Macroeconomics

Ganesh Kumar N.

Agenda
Course administration

Scope of macroeconomics

Overview of recent macroeconomic
news/data/events

Observed facts of economies

Long run, short run, medium run models

Business cycles

Course Evaluation
Component

%age

Quizzes

20

Mid Term

35

End Term

35

Class
Participation

10

Scope of Macroeconomics

Macroeconomics is concerned with economy

as a whole

Booms and recessions

Consumption and investment
Rate of inflation, wages
Interest rates
Unemployment
Exports, Imports, Balance of payments
Budget deficits
Monetary policy and Fiscal policy

Observed facts about economies

Over long periods of time economy grows at
steady rates Long run behaviour of the
economy

In some periods inflation rates are much
higher 1970s; Medium run behaviour of the
economy.

In bad year unemployment rate rises short
run behaviour year to year fluctuations

Macroeconomics help us understand the
reasons for these observed facts

Long run: Growth theory

GDP 80-81 prices

Actual Vs. Potential GDP

1950

In growth theory, we focus on

long term growth ignoring short
term fluctuations booms and
recessions.

1960

1970

1980

1990

Aggregate demand & aggregate

supply
Aggregate supply: amount of output an
economy can produce given resources and
technology

Aggregate demand: Total demand for goods
& services (consumption, investment, govt.
purchases, net exports)

Economy with fixed productive

capacity
Why in some countries prices are stable
for many years while in some prices
double every month?

In the long run output is determined by
supply side (productive capacity)

Price level is determined by demand
relative to the output economy can
supply.

Economy with fixed productive

capacity
Level of output
is determined by
productive
capacity

P
AS

AD

Y0

Inflation (price
rise) is generally
due to changes in
AD
Output, Y

AS in the long run

P

Time

AS

Output, Y

Short run
Fluctuations in output around the potential output

Flat AS: Any level of output can be produced at a
given price
Underlying assumption is output does not affect
prices in the short run

Fluctuations in output are due to fluctuations in
AD

Short run
P

AS

AD

Y0

Output, Y

Medium run

Positively
sloping AS:

AS

AD

Y0

When AD
demand pushes
output beyond
sustainable level
as per the long
run model, firms
start raising
prices
Output, Y

Business cycles
Inflation, growth and output are related
through business cycles

It is a regular pattern of expansion
(recovery) and contraction (recession)
in economic activity around the path of
trend growth

GDP (80-81 prices)

Business Cycles

1975

Recession

Peak

Recovery
Trough
1976

1977

1978

1979

1980

1981

1982

A recession is a decline in output that persists for more

than two consecutive quarters in a year.

Duration of Cycles and

Recession in USA
Average of all cycles
1854-1919 (16 cycles)

No. of months of
recession
22

1919-1945 (6 cycles)

18

1945-2001 (10 cycles)

10

Great Depression:
August 1929(III)March 1933(I)

43

Mother of all recessions - Great

depression
Between 1929 and 1933 in USA:

The stock market fell by 85%

GNP fell by nearly 30%

Unemployment rose from 3% to 25%

Consumer price index fell by 25%

Investment collapsed.

Inflation and business cycle

Output gap =actual output potential output

Inflation rates are positively related to output gap

During recession inflation comes down

During boom inflation rate picks up

USA: Rate of Inflation in Consumer Prices,

1960-2002

National Income Accounts:

Agenda

National income accounts

Circular flow of income, GDP, components
of aggregate demand

Inflation & its measurement WPI, CPI,

GDP deflator

Some important identities

Nominal & real variables

Data sources

CIRCULAR FLOW OF INCOME

Consumption Exp.
Goods and Services
Household
Sector

FIRMS

Factor Services
Payment of Factor Income
(Wages, Profit, Interest, Rent)

Govt.
Spending

Govt

Investment

Capital Mkt

Tax
Saving

Consumption Exp.
Goods and Services
Household
Sector

FIRMS

Factor Services
Payment of Factor Income
CIRCULAR FLOW OF INCOME

Gross Domestic Product (GDP)

Economic performance of country is measured
in terms of GDP growth
Indias GDP growth at current prices
2006-07 07-08
2010-11
---------------------------Growth rate % 16.3
16.1
20.3

In which year India has done better?

Gross Domestic Product (GDP)

GDP is the market value of all final goods and
services produced within a country in a given
period of time
Measuring GDP
1. Product approach
2. Income approach
3. Expenditure approach

Govt.
Expenditure

Govt

Investment

Capital Mkt

Tax
Saving

Consumption Exp.
Goods and Services
Household
Sector

FIRMS

Factor Services
Payment of Factor Income
CIRCULAR FLOW OF INCOME

Nominal GDP (GDP at current Prices)

Product approach
Items

2008
Price (Rs.)

Quantity

Market Value

Oranges

20

10,000

2,00,000

Apples

30

5,000

1,50,000

Total

3,50,000
2013

Items

Price (Rs.)

Quantity

Market Value

Oranges

25

20,000

5,00,000

Apples

50

10,000

5,00,000

Total

10,00,000

Real GDP (GDP at const. prices)

2013
Items

Price (Rs.)
2008

Quantity
2013

Value at
2008 prices

Oranges

20

20,000

4,00,000

Apples

30

10,000

3,00,000

Total

7,00,000

GDP and related indicators (Source: Economic Survey

2011)
GDP Rs. crore
(current prices)
GDP at
Constant prices
(2004-5)

2008-9
55,82,623

2009-10
65,50,271

2010-11
78,77,947

41,62,509

44,93,743

48,79,232

06-07 07-08 08-09 09-10 10-11

---------------------------------------------------16.3
16.1
12.0 17.3
20.3

Growth rate %
(current prices)
Growth of GDP
9.6
(constant prices) %

9.3

6.8

8.0

8.6

Components of Aggregate demand

We look at different purposes for which
domestically produced goods and services
are demanded.

Aggregate demand is the total demand for
goods and services in the economy.

AD= Consumption (C), Investment (I), Govt.
spending (G), and net exports (NX).

AD= C+I+G+NX
Consumption

Consumption is spending by household on
food, clothing, education etc.

Components of Aggregate
demand
Investment

Investment (I) means addition to physical
stock of capital. It also includes inventories
with firms.
Govt. Spending (G)

It refers to govt. purchases of goods and
services.

It includes such items as national defence
expenditure, costs of roads, salaries of govt.
employees etc.

Components of Aggregate
demand
Net exports (NX)

Spending by foreigners on domestic
goods [ export, X] minus spending by
domestic residents on foreign goods
(import, Q)

NX = X-Q

200 China (2004)

India (2012-13)

1
-10.1

42
45

12

C
G
I
NX

59.6

39

11.3

Problems of GDP Measurement

Productive Vs. Non-productive activity: In
general activities resulting in marketable goods
and services should be included in national
income.
Non-market transactions- Example: Produce
consumed by farmers also included in GDP

Problems of GDP Measurement

Excluded form GDP
Underground economy
Change in the quality of goods
Environmental pollution/ degradation
Healthcare, schooling, distribution of income,
happiness

GDP deflator
GDP deflator: Measure of price index

(Nominal GDP/Real GDP)*100

Our example: (10,00,000/7,00,000)*100
= 133.33

This means that prices have risen by
33.33% on an average over 2008-13.

GDP and related indicators (Source: Economic Survey

2011)
GDP Rs. crore
(current prices)
GDP at
Constant prices
(2004-5)

2008-9
5582623

2009-10
6550271

2010-11
7877947

4162509

4493743

4879232

Questions:
1. What is the GDP deflator for 2009-10 and 2010-11?
2. What is the inflation rate for 2010-11?

WHOLESALE PRICE INDEX

Base 2004-5
Primary atricles
Food
Non-food
Minerals
Fuel
Coal Mining
Mineral oil
Manufacturing
Food
Non-food

Weights
20.1
14.3
4.3
1.5
14.9
2.1
9.4
64.9
9.9
55

New WPI (Introduced in Aug.2010) tracks 676 commodities

Consumer Price Index (CPI)

(2010 base)

Basket:
Food, Beverages and Tobacco:

49.71%

Fuel and light:

9.49%

Housing:

9.77%

Clothing and foot wear:

4.73%

Misc. (Education, healthcare etc.):

26.31%

Inflation rate is the % change in price index.

Jul-11

Apr-11

Jan-11

Oct-10

WPI Inflation

Jul-10

Apr-10

Jan-10

Oct-09

CPI (IW)

Jul-09

Apr-09

Jan-09

Oct-08

Jul-08

Apr-08

Jan-08

25
Food Inflation

20

15

10

-5

Some important identities

Y=C+I+G+NX (income/output = expenditure)
YD=Y+TR-TA (disposable income)
YD=C+S

C+S=(C+I+G+NX)+TR-TA

S-I=(G+TR-TA)+NX

S-I= (TR+G-TA)+(X-Q) . Twin deficits

1992
269
30
U.S TRADE
1993 AND BUDGET
223 DEFICITS
65
Budget Deficit

Trade Deficit

Billions of Dollars

300
250
200
150
100
50
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Year

INDIA FISCAL DEFICIT AND CURRENT A/C DEFICIT

7
6
5
4
3
2
1
0
-1
-2
-3

FD
CAD

Other NI concepts
Gross National Product (GNP) (Market Prices)
GNP(MP) = GDP (MP) + Net Factor Earnings from
abroad
Net National Product (NNP)
NNP(MP) = GNP(MP) depreciation
NNP(Factor Cost) (National income)
NNP(FC) = NNP (MP) Indirect taxes (IDT) +
subsidies
(Market price = factor cost + IDT subsidies)

Sources of Data
Government of India, Ministry of Statistics and
programme Implementation Web site:
http://mospi.gov.in/
CSO:The Central Statistical Organisation is
responsible for coordination of statistical activities
in the country, and evolving and maintaining
statistical standards.
Data: National accounts, CPI, WPI etc.f NSSO
The National Sample Survey (NSS), initiated in the
year 1950, is a nation-wide, large-scale,
continuous survey operation conducted in the form
of successive rounds. Surveys on consumption,
employment.