Unit 1: Macroeconomic Concepts
1. National Income and Its Measurement:
National Income: The total value of all goods and services produced in an economy
within a specific period (usually a year). It measures the overall economic activity of a
nation.
Methods of Measurement:
1. Income Method: Summing up all incomes (wages, rents, interests, profits) earned
by the factors of production.
2. Expenditure Method: Adding up all expenditures in the economy (Consumption
+ Investment + Government Spending + Net Exports).
3. Production/Output Method: Calculating the value of all final goods and services
produced in the economy.
2. National Income Accounts:
These are comprehensive records of the economic activities of a country, structured into
different accounts such as:
o Gross Domestic Product (GDP): The market value of all final goods and
services produced within a country.
o Net Domestic Product (NDP): GDP adjusted for depreciation.
o Gross National Product (GNP): Total output produced by the residents of a
country, including income from abroad.
3. Nominal vs. Real Income:
Nominal Income: Income measured in current prices, without accounting for inflation.
Real Income: Adjusted for inflation, it reflects the actual purchasing power of income.
4. Actual vs. Potential Income:
Actual Income: The current level of output produced by an economy.
Potential Income: The maximum possible level of output the economy could achieve
with full employment and efficient resource use, without triggering inflation.
5. Classical Theory of Income and Employment:
Core Idea: The economy always tends to full employment through the self-regulating
market mechanism.
o Say’s Law: “Supply creates its own demand.” This implies that there will always
be enough demand to absorb output.
o Assumption: Prices and wages are flexible, ensuring equilibrium in both the labor
and goods markets.
6. Keynes's Criticism of Classical Theory:
Keynesian View: Demand, not supply, drives economic activity.
o The economy can remain stuck in a situation of underemployment equilibrium
due to insufficient aggregate demand.
o Government intervention (via fiscal and monetary policies) is necessary to boost
demand and achieve full employment.
Unit 2: Keynesian Economics
1. Keynes' Theory of Income and Employment:
Keynesian Model: Focuses on aggregate demand as the key driver of income and
employment levels.
o Aggregate Demand (AD): The total demand for goods and services in the
economy.
o Aggregate Supply (AS): The total output producers are willing to supply at a
given price level.
2. Consumption and Investment Functions:
Consumption Function: The relationship between consumption and income. Keynes
believed that as income increases, consumption increases but at a decreasing rate.
o C = a + bY where C = Consumption, a = Autonomous consumption, b =
Marginal Propensity to Consume (MPC), Y = Income.
Investment Function: Investment is determined by interest rates and business
expectations about the future.
3. Concepts of MPS, APS, MPC, APC:
MPC (Marginal Propensity to Consume): The fraction of additional income that is
spent on consumption.
MPS (Marginal Propensity to Save): The fraction of additional income that is saved.
APC (Average Propensity to Consume): The total consumption divided by total
income.
APS (Average Propensity to Save): The total savings divided by total income.
4. Multiplier Concept:
Multiplier: The ratio of change in income to the initial change in spending that brought it
about. It shows how an initial injection of spending (e.g., government investment) leads
to a greater overall increase in national income.
o Multiplier Formula: k=11−MPCk = \frac{1}{1 - MPC}k=1−MPC1 or
k=1MPSk = \frac{1}{MPS}k=MPS1.
5. IS-LM Model:
A model representing the interaction of the goods market (Investment-Saving or IS
curve) and the money market (Liquidity-Money or LM curve).
o IS Curve: Shows combinations of interest rates and output where the goods
market is in equilibrium (where investment equals savings).
o LM Curve: Shows combinations of interest rates and output where the money
market is in equilibrium (where demand for money equals supply).
o Equilibrium: Where the IS and LM curves intersect, determining the equilibrium
levels of output and interest rates.
Unit 3: Money and Inflation
1. Functions of Money:
Medium of Exchange: Facilitates transactions.
Store of Value: Retains value over time, allowing people to save.
Unit of Account: Provides a standard for measuring and comparing values.
Standard of Deferred Payment: Enables future payments (credit transactions).
2. Quantity Theory of Money:
The theory that changes in the money supply directly affect price levels. Represented by
the Equation of Exchange:
o MV = PT (where M = Money Supply, V = Velocity of Money, P = Price Level, T
= Transactions or Output).
3. Determination of Money Supply and Demand:
Money Supply: Controlled by the central bank, influenced by policies such as open
market operations, discount rate, and reserve requirements.
Money Demand: Influenced by factors such as income levels, interest rates, and the need
for transactions, precautionary, and speculative motives.
4. H Theory of Money Multiplier:
Explains how an initial deposit in a bank leads to a greater increase in the total money
supply. The formula for the money multiplier is:
o Money Multiplier=1Reserve RequirementMoney \ Multiplier = \frac{1}{Reserve
\ Requirement}Money Multiplier=Reserve Requirement1.
5. Inflation:
Definition: A sustained increase in the general price level of goods and services in an
economy over time.
o Demand-Pull Inflation: Caused by an increase in aggregate demand.
o Cost-Push Inflation: Caused by an increase in production costs (e.g., higher
wages, raw material prices).
o Consequences: Reduces purchasing power, affects savings, can lead to
uncertainty in the economy.
o Anti-Inflationary Policies: Include tightening monetary policy (raising interest
rates), reducing government spending, and increasing taxes.
6. Phillips Curve:
Short-Run Phillips Curve: Shows an inverse relationship between inflation and
unemployment.
Long-Run Phillips Curve: Suggests that in the long run, there is no trade-off between
inflation and unemployment (natural rate of unemployment).
Unit 4: Open Economy Macroeconomics
1. Balance of Payments (BoP) Account:
A record of all economic transactions between a country and the rest of the world.
Divided into:
o Current Account: Includes trade in goods and services, net income from abroad,
and net current transfers.
o Capital Account: Records capital transfers and transactions in non-produced,
non-financial assets.
o Financial Account: Includes investments in foreign countries and foreign
investments in the domestic economy.
2. Foreign Exchange Market and Exchange Rate:
Foreign Exchange Market: Where currencies are traded, and the exchange rate is
determined.
Exchange Rate: The price of one currency in terms of another.
o Fixed Exchange Rate: Set by the government or central bank.
o Floating Exchange Rate: Determined by market forces of supply and demand.
3. Monetary and Fiscal Policy in Open Economy:
Monetary Policy: Actions by the central bank to control money supply and interest rates.
o Impact: Affects exchange rates and trade balances by influencing capital flows.
Fiscal Policy: Government decisions on taxation and spending.
o Impact: Affects aggregate demand and the country’s trade balance.
4. Free Trade vs Protection:
Free Trade: Encourages international trade without restrictions such as tariffs or quotas.
o Advantages: Greater efficiency, lower prices for consumers, access to larger
markets.
Protectionism: Imposes tariffs, quotas, and subsidies to protect domestic industries from
foreign competition.
o Arguments for Protection: Protects jobs, helps infant industries, ensures national
security in critical sectors.
5. Instruments & Objectives of Monetary and Fiscal Policy:
Monetary Policy Instruments:
1. Open Market Operations: Buying/selling government securities to control the
money supply.
2. Discount Rate: The interest rate charged to commercial banks for loans from the
central bank.
3. Reserve Requirements: The minimum reserves a bank must hold against
deposits.
Fiscal Policy Instruments:
1. Government Spending: Used to stimulate or contract the economy.
2. Taxation: Changes in tax rates influence consumer and business behavior.
Objectives: Price stability, full employment, and economic growth.
