UNIT – 1- NATIONAL INCOME AND MONEY

CHAPTER -1 MACROECONOMICS: MEANING, NATURE AND SCOPE

MACROECONOMICS:

INTRODUCTION:

Macroeconomics is a field of economics that deals with the behaviour and performance of the
entire economy as a whole, rather than individual markets or specific industries. It is concerned
with studying the aggregate levels of economic activity, including output, income, employment,
inflation, and international trade.

Macroeconomics looks at the big picture of the economy, examining how different sectors and
markets interact and affect each other. It explores the relationships between key economic
variables and seeks to understand the factors that drive economic growth, inflation, and
unemployment.

The study of macroeconomics involves the use of models and theories to analyze and forecast
economic trends and patterns. These models are often based on mathematical and statistical
analysis of economic data, and they help economists understand the underlying mechanisms that
drive economic activity.

Macroeconomics is an important area of study because it provides policymakers with the

information they need to make informed decisions about economic policies. For example,
macroeconomic analysis can help governments design policies that promote economic growth,
stability, and full employment, while also minimizing inflation and trade imbalances. It is a
critical tool for understanding the broader economic forces that shape our world.

MEANING:

Macroeconomics is a branch of economics that studies the behaviour and performance of an

economy as a whole, rather than the behaviour of individual economic agents such as
households, firms, and markets. Macroeconomics focuses on the study of aggregate measures
such as national income, output, employment, and inflation, and seeks to understand how these
measures are determined and how they change over time.

Macroeconomic analysis typically involves examining the interactions among key

macroeconomic variables such as gross domestic product (GDP), inflation, unemployment,
interest rates, and international trade. These variables are interconnected and can have profound
effects on the well-being of individuals and society as a whole.

Macroeconomics also addresses policy issues such as fiscal and monetary policy, which are used
to influence the overall performance of the economy. Policymakers use macroeconomic models

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to help them understand how changes in government spending, taxation, interest rates, and
money supply affect the economy.

Overall, macroeconomics plays an important role in informing economic policy decisions and in
helping individuals, businesses, and governments make informed decisions about their economic
activities.

MACROECONOMICS: NATURE

Macroeconomics is a branch of economics that studies the behaviour and performance of an

entire economy as a whole, rather than focusing on individual markets or specific industries. The
nature of macroeconomics is concerned with the study of the behaviour and performance of the
entire economy as a whole, rather than focusing on individual markets or specific industries. It
aims to understand the relationships between different macroeconomic variables, such as output,
inflation, and unemployment, and how these variables interact with each other.

Macroeconomics is a highly analytical and theoretical field, relying on mathematical and

statistical models to study economic phenomena. It also utilizes empirical research and data
analysis to test and refine these models.

One of the key characteristics of macroeconomics is that it is forward-looking. Macroeconomists

use data and models to make forecasts about future economic conditions and to develop policies
that can promote desirable economic outcomes.

Macroeconomics is also concerned with the long-term trends in the economy, as well as the
short-term fluctuations that occur over the business cycle. This includes the study of economic
growth, productivity, and technological progress, as well as the factors that contribute to
recessions, booms, and other cyclical fluctuations.

Another important aspect of the nature of macroeconomics is its relevance to public policy.
Macroeconomic analysis is used to inform the design and implementation of government
policies, such as monetary policy and fiscal policy, that affect the overall performance of the
economy. It also helps policymakers understand the effects of their decisions on different sectors
of the economy, and on different groups of people, including workers, consumers, and investors.

Overall, the nature of macroeconomics is interdisciplinary, analytical, and forward-looking, and

it plays a critical role in helping us understand and manage the complexities of modern
economies.

SCOPE OF MACROECONOMICS:

The scope of macroeconomics includes the analysis of a wide range of economic issues,
including the determination of economic output, inflation, employment, and international trade.
It also involves the study of long-term trends and cyclical fluctuations in the economy, and the

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factors that drive economic growth, inflation, and unemployment. Below are the key areas that
fall under the scope of macroeconomics:

1. Economic Growth:

Macroeconomics studies the factors that influence economic growth and the long-term trends
in the economy. This includes the analysis of the sources of economic growth, such as
technology, productivity, and human capital, and the role of institutions and policies in
fostering growth.

2. Employment and Unemployment:

It analyses the labour market, including factors that affect the supply and demand for labour,
and the determinants of unemployment. Macroeconomists study the causes of changes in
employment and unemployment, such as technological advancements, changes in labour
force participation, and shifts in the demand for goods and services.

3. Inflation and Deflation:

Macroeconomics studies the causes and consequences of inflation and deflation, and the
impact of monetary and fiscal policies on the price level. It also examines the sources of
inflation, such as changes in the money supply, changes in aggregate demand, and changes in
the cost of production.

4. International Trade:

Macroeconomics analyses the determinants of international trade and the effects of trade on
the economy, including the balance of trade and exchange rates. It also studies the impact of
globalization on the economy and the ways in which trade policies can influence economic
outcomes.

5. Fiscal and Monetary Policy:

Macroeconomics analyses the use of fiscal and monetary policy tools by governments and
central banks to stabilize the economy. It includes the study of the effectiveness of different
policies in promoting full employment, stable prices, and sustainable economic growth.

6. Business Cycles:

It studies the causes and consequences of business cycles, including the phases of expansion,
recession, and recovery. Macroeconomists analyze the factors that contribute to the cyclical
fluctuations of the economy and examine the ways in which government policies can
mitigate the negative effects of recessions.

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 CHAPTER -2 - NATIONAL INCOME

CIRCULAR FLOW OF INCOME (FOUR SECTOR MODEL)

MEANING:

The circular flow means the un-ending flow of production of goods and services, income, and
expenditure in an economy. It shows the redistribution of income in a circular manner between
the production units and households.

Circular flow of income in a four-sector economy consists of

1) HOUSEHOLDS,
2) FIRMS,
3) GOVERNMENT AND
4) FOREIGN SECTOR.

HOUSEHOLD SECTOR:

Households provide factor services to firms, government and foreign sector.

In return, it receives factor payments. Households also receive transfer payments from the
government and the foreign sector.

Households spend their income on:

a. Payment for goods and services purchased from firms;

b. Tax payments to government;
c. Payments for imports.

FIRMS:

Firms receive revenue from households, government and the foreign sector for sale of their
goods and services. Firms also receive subsidies from the government.

Firm makes payments for:

a. Factor services to households;

b. Taxes to the government;
c. Imports to the foreign sector.

GOVERNMENT:

Government receives revenue from firms, households and the foreign sector for sale of goods
and services, taxes, fees, etc. Government makes factor payments to households and also spends
money on transfer payments and subsidies.

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FOREIGN SECTOR:

Foreign sector receives revenue from firms, households and government for export of goods and
services. It makes payments for import of goods and services from firms and the government. It
also makes payment for the factor services to the households.

The savings of households, firms and the government sector get accumulated in the financial
market. Financial market invests money by lending out money to households, firms and the
government. The inflows of money in the financial market are equal to outflows of money. It
makes the circular flow of income complete and continuous. The circular flow of income in a
four-sector economy is shown in Fig.1.7

Figure 1.7

METHODS FOR MEASURING NATIONAL INCOME:

The national income of a country can be measured by three alternative methods:

1. Product Method
2. Income Method, and
3. Expenditure Method.

Calculating and measuring national income is important because that’s how we can assess an
economy’s growth rate. There are several methods of calculating national income.

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1. PRODUCT METHOD:

In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final goods
here refer to those goods which are directly consumed and not used in further production
process.

Goods which are further used in production process are called intermediate goods. In the value of
final goods, value of intermediate goods is already included therefore we do not count value of
intermediate goods in national income otherwise there will be double counting of value of goods.

To avoid the problem of double counting we can use the value-addition method in which not the
whole value of a commodity but value-addition (i.e. value of final good value of intermediate
good) at each stage of production is calculated and these are summed up to arrive at GDP.

The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at
market price can be converted into by methods discussed earlier.

The formula for this method is:

GNI = Gross Value of Output - Value of Intermediate Consumption.

2. INCOME METHOD:

Under this method, national income is measured as a flow of factor incomes. There are generally
four factors of production labour, capital, land and entrepreneurship. Labour gets wages and
salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their
remuneration.

Besides, there are some self-employed persons who employ their own labour and capital such as
doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these
factor incomes is called NDP at factor costs.

The formula for this method is:

GNI = Compensation of Employees + Gross Operating Surplus + Gross Mixed

Income + Taxes on Production and Imports - Subsidies.

3. EXPENDITURE METHOD:

In this method, national income is measured as a flow of expenditure. GDP is sum-total of

private consumption expenditure. Government consumption expenditure, gross capital
formation (Government and private) and net exports (Export-Import).

The formula for this method is: GNI = C + I + G + (X - M), where C is consumption, I is
investment, G is government spending, X is exports, and M is imports.

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 LIMITATIONS IN MEASURING NATIONAL INCOME:

1. Income earned through illegal activities like gambling, smuggling, illicit extraction of liquor,
etc., is not included in National Income.

2. Many activities in an economy are not evaluated in monetary terms. For example, the
domestic services women perform at home are not paid for. These Non-marketed activities
are not accounted in National Income.

3. Barter exchanges which are still prevalent in rural and tribal areas are not accounted in
National Income.

4. Farmers keep a large portion of food and other goods produced on the farm for self
consumption. It is difficult to account these in National income.

5. Externalities refer to the benefits (or harms) a firm or an individual causes to another for
which they are not paid (or penalised). Negative externality is also not accounted.

6. National Income doesn’t give any picture of distribution of income and income inequality
within the economy.

7. The deduction of depreciation allowances, accidental damages, repair and replacement

charges from the national income is not an easy task. It requires high degree of judgment.

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 CHAPTER-3 -VALUE OF MONEY

MEANING:

The value of money refers to the goods and services which can be purchased by per unit of
money. It can be measured directly, because it is mainly based on the price level

PRICE INDEX NUMBERS:

A price index number is a statistical measure that represents the average price of a basket of
goods and services over time. It is used to track changes in the prices of goods and services in a
particular market or economy, and to measure inflation or deflation.

Price index numbers are typically calculated as a ratio of the current price of a basket of goods
and services to the price of the same basket in a base period, which is usually set to 100. For
example, if the price of the basket of goods and services in the current period is 120% of the
price in the base period, the price index number would be 120.

TYPES OF PRICE INDEX NUMBERS:

There are different types of price index numbers:

1. Consumer Price Index (CPI):

The CPI measures changes in the price of a basket of goods and services typically purchased
by households, such as food, housing, clothing, and transportation.

2. Producer Price Index (PPI):

The PPI measures changes in the prices of goods and services at the producer level, before
they are sold to consumers.

3. Wholesale Price Index (WPI):

The WPI measures changes in the prices of goods sold in bulk or wholesale, such as
commodities like raw materials and industrial products.

4. Export and Import Price Indices:

These indices measure changes in the prices of goods and services traded between countries.

Price index numbers are used by policymakers, businesses, and individuals to monitor changes in
the cost of living and to adjust policies, contracts, and investment decisions accordingly. They
are also used to adjust wages, pensions, and other payments to keep pace with changes in the
cost of living.

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 CONSTRUCTION OF CONSUMER PRICES INDEX NUMBER:

The construction of a consumer price index (CPI) is a commonly used method for measuring the
value of money over time. The CPI measures the average price of a basket of goods and services
that are typically consumed by households. The index tracks changes in the price of this basket
of goods over time, providing a measure of inflation or deflation.

The following are the steps involved in constructing a consumer price index:

1. Selection of the Base Year:

The first thing necessary is to select a base year. It is the year with which we wish to compare
the present prices, in order to see how much the prices have risen or fallen. The base year
must be a normal year. It should not be a year of famine, or war, or a year of exceptional
prosperity.

2. Selection of Commodities:
The next step is to select the commodities to be included in the index number. The
commodities will depend on the purpose for which the index number is prepared. Suppose
we want to know how a particular class of people has been affected by a change in the
general price level. In that case, we should include only those commodities which enter into
the consumption of that class.

3. Collection of Prices:
After commodities have been selected, their prices have to be ascertained. Retail prices are
the best for the purpose, because it is at the retail prices that a commodity is actually
consumed. But retail prices differ almost from shop to shop, and there is no proper record of
them. Hence we have to take the wholesale prices of which there are a proper record.

4. Finding Percentage Change:

The next step is to represent the present prices as the percentages of the base year prices. The
base year price is equated to 100, and then the current year’s price is represented accordingly.
This will be clear from the index number given on the next page.

5. Averaging:
Finally, we take the average of both the base year and the current year figures in order to find
out the overall change.

6. Computing the Price Index:

The price index is calculated as the weighted average of the prices of the items in the basket,
with the weights determined by their importance in household consumption. The price index
is calculated for each time period, such as each month or quarter.

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7. Computing Inflation Rates:
The inflation rate is calculated as the percentage change in the price index from one time
period to the next. For example, the inflation rate for a given year would be the percentage
change in the price index from the beginning to the end of that year.

Conclusion:
The CPI is widely used by governments, businesses, and individuals to track changes in the cost
of living and to adjust economic policies and business strategies accordingly. It is also used to
adjust wages, pensions, and other payments to keep pace with changes in the cost of living.

CONSTRUCTION OF CONSUMER PRICE INDEX NUMBER: DIFFICULTIES

The construction of a consumer price index (CPI) can be a challenging task, and there are several
difficulties that can arise in the process. Some of the main difficulties in constructing CPI are:

1. Determining the Appropriate Basket of Goods:

Choosing the appropriate basket of goods and services to represent the typical consumption
patterns of households can be difficult. It requires careful consideration of the types of items
that should be included, as well as their weights and prices.

2. Changes in Quality and Product Mix:

Over time, the quality of goods and services may improve, or new products may be
introduced. This can make it difficult to compare prices over time, as the characteristics of
the products being measured may be changing.

3. Changes in Price Over Time:

Prices of goods and services can change rapidly and unpredictably, especially in volatile
markets. This can make it difficult to measure changes in the overall price level accurately.

4. Geographical Differences:

Prices can vary significantly between different regions, which can make it difficult to
construct a single price index that accurately reflects the cost of living for all households.

5. Substitution Effect:

When the price of a particular item in the basket increases, households may substitute it for a
cheaper alternative. This can make it difficult to measure changes in the overall cost of living
accurately.

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6. Outdated Weights:

The weights assigned to the items in the basket may become outdated, as households'
consumption patterns change over time. This can lead to a price index that does not
accurately reflect the cost of living for current households.

Conclusion:
Despite these difficulties, the construction of a CPI remains an important tool for measuring
changes in the cost of living and for making policy decisions. By recognizing and addressing
these challenges, statisticians can construct price indices that provide accurate and useful
information for policymakers and individuals.

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