controlled and regulated private industrial enterprise i. e., controlled the
location, setting up and expansion of private industrial undertakings.
• .
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• The following striking features are present in India showing it

is a mixed economy
• Private ownership of means of production - Agriculture and
most of the industrial and services sectors are in the private
hands.
• Important role of market mechanism - Market forces of
demand and supply have free role in determining prices in
various markets.
• Growth of monopoly houses - Tatas, Birlas, Reliance, Infosys
etc.

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• Presence of a large public sector along with free enterprise

- the need to provide infrastructure for the growth of the
private sector. not hand over strategic sectors like arms
and ammunition, atomic energy, air transport etc to the
private sector . so public sector was developed on a large
scale.
• Economic planning as a means of realizing overall national
economic goals Economic planning an integral part of a
mixed economy. The planning commission lays down
overall targets for the economy as a whole for public sector
and even for sectors in private hands like agriculture. . Thus
planning is only indicative and not compulsive. India will
always remain a mixed economy.

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CONCEPTS AND COMPONENTS OF
NATIONAL INCOME (NI)
• National income is the aggregate money value
of all goods and services produced in a
country during one year, account being taken
of the deductions made due to wear and tear
and depreciation of plant and machinery used
in the production of goods and services. It is
distributed in the form of rent, wages, interest
and profits among the factors of production

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• The figures of national income represent the following

features:
• a. The total volume of goods and services produced in an
economy during one year.
• b. Total income the factors of production get in any given
period say one year.
• c. The sum of consumers expenditure, investors
expenditure and government expenditure i.e., C + I + G
• The total of these will be the same but each one is
significant because they reflect the total operation of the
economy at three basic levels of economic functions, i.e.,
production, and distribution and consumption.

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• Marshall's definition of national income

• Alfred Marshall defines National Income as "the labour
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. The limiting word net is needed to
provide for using up of raw and half finished
commodities and for the wearing out and depreciation
of plant which is involved in production; all such waste
must, of course be deducted from the gross produce
before the true or net income can be found. And net
income due on account of foreign investments must be
added in. This is the true net national income
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• Pigou's definition of natlonal income

• In the words of Pigou "the national dividend is
that part of the objective income of the
community including of course, income
derived from abroad which can be measured
in terms of money".

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• Fisher analysed national income from the

'consumption end'. He defined national income thus,
"the national dividend or income consists solely of
services as received by ultimate consumers, whether
from their material or from their human environment.
Thus a piano or an overcoat made for use this year is
not a part of this year's income, but an addition to
capital. Only services rendered to one during this year
by these things are income". This in short means that
national income is determined not by its annual
production but by its annual consumption.

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CONCEPTS OF NATIONAL INCOME

• Gross National Product (GNP)
• This is the basic social accounting measure of
the total output or aggregate supply of goods
and services. Gross National Product is
defined as the total market value of all final
goods and services produced in a year. It is a
monetary measure and it measures the value
of only finished/final goods and not
unfinished goods

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• the income received from foreign investments

and other factor services rendered abroad
should be added to the Gross Domestic
Product (GDP) in order to arrive at GNP.
Similarly the income produced by the foreign
nationals in the country should be deducted
from the GDP for purpose of . computing the
GNP

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• GNP=GDP+X-M.
• If 'X' represents the income earned by the
.nationals abroad and 'M' represents the
income earned by the foreigners in the
country

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• . Net National Product (NNP)

• NNP is calculated by deducting 'from GNP the capital
consumption allowance. "Capital Consumption
Allowance (CCA)' is the value charged for depreciation
resulting from wear and tear, accidental damages to
fixed capital and capital output charges to current
expenses. Thus NNP = GNP - CCA. When CCA is
provided for, it is called National income at 'market
price'. The higher the depreciation charges of GNP, the
lower the NNP. Thus national income at market price =
GNP - CCA.

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• . National Income at Factor Cost (NI)

• National income at factor cost is the sum total of
all incomes received by all factors of production
who have worked in the production of an
economy's output. In simple terms it means that
it is equal to the sum total of rent, wages, interest
and profits which have accrued to the suppliers
of the factors of production in a given year. NI or
NI at factor cost = NNP - Indirect Tax + Subsidies

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• Personal Incomes (PI)

• Personal income is the sum total of incomes actually-
received by the people in a given year. Certain part of the
income which the people have earned may not be
distributed to them. For example, social security
contributions, business taxes, undistributed profit and
many such items represent a part of the income earned by
the people but not actually received by them. Some income
which is not earned is received. This is called transfer
payments example old age pensions.
• Thus PI = NI - Social security contributions - undistributed
profits + old age pensions.

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• . Disposable Income (D I)
• Disposable income is that part of personal
income which the people are free to dispose
of. It is the actual income which the people
can actually spend.
• Thus D1 = Pl- Personal taxes. D1 = C+S.
• Personal Outlays (P 0)
• PO = DPI - Personal savings.
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• National Income at Current Price

• National income when calculated on the basis of 'current
market prices' is known as national income at current
prices. It does not help to understand the real state of the
economy.
• National Income at Constant Prices
• National income when calculated on 'fixed prices' at some
period of time normally called as the base year, is known as
national income at constant prices or real national income.
• Per capita Income
• Per capita income is the average income per person or
head of population. It can be calculated by dividing the
national income by the population
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METHODS OF COMPUTING NATIONAL
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INCOME
• The circular flow of production, income and
expenditure represents three related phases
namely production, distribution and
disposition. These three phases enable us to
look at national income in 3 ways –as a flow of
goods and services, as a flow of income or as a
flow of expenditure on goods and services

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• 1. The product method

• 2. The income method
• 3. The expenditure method _
• The Product Method (alternatively known as
value added method)
• According to this method production of all
types of goods is estimated and valued at
market prices
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• Production method =
• a. Product of agriculture sector +
• b. Product of industrial sector +
• c. Products of trade +
• d. Service sector income +
• e. Value of imports -
• f. Value of exports -
• g. Indirect taxes + Subsidies to be deducted
• Total = NI

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• 2. The Income Method

• This method measures national income after it has
been distributed and appears as income. Hence this
method approaches national income from the
'distribution side'. It consists in adding up the total
incomes received by the people in the country. Here
incomes from personal income as well as property
incomes should be added. Further undistributed profits
are also added. This gives the national income as a sum
of net incomes earned by individuals and business
enterprise

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• Income method =
• a. Wages and salaries of employees +
• b. Income of business companies +
• c. Rental incomes of persons +
• d. Corporate profits +
• e. Income from net interest +
• f. Indirect taxes
• g. Depreciation of capital goods
• Total = GNP

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•
• 3. The Expenditure Method
• This method arrives at national income by adding up all the
expenditure made in goods and services during one year.on
consumer goods or investment goods. made by all
individuals and the government of a country during a year.
Thus the gross national product is found out by adding up
• a. Personal consumption expenditure +
• b. Gross domestic private investment +
• c. Net foreign investment +
• d. Government purchases of goods and services
• Total = GNP

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CIRCULAR FLOW AND NATIONAL
INCOME ACCOUNTING
• Modern economic life is characterised by
continuous flow of money payments. In every
economy people are busy producing and
consuming goods and services

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Circular flow in a two-sector economy

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Circular flow in a Three-sector
economy

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Circular flow in four sector

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• All these models of circular flow show clearly the working of

the economic system.
• The circular flow of money has policy significance.
• The economy would continue to function at an even pace if
flow is smooth
• But a decrease in circular . flow of money brought about by
increasing savings of the community or a reduction of bank
credit will set in motion a cumulative deflationary trend in the
economy.
• An increase in the circular flow of money will result in the
opposite trend - increase in incomes, in demand for goods
and services and prices.
• In the interest of economic stability, therefore, the flow of
money should be smooth. Hence policies would have to be
undertaken to check both the tendencies of depression and
inflation. Keynes based his principle of the multiplier and
accelerator on the circular flow of money.
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Difficulties in calculation of national
income
• Simon Kuznets called the “Father of GNP”(as
he was responsible for providing the statistical
foundations for modern studies of the
relationships among income, consumption
and investment ) was aware of GNP’s
deficiencies as a measure of well being

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• Definition of the term 'nation' in national income

• Method to be used in national income calculations
• Stage of economic activity at which national income should
be calculated .selection of a particular stage depend upon
the function which the national income estimate is
expected to perform.
• For example, if a nation wants to show its economic power
and potentialities, then the production stage would be
most suitable.
• But if the aim is to study the economic welfare of the
individuals, as reflected by their incomes earned, then the
consumption stage would be most suitable.
•
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• Type of goods and services which should be

included in the national income It is
impossible to include the value of personal
services rendered to oneself in the national
product accounts.
• So draw a line between economic goods
which embody economic activity on the part
of the people and other goods which
represent general activity of life even though
both goods satisfy the same human want.
• Housewife work Pigovian paradox

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DIFFICULTIES RELATED WITH

UNDERDEVELOPED COUNTRIES OR
LIMITATIONS
• 1. The coexistence of monetised and non
monetised sectors
• 2. Agriculture is the primary occupation
which is at subsistence level self
consumption
• 3. Illiteracy of the people no records
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• 4. Lack of occupational specialisation
• 5. Lack of accurate data from all sectors
• Underground economy
• 6. Problems of incomes earned by the nationals
abroad
• 7. How to reconcile unpaid services
• Services like mothers work, fathers services,
brothers and voluntary services
• 8. Position of defence Services
• 9. Problem of double' or multiple accounting
• 10. Largeness of the country
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IMPORTANCE OF NATIONAL INCOME
ESTIMATES
• 1. It measures the overall production
performance during the year Per capita
income--level of economic welfare
• 2. Enables the country to know whether the
economy is growing, stagnating or declining .
• 3 Helps in analysing the distribution of
national income among the factors of
production

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• 4 help to formulate sound economic policies –

C S I growth and planning
• 5. It helps a country to compare its economic
standard with other countries
• 6. National income estimates are
indispensable to planners
• 7. National income estimates decide the
subscriptions of various countries –to IMF etc

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NATIONAL INCOME AND ITS

LIMITATION AS AN INDEX OF
ECONOMIC WELFARE
• Levels of national income are only one measure
of welfare of a society as national income is a
relatively narrow measurement being merely the
addition of all marketable output in the economy.
Does not measure the genuine output of the
economy. Many goods and services are not
marketed. The produce of a subsistence farmer
or domestic work of a householder are examples
of genuine output which goes unrecorded.
• Many goods and services which are marketed are
not recorded primarily due to tax evasion
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• Welfare gained outside the productive system

The quality of the physical environment is one
example. A clean and healthy environment
affects living standards.
• Political liberties too are vital to our welfare
• Besides, increasing material affluence does
not necessarily lead to increase in welfare
• Several other wastes of resources can be cited
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• Further a rise or fall in the general price-level will cause

the national income to rise or fall even though there is
no change in the actual production of goods and
services in the economy
• National income or per capita income increase must be
interpreted with reference to the general economic
environment in which it is brought about.
• Higher national income may be brought about by
employing women and children or by -making workers
to work even on holidays under unhealthy conditions.
In this case, a rise in national income will not indicate a
rise in the economic welfare of the community.

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• The distribution of income in the community is also to

the considered while discussing per capita income as
an index
• the people may spend on drinking, gambling, etc.,
which will ultimately reduce economic welfare of the
people. Meier and Baldwin who emphasising social
cultural factors in the process of development say, "For
economic welfare is only a part of general economic
welfare, and it is the latter which should have prime
consideration. An increase in national income will not
entail an increase in social welfare, if the increase is
accompanied by weak cultural adjustments".

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• India as a mixed economy and features

• TRENDS IN INDIA’S NATIONAL INCOME AND
STRUCTURE
• INDIAN ECONOMY 2015-16
• ( To be done by students presentations)

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• QUESTIONS FOR REVIEW

• Conceptual type
• 1 State the objectives of macro economics
• 2 Define macro economics
• 3 Point out the difference between micro and macro
economics
• 4 Outline the scope of macro economics
• 5 What are the macro economic variables?
• 6 Distinguish between GNP and NNP
• 7 Distinguish between personal income and disposable
income
• 8 Define the term economic system
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• 9 State the various resources of economic system

• 10 What is a mixed economy?
• 11What is a free market economy?
• 12 State any 4 goals of economic system
• 13Define national income
• 14 Give the meaning of GDP
• 15 What is disposable income?
• 16 What is real GDP?
• 17 What is percapita income?
• 18 What is the difference between nominal interest
rate and real rate of interest
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• Analytical type
• 1 What is macro economics? Explain its significance
• 2 What are the various concepts of national income?
• 3 Explain the various methods of measuring national income of a
country
• 4 Explain the concept of circular flow of income
• 5 What are the difficulties involved in the calculation of national
income?
• 7 Explain the expenditure method for calculating national income
• 8 Explain the nature and scope of macro economics
• 9 Analyse the interface of macro economics with business and
industry
• 10 Explain the various types of economic systems
• 11 Write a note on mixed economy
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• 12 What is the significance of macro economic

analysis in business decisions?
• 13 Explain the difficulties an underdeveloped
economy faces in calculation of national income
• 14 Highlight the significance of national income
analysis to business people. how is national
income calculated and what are the difficulties in
measurement?
• 15 What are the various economic systems?
Explain their features
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