Macroeconomics 10 dec

December 10 2011

Macroeconomics

Concept of National Product

2

»Capacity to produce goods and services

over a period of time

»GNP growth rate is a powerful indicator of

the growth rate of an economy

»Sum of all final goods and services

produced during a specified time period

»Output can be measure at Market Prices of

Factor Cost

»Concept of value addition

Relationship

3

GNPMP

NNPMP GNPFC

GDPFC

NDPFC

NDPMP

NNPFC

GDPMP

- Dep- Net indirect taxes

- Net indirect

taxes

- Net indirect taxes - Dep

- Dep

- Dep

- Net income from abroad

- Net in

com

e

from

abro

ad

- N

et

inco

me

from

abro

ad

- Net indirect

taxes

- Net income from abroad

Real Vs. Nominal GNP

4

»“Real” refers to prices or values that have

been adjusted for inflation or price level

fluctuations

»Real GNP is the GNP in current rupees

deflated for changes in the prices of items

included in GNP

»Nominal GNP is just expressed as current

rupees

»Doesn’t indicate change in price levels

Real Vs. Nominal GNP

5

»Over time Nominal values reflect changes in

»Real size of an economic variable

»General level of prices

»For example, if nominal GNP in 1998-99 was

16 crores compared to 7 crores in ’93-94.

Does this mean output has doubled?

»Real GNP for ‘93-94 is only 10 crores. What

does this imply?

Real Vs. Nominal GNP

6

»What are the situations in which Nominal

GNP increases?

»If more output is produced

»If prices rise

»What are we more interested in and why?

»Concept of GNP Deflator

»Real GNP = Nominal GNP *(GNP deflator for

base year/GNP deflator for current year)

Price Indices

7

»2 aspects of movements in prices – change

in relative prices, change in overall price

level

»Consumer Price Index (CPI)

»What is CLI?

»Concept of “utility”

»The ‘compromise’ called CPI

»Compared to the base year (Laspeyre)

CPI

8

»(Cost of purchasing the base year basked in

current year*100) / Cost of purchasing the

base year basket in the base year

»Factors considered

»Consumption basket in the base year

»Prices of items in the basket in the base

year

»Price relatives in the current year

CPI

9

Item Qty 1970-71

Price 197-71

Price 1980-81

Price Relative

Rice 15 kg Rs. 3/kg Rs. 4/kg

Wheat 10 kg Rs. 2/kg Rs. 3/kg

Milk 30 ltrs Rs. 3/ltr Rs. 5/ltr

Cotton Cloth

5 mtrs Rs. 8/mtr Rs. 12/mtr

Housing A two room house

Rs. 100 p.m.

Rs. 200 p.m.

»Calculate Total expenditures, weights, price

relatives, CPI

Wholesale Price Index

10

»Similar principles of construction

»Differences:

»Items included

»Wholesale prices

»Weights calculation

»Published by the Office of the Economic

Adviser to the GoI

National Income Deflators

11

»Ratio of current price GDP to constant price

GDP

»Covers all final goods and services

»Difference from CPI – Includes investment

goods

»Difference from WPI - ???

»Can deflators be calculated for other

product measures?

Index Numbers of Production

12

»Index Number of Agricultural Production

»Covers mining, manufacturing, electricity

generation; excludes construction –

incorporates 352 items

»Current problems?

»Index of agricultural production

»42 crops under 2 groups

»Similar construction methodology

Money and Credit

13

»Instruments of growth – monetary and fiscal

policy

»Liquidity

»Money stock measures:

»M1: RBI currency notes with public +

Rupee coins and notes with public +

Small coins + DD with banks + Other

deposits with RBI

Money and Credit

14

»M2: M1 + PO Savings Deposits

»M3: M1 + TD with banks

»M4: M3 + All PO Deposits

»These money measures are in the

descending order of liquidity

»Money supply – stock or flow? Why?

Money and Credit

15

»Monetary liabilities of banking system +

Non-monetary liabilities = Financial Assets

+ Other assets

»Net non-monetary liabilities = Other assets

– Non-monetary liabilities

»Monetary liabilities = Financial assets – Net

non-monetary liabilities

»Changes in monetary liabilities ~ changes in

financial assets + Net non-monetary liab.

Measurement of National Income

16

»3 methods, ideally yielding the same result

»Output method

»Expenditure method

»Income method

Output method

17

»Aggregates values of all final goods and

services produced during a year or by

aggregating the values of all intermediate

products

»Yields GDPFC and GNPFC

»Used especially for primary sectors

»Example: Agricultural and extractive

industries + Manufacturing Industries +

Services and Construction = GDPFC

Expenditure method

18

»Aggregates all money spent by private

citizens, firms and government

»Excludes values of intermediate goods

»Yields GNPMP

»Example: Consumer’s expenditure +

Government current expenditures on goods

and services + Fixed capital formation +

Exports – Imports = GNPMP

Income method

19

»Aggregates incomes of only the residents’

incomes that obtain income directly from

the current production of goods and

services

»Yields GDP at factor cost

»Example: Income from employment +

Income from self-employment + Gross

profits of companies + Rents = GDPFC

»Conceptually, should yield the same result

Alternative measures of National Output

20

»Gross National Product

»Net National Product

»National Income

»Personal Income

»Disposable Income

Alternative measures of National Output

21

»Net Export (E-M) + C + I + G

»GNPMP – Depreciation = NNPMP

»NNPMP – Net Indirect Taxes + Wages

+Proprietors’ Income + Interest + Rents +

Corporate Profits = NI = NNPFC

»NI – Corporate Profits and Social Security

Insurance taxes + Transfer Payments = PI

»PI – Personal Taxes = PDI – Personal Savings

= Personal Consumption

Difficulties in measuring NI

22

»Non-market Production

»Imputed Values

»Underground Economy

»Side Effects and Economic Bads

»Leisure and Human Costs

»Double Counting

Uses of NI Statistics

23

»As an instrument for Economic Planning and

Review

»As a means of indicating changes in a

country’s standard of living

»To indicate changes in economic growth of a

country

»As a means of comparing economic

performance of different countries

Practice Problems

24

»Calculate

»Depreciation

»Net Factor Income from Abroad

»Subsidies

»NDP at FC

Particulars Rupees

GNP at FC 95023

Indirect taxes 14723

NDP at MP 100422

NNP at MP 100575

GNP at MP 107226

Solution

25

»Depreciation = 107226 – 100575 = 6,651

»NFIA = 107226-(100422+6651) = 100575-

100422 = 153

»Subsidies = 95023 + 14723 -107226 = 2520

»NDPFC = 100575 – (14723-2520) = 88,372

Particulars Rupees

GNP at FC 95023

Indirect taxes 14723

NDP at MP 100422

NNP at MP 100575

GNP at MP 107226

Practice Problems

26

»Calculate GNP at MP, National Income,

Personal Disposable Income

Particulars Rupees

GDP at FC 6000

Corporate Income Tax 1200

Personal Income Tax 800

Subsidies 400

Factor Income Received from abroad

1500

Factor Income Paid abroad

1800

Undistributed Profits 250

Indirect Taxes 800

Depreciation 400

Solution

27

»GNPMP = 6000 –

(1500-1800) +

(800-400) = 6100

» NI = NNPFC = 6100

– 400 – 800 + 400 =

5,300

»PDI = Personal

Income – Personal

Tax = 5300 – 250 –

1200 – 800 = 3,050

Particulars Rupees

GDP at FC 6000

Corporate Income Tax 1200

Personal Income Tax 800

Subsidies 400

Factor Income Received from abroad

1500

Factor Income Paid abroad

1800

Undistributed Profits 250

Indirect Taxes 800

Depreciation 400

Practice Problems

28

»Difference between GDP at MP and NNP at

FC is?

Particulars Rupees

Net Factor Income from abroad

(-)500

Depreciation 2000

Indirect Taxes 1900

Subsidies 1000

»GDPMP + NFIA – Dep +Subsidies – Indirect

Taxes = 2000 + 500 +1900 – 1000 = 3,400

Practice Problems

29

»Calculate GNP at MP, NNP at MP, NDP at

MP, NDP at FC, GNP at FC

Particulars Rupees

NNP at FC 4,73,246

Depreciation 61,809

Subsidies 19,431

Net Factor Income from abroad

(-)6,833

Indirect Taxes 87,043

Personal Income Tax 9,759

Corporate Taxes 7,300

Retained Profit 6,758

Practice Problems

30

»Calculate GNP at FC

Particulars Rupees

NDP at MP 88,750

Net factor income from abroad

(-)260

Depreciation 5,220

Subsidies 1,820

Indirect taxes 10,825

31

Aggregate Demand and Supply

Aggregate Demand and Aggregate Supply

32

»Some countries are rich and some are not!

»Aggregate Demand and Aggregate Supply

answer questions about equilibriums in

goods, money market, unemployment, GDP

levels etc

»Provides a “big picture” view of the

economy

»Describes the overall relationship between

overall price level and output

Aggregate Demand and Aggregate Supply

33

»Aggregate Supply (AS) curve describes, for

each given price level, the quantity of

output firms are willing to supply

»Aggregate Demand (AD) curve shows the

combinations of the price level and level of

output at which the goods and money

markets are simultaneously in equilibrium

Aggregate Demand and Aggregate Supply

34

»Difference in the micro and macro economic

concepts of demand and supply

»Equilibrium state of AS and AD

»Shift in AD curve

»Shift in AS curve

Aggregate Supply curve

35

»Classical Supply curve:

»Vertical – indicating that the same

amount of goods will be supplied

whatever be the price level

»Assumption: Labor market equilibrium

»Long term possibility

»Why should supply curve be vertical in

long run? Recall how it was in

microeconomics!

Aggregate Supply curve

36

»Classical Supply curve:

»Potential GDP

»Shift of vertical AS curve

»Does potential GDP grow over time?

»Changes in potential GDP do not depend

on the price level

»Potential GDP changes very little over

time

Aggregate Supply curve

37

»Keynesian Supply curve:

»Horizontal– indicating that firms will supply

whatever amount of goods is demanded at

the existing price level

»Assumption: Unemployment

»Why should supply curve be horizontal in the

short run?

»Short-run price stickiness

»Price level does not depend on GDP - inflation

Aggregate Demand curve

38

»AD curve shows the combination of the

price level and level of output at which the

goods and money markets are

simultaneously in equilibrium

»Expansionary policies’ effects?

»Do consumer and investor confidence have

an effect on AD?

»Depends on real money supply

»AD curve slopes downwards and shifts

AD in Alternative Supply assumptions

39

»Equilibrium under Keynesian case

»Given perfectly elastic supply, shifting

AD to the right will increase output but

leave the equilibrium price level

unchanged

»Equilibrium under Classical case

»Given perfectly inelastic supply, shifting

AD to the right results in an increase in

the price level but no change in output

Supply side economics

40

»Some supply-side policies:

»Removing regulations, maintaining an

efficient legal system, technological

progress

»What is the effect of cutting tax rates?

»Does it have an effect on AD or AS?

»Only supply-side policies permanently

increase output

»AS and AD in the long run

Questions???

Have a happy Sunday!