Macro Economics Capsule

Chapter 1 Introduction
Father of Macro Economics- John Maynard Keynes
'The General Theory of Employment, Interest and
Money' in 1936.
Emergence of Macro Economics: Classical Economists
like Adam Smith, David Ricardo, J. B. Say etc. are
believed in and argued for ‘Laisses faire' and ‘Say's law
of market'. Laissez faire means least intervention of Real flow: The flow of factor services and goods and
government in the economy’. Say’s law means “supply services.
creates its own demand”. They believed the 'invisible Four Factors of production and its remuneration:
hand' will ensure equilibrium and full employment. Land-Rent, Labour-Wage, Capital-Interest,
Classical Theory: Classical theory of employment and Organisation-Profit.
output is based on (1) Says law of market (2) Wage price Money flow: The flow of factor payments and the
flexibility and (3) Full employment expenditure on goods and services.
Classical ideas were proved wrong by the Great Methods of Measurement of National Income
Depression of 1929-1930 period in USA. During this The measurement of national income is essential for
period unemployment rate rose from 3% to 25% and the assessing the performance of the economy. Generally we
aggregate output in USA fell by about 33%. During this use three methods to calculate national income.
period in 1936 John Maynard Keynes published his book 1. Product method or value added method.
‘The General Theory Of Employment Interest And 2. Expenditure method. 3. Income method.
Money’. According to Keynes “Output of an economy is 1. Product Method or Value Added Method
determined by aggregate demand and aggregate supply”. If we measure the flow by measuring the aggregate value
This is why a new branch of Economics is emerged. It is of final goods and services produced by all the firms, it
called Macro Economics and John Maynard Keynes is will be called product method.
considered as the father of Macro Economics. Sales = Price X Quantity OR
Four Sectors of the economy- 1. Firms 2. Households 3. Value of output = Price X Quantity
Government 4. External sector Gross Value added (GVA) = Value of output – value of
Closed Economy: An economy that has no economic intermediate goods OR
relations with other countries GVA = Sales – intermediate goods
Open Economy: An economy that has economic If we sum the GVA of all the firms in an economy:
relations with other countries. GDP = GVA1 +GVA2 + GVA3+........ + GVAN
Chapter 2 National Income Accounting GDP ≡ GDP is the market value of all final goods and
Final good: An item that is meant for final use and will services produced within a domestic territory of a country
not pass through any more stages of production or measured in a year.
transformations is called a final good. 2. Expenditure Method: Four components of final
Raw material or inputs for production of commodities expenditure.
are called intermediate goods. 1. Private final consumption expenditure (C)
Consumption goods: Goods like food and clothing, and 2. Final investment expenditure (I)
services like recreation that are consumed when 3. Govt. expenditure on final goods (G)
purchased by their ultimate consumers are called 4. Net export (X-M / export – import)
consumption goods or consumer goods. GDP = C+ I + G + Net Export
Capital goods that are of durable character which are 3. Income Method: Here we measure the sum total of all
used in the production process. factor payments. Rewards for factors of production are
Stock: Stocks are defined at a particular point of time. Wage, Profit, Interest and Rent.
Flow: Flows are defined over a period of time. GDP = W + P + I +R
Income, or output, or profits are concepts that make sense Factor Cost and Market Prices
only when a time period is specified. These are called In India, the most highlighted measure of national
flows because they occur in a period of time. income has been in the GDP at factor cost.
Stock Flow GDPFC = GDPMP - Net Indirect Tax
Nominal GDP and Real GDP : The money value of all
The level of water in a The amount of water into goods and services calculated at the current year prices
tank and draining from the tank or market prices from the domestic territory is called the
Water in a reservoir Water in a river nominal GDP. The money value of all goods and services
calculated at the base prices from the domestic territory
The quantity of money Spending of money is called real GDP.
Net Investment = Gross investment – Depreciation GDP Deflator : It is the ratio between Nominal GDP and
Circular flow of Income : is a pictorial representation of real GDP expressed as percentage. The GDP deflator
interdependence or inter-relationship between the various
sectors of the economy.
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shows changes in general price level in an economy. in hand is called demand for money or liquidity
Nominal GDP preference. People desire to hold money balance broadly
GDP Deflator= X 100
Real GDP from Transaction Motive and Speculative Motive
GDP 1. Transaction Motive: Money is required to conduct
GDP Deflator= X 100 transactions, larger the quantum of transactions, larger
gdp
Some Macro Economic identities would be the demand for money. Transaction is mainly
Gross National Product (GNP) depends on income. Transaction demand for money is a
GNP ≡ GDP + Factor income earned by the domestic fraction of the volume of transactions in the economy
factors of production employed in the rest of the world – over a period of time.
Factor income earned by the factors of production of the 2. Speculative Motive: Speculative demand for money is
rest of the world employed in the domestic economy the desire of the people to hold money in their hands for
GNP ≡ GDP + Net factor income from abroad speculative purposes. In other words it is the desire of
GNPMP = GDPMP + NFIA people to hold money in order to gain from bonds is
NDPMP = GDPMP − Dep called speculative motive.
NDPFC = NDPMP - Net indirect taxes Expecting a rise in Market rate of interest in future
Net National Product (NNP) people will keep Money with them. Here Speculative
NNP ≡ GNP – Depreciation Demand For Money will
NNPFC or National Income. be infinity. Such a
NNPFC ≡ National Income (NI ) ≡ NNP at market prices – situation Speculative
(Indirect taxes – Subsidies) ≡ NNP at market prices – Net Demand For Money is
indirect taxes (Net indirect taxes ≡ Indirect taxes – perfectly elastic, it is
Subsidies) called Liquidity Trap.
Net indirect taxes ≡ Indirect taxes – Subsidies Central bank: Central
National Income (NI)/NNPFC = NNPMP – NIT Bank is a very important
Personal Income (PI) ≡ NI – Undistributed profits – Net institution and almost every country has one central bank.
interest payments made by households – Corporate tax + Indian CB is the ‘RBI’ (1935).
Transfer payments to the households from the Money Supply in India.
government and firms. M1 = CU + DD
Personal Disposable Income (PDI ) ≡ PI – Personal tax M2 = M1 + saving bank deposits with post office.
payments – Non-tax payments.
National Disposable Income = Net National Product at M3= M1 + Net time deposits with Commercial Banks
market prices + Other current transfers from the rest of M4= M3+ Total Post Office deposits except National
the world. Savings certificate.
GDP and Welfare: GDP is considered as one of the
instruments of measuring economic welfare. If the person CU= Currency DD = Demand Deposits.
can purchase more amounts of goods and services, his M1 and M2 are together called Narrow Money. M3 and
physical welfare will be high. But this argument is M4 are together called Broad Money. M1 is the most
criticised on the following ground. liquid money and M4 is the Least liquid money.
GDP is not a good measure of economic welfare due to Monetary Policy: Monetary policy is concerned with the
Existence of inequality in the distribution of GDP. measures taken to regulate the supply of money, the cost
Non-monetary exchanges: Services of housewives, value and availability of credit in the economy.
of barter etc. are not include in calculating GDP. Instruments of Monetary Policy
Externalities not include in GDP. 1. Bank Rate Policy: Bank rate or rediscount rate is the
Chapter 3 Money and Banking rate fixed by the central bank at which it rediscounts the
Money- commonly accepted medium of exchange. first class bills of exchange and government securities
Functions of money held by the commercial banks. The bank rate is the
1. Medium of exchange: Barter exchanges become interest rate charged by the central bank at which it
extremely difficult in a large economy because of the provides rediscount to banks.
high costs the people would have to incur to looking for The central bank controls credit by making variations in
suitable persons to exchange their surpluses. the bank rate. When the economy is in Inflation RBI
2. Unit of account: The value of all goods and services increases Bank rate. When the economy is in deflation
can be expressed in monetary unit. RBI Decreases Bank rate.
3. Store of value: Money is not perishable and its storage 2. Open Market Operation: This method refers to the
costs are also considerably lower. It is also acceptable to sale and purchase of securities, bills and bonds of
anyone at any point of time. Wealth can be stored in the government and private financial institutions by the
form of money for future use. central bank from the open market. During the inflation
Demand for money and supply of money time RBI sells securities and the time of deflation RBI
Demand for money: The desire of people to hold Money purchase securities.
 Macro Economics Capsule
3. Varying Reserve Ratio: Every commercial bank is Government Budget: Article 112 of constitution deals
required by law to maintain a minimum percentage of its with budget in India. Budget is the statement of estimated
deposits with the central bank. It may be either a receipts and expenditures of the government. It is also
percentage of its time and demand deposits separately or called ‘Annual Financial Statement’(1 April to 31
of total deposits. During the inflation time RBI increases March).
Reserve Ratio and during deflation time RBI decreases Components of Government Budget
reserve ratios. Government budget is the document consists of the
Quantitative Measures – Bank Rate, CRR, Open Market receipts and expenditure of the government for a
Operation etc particular financial year.
Qualitative measures –persuasion, moralsuasion, margin Objectives of government budget: The government
requirement etc plays a very important role in increasing the welfare of
Chapter 4 Determination of Income and Employment the people. Government intervenes in the economy in the
Aggregate demand and its components following ways.
Ex ante and Ex post 1. Allocative function – Government provides certain
The planned value of a variable is called ex ante measure goods and services which cannot be provided by the
or value. The actual of a variable is called ex post market mechanism. Examples: defence, roads,
measure or value. government administration etc (public goods)
Consumption ( Ex Ante Consumption) Private goods -cars, food items etc.
The most important determinant of consumption is Public goods Private goods
income. Even if income is zero, some consumption still
takes place. Since this level of consumption is Provided by government Provided by private sector
independent of income, it is called autonomous Available to all Not available to all
consumption. C=C+ cy Where: C is the consumption
Non rival relationship rival relationship
expenditure C autonomous consumption
cY shows the dependence of consumption on income. Non-excludable Excludable
When income rises induced consumption rises by MPC 2. The Redistribution function - in an economy there
i.e. c or the marginal propensity to consume. MPC is the exist inequality of income and wealth. In such a situation
rate of change of consumption as income changes. government distribute income and wealth through
ΔC taxation and public expenditure.
MPC= Where, ΔC= change on Consumption ΔY=
ΔY 3. Stabilisation function: Economies may face inflation,
change in income deflation, recession, depression etc. To correct these
Generally, MPC lies between 0 and 1 problems government uses budget.
Savings: is that part of income that is not consumed. Classification of Receipts
S = Y − C The proportion of additional total income Revenue Receipts: Revenue receipts are those receipts
used for saving is called Marginal Propensity to save that do not lead to a claim on the government.
ΔS They are divided into tax and non-tax revenues.
(MPS). MPS= Where, Δ S = change in Saving and
ΔY Tax Revenue- direct taxes- personal income tax and
ΔY = change in Income corporation tax, Other direct taxes like wealth tax, gift tax
We define the marginal propensity to save (MPS) as the and estate duty have never brought in large amount of
rate of change in savings as income increases. revenue and thus have been referred to as ‘paper taxes’.
MPC + MPS = 1 or MPC = 1 – MPS or MPS = 1 - MPC Non-tax revenue - interest receipts on account of loans
Determination of Income in a two sector Model by the central government, dividends and profits on
In an economy without a government, the ex ante investments made by the government, fees and other
aggregate demand (AD) for final goods is the sum total receipts for services rendered by the government. Cash
of the ex ante consumption expenditure and ex ante grants-in-aid from foreign countries and international
investment expenditure. organisations.
AD=C+ I OR AD=C+ I +cy Classification of its expenditure
If the final goods market is in equilibrium this can be Revenue Expenditure: Revenue Expenditure is
written as Y =C + I +cy or AD= A+cY where A=C+ I expenditure incurred for purposes other than the creation
Economy reaches equilibrium at that point where the ex of physical or financial assets of the central government.
ante output or the planned supply of final goods equal to - interest payments, grants given to state governments.
ex ante or planned aggregate demand for final goods in Budget documents classify total expenditure into plan
the economy. and non-plan expenditure.
Paradox of Thrift: If the MPS in an economy has Plan revenue expenditure relates to central Plans and
increased it may not lead to increase in total savings. central assistance for State and Union Territory plans.
Instead the total savings may remain constant or may Non-plan expenditure. The main items of non-plan
decrease. This tendency is known as Paradox of thrift. expenditure are interest payments, defence services,
Chapter 5 Government Budget and the Economy subsidies, salaries and pensions. Interest payments on
 Macro Economics Capsule
market loans, external loans and from various reserve
funds.
Capital Expenditure- Creates physical or financial
assets or reduction in financial liabilities. This includes
expenditure on the acquisition of land, building,
machinery, equipment, investment in shares, and loans
and advances by the central government to state
governments, PSUs and other parties.
Plan capital expenditure, like its revenue counterpart, Balance of Trade (BOT) is the difference between the
relates to central plan and central assistance for state and value of exports and value of imports of goods of a
union territory plans. country in a given period of time.
Non-plan capital expenditure covers various general, BOT is said to be in balance:
social and economic services provided by the Exports of goods= imports of goods.
government. Surplus BOT or Trade Surplus: Exports > imports
Balanced, Surplus and Deficit budget Deficit BOT or Trade Deficit: Exports < imports
Balanced budget: Expenditure = Revenue The foreign exchange market: The market in which
Surplus budget: Expenditure < Revenue national currencies are traded for one another is known as
Deficit budget: Expenditure > Revenue the foreign exchange market.
Measures of government deficit Exchange Rate (Forex Rate): Foreign Exchange Rate is
1. Revenue deficit- refers to the excess of revenue the price of one currency in terms of another.
expenditure over revenue receipts. Determination of the Exchange Rate: Exchange rate
Revenue deficit = Revenue expenditure – Revenue can be determined through Flexible Exchange Rate,
receipts Fixed Exchange Rate or Managed Floating Exchange
2. Fiscal deficit – is the difference between the total Rate.
expenditure and its total receipts excluding borrowing. 1. Flexible Exchange Rate
Gross fiscal deficit = Total expenditure – (Revenue Here exchange rate is determined
receipts +Non-debt creating capital receipts) by the market forces of demand and
Gross fiscal deficit = Net borrowing at home + supply. It is also known as Floating
Borrowing from RBI + Borrowing from abroad Exchange Rate.
Primary Deficit- indicates the borrowing requirement of Depreciation: Decrease in the value of domestic
the government for the purpose other than interest currency under the flexible exchange rate system is
payment. known as currency depreciation.
Gross Primary Deficit = Gross Fiscal Deficit – Net Appreciation: Increase in the value of domestic currency
interest liabilities under the flexible exchange rate system is known as
Chapter 6: Open Economy Macroeconomics currency appreciation.
Open economy: is a type of economy which has 2. Fixed exchange rate system
economic relations with the rest of the world. Here exchange rate of a currency is fixed by Govt or
Linkages in an open economy Central bank. This is also known as pegging.
1. Output Market: An economy can trade in goods and Devaluation: Here the Central bank decreases the value
services with other countries. of domestic currency.
2. Financial Market: An economy can buy financial Revaluation: Here the Central bank increases the value
assets from other countries. of domestic currency.
3. Labour Market: Firms can choose where to locate 3. Managed Floating: It is a mixture of a flexible
production and workers to choose where to work. exchange rate system and a fixed rate system. This
The balance of Payment: The balance of payments system is also called dirty floating. Under this system,
(BoP) record the transactions in goods, services and central banks buy and sell foreign currencies to keep the
assets between residents of a country with the rest of the exchange rate stable. In India, the custodian of foreign
world for a specified time period typically a year. exchange reserve is RBI.
There are two main accounts in the BoP — the current Chapter 1: https://youtu.be/Ih0Df4-qyx8
account and the capital account. Chapter 2: https://youtu.be/xYzrqcagNU0
Current account https://youtu.be/xvk1NVuEklE
Current Account is the record of trade in goods and Chapter 3: https://youtu.be/68OrjTwral0
services and transfer payments. Trade in goods includes Chapter 4: https://youtu.be/zLDNkTLfReo
exports and imports of goods. Trade in services includes Chapter 5: https://youtu.be/9KN5h-z7WYk
factor income and non-factor income transactions. Chapter 6: https://youtu.be/A_Hdd2Zd2SI
Transfer payments are the receipts which the residents of Boban J, Govt. HSS, Sasthamcotta Kollam
a country get for ‘free’, without having to provide any
goods or services in return.