Module 4 Macro business environment

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MODULE 4

MEASURING THEECONOMY

Basic economic concepts, Open and Closed Economies, Primary, Secondary and Tertiary sectors

and their contribution to the economy. SWOT Analysis for the Indian economy. Measuring GDP

and GDP Growth rate. Components of GDP. Business Cycle- Features, Phases, Economic Time

seriesEconomic indicators, Correlation, persistence, coherence. Inflation: Types,

Measurement, Kinds of price Indices. Employment and unemployment rates: Measurement.National Income: Estimates, Trends, Measurement, Problems in measuring National Income.

Varun Raj

Preethi

Prem

Raghavendra BG

Rajath

Sagar

Sangeetha

Sneha

Vij ay B

Vinay

Vinutha

Varun Prakash


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Fundamental Concepts of Managerial Economics:

Opportunity Costs,Incremental Principle concept,Time perspective,Discounting and Equi-Marginal principles.

Opportunity cost:Opportunity or alternative or economic costs are between the second bestuse of a firms resources which the firm foregoes in order to avail itself of

the return from the best use of the resources. Opportunity cost is the cost of

sacrificed alternatives.All decisions which involve choice must involveopportunity cost.Opportunity cost may be real or monetary, explicit or implicit or

quantifiable or unquantifiable.

The Incremental Principle concept:It refers to the change in total. Incremental cost is the change in total cost due to a

specific decision like production or distribution. Incremental revenue is the changein total revenue caused by changes in production or prices.When incremental

revenue exceeds incremental cost, it indicates a profitable situation. In anybusiness decision, a project will be profitable only when the incremental revenue

(called marginal revenue) is greater than the incremental (marginal) cost. Theprinciples of marginal revenue and marginal cost are basic to microeconomic

theory.

Time Perceptive:Any changes in decisions involve time element and managerial economicsuses functional time periods of long and short runs in business analysis.

Management has to review the long run effects on costs and revenuedecisions on its corporate strategy.


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Discounting and Equi-Marginal principles:Discounting principle: Consideration of different time periods necessitatesthe criticality of the discountingprinciple. A rupee next year is not the same as

a rupee this year and the rate of interest would be the discount rate at whichfuture value is discounted in present. A present gain is valued more than a

future gain. In investment decisions, discounting of future values with reference

to present value is accomplished.

The following formula is used in respect of discounting.

V= A

(1+i)

Where V = present value; A = annuity or returns expected in ayear and i = current rate of interest.

Equi-marginal principle: Its states that rational decision makers allocateresources in such a way that the ratio of marginal revenue and marginal cost ofvarious uses of a given resource or of various resources in a given use is the

same.

The equi-marginal principle may be applied in differentsituations.

Multi-market seller: MR1=MR2=MR3=MRn (MR=

marginal revenue)

Multi-plant monopolist: MC1=MC2=MC3 MCn (MC=

marginal cost)

Multi-factor employer: MP1=MP2=MP3=.MPn (MP=

marginal product)

Multi-product firm: M1=MM M (M= marginal profit)

Multi-good consumer: MU1=MU2=MU3= MUn (MU=

marginal utility)


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Open Economy:

By open economy it means that economy in which private people are

allowed to participate in making economic decisions, in which there areeconomic activities between domestic community and outside.

E.g., Trade can be in the form of managerial exchange, technologytransfers, all kinds of goods and services. Although, there are certain

exceptions that cannot be exchanged, like, railway services of a country

cannot be traded with another to avail this service, a country has to produceits own.

Closed Economy:

An economy in which no activity is conducted with outside economies. A closed

economy is self-sufficient, meaning that no imports are brought in and no exports

are sent out. The goal is to provide consumers with everything that they need from

within the economy's borders.

A closed economy is the opposite of an open economy, in which a country will

conduct trade with outside regions.

Contribution of Different Sectors in Indian Economy:

Primary Sector:

The share of the primary sector which includes agriculture, forestry and fishery has

gone down from55.3 % in GDP in 1950-51 to 44.5 % in 1970-71 and to a still

lower figure at 26.1 % in 1996-97 and 17.5% in 2009. Still it employs 52% of

population. As agriculture contributes the bulk share to the primary sector, it would

be of interest to estimate the trend of the contribution of agriculture to GDP. The

share of fishing in GDP has remained stable at 0.8 % throughout the 46 year

period. It is really distressing that the share of forestry in GDP has shown a

continuous decline from 5 % in 1950-51 to 4 % in 1970-71 and further to barely

1.0 % in 1996-97. This only underlines the fact that in the primary sector,

agriculture alone is the most important and the trend and change in agricultural

output determines the share of the primary sector in national output .


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Secondary Sector:

The share of the secondary sector which includes mining, manufacturing,

construction, electricity, gas and water supply has shown a steady increase from

16.1 % GDP in 1950-51 to 31.1 % in 1996-97 and 29.5% in 2009. Two majorcomponents of the secondary sector are manufacturing industries and construction.

The share of manufacturing in GDP increased from 11.4 % in 1950-51 to 22.5 % in

1996-97. It may also be noted that manufacturing industries are grouped under

registered and unregistered units. The share of registered units in manufacturing

industries more than doubled during the 45 year period i.e. from 5.4 % in 1950-51

to 14.5 % in 1995-96. But as against this, the share of the unregistered units

marginally improved from 6 % of GDP in 1950-51 to 8.0 % in 1996-97. Similarly,

the share of construction improved from 3.3 % in 1950-51 to 5.0 % in 1970-71 andthereafter it declined to 4.3 %in 1996-97 .

Tertiary Sector:

The share of the tertiary sector which includes trade, transport, storage,

communications, banking, insurance, real estate and community and personal

services improved from 28.5 % in 1950-51 to 32 % in 1970-71 and further

increased 42.9 % in 1995-96 and 53% in 2009. Tertiary sector is composed of

three components. (a) the share of transport, communications and trade improvedfrom 11 % in 1950-51 to 20.2 % in 1996-97; (b) the share of public administration

and defence improved from 2.3 % of GDP in 1950-51 to 4.9 % in 1996-97. The

share of other services which was 6.4 % in 1950-51 remained more or less stable

and slightly declined to 5.8 % in 1996-97; (c) the share of finance and real estate

which includes banking and insurance improved marginally from 9 % in 1950-51

to 12.1 % in 1996-97. The structural change in the composition of national income

by industrial origin in the consequences of the process of economic growth

initiated during the plans.


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SWOT ANALYSIS OF INDIAN ECONOMY:

STRENGTH:

Intelligent human resource . Natural resource . Comparatively other counties labor cost is less . High percentage of cultivable land . Huge English specking International language (English) Growth of IT and BPO sectors bring in valuable foreign exchange . High growth rate in GDP . Diversified nature of economy . Extensity higher education system . 3rd largest reservoir of engineers.

WEAKNESS :

Highest percentage of workforce involved in agriculture which contributes25% on GDP.

High unemployment rate Below poverty line , corruption , around 1/4th of population below the

poverty line .

Socioeconomic conditions. Poor infrastructure . Import is more than experts . Lack of technological invention . Lack of domestic entrepreneurs . Political instability . Low literacy rate . Rural and urban classification . Poor leaving standard .


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OPPORTUNITIES :

Entry of private firms in various centres of business . Area of Bio-technology . Inflow of FDI , likely to increase in many sectors . Huge foreign exchange earning , prospect in IT sectors . Huge natural gas found in India , Natural gas as tremendous opportunities. Area of infrastructure . Investment in R & D , engineering design .

THREATS :

Increase in the sick units ,because of MNCs. High physical depict. Threat of government intervention in some states. Volatile in the crude oil price and commodities. Growing import bills. Population explosion . Political stability . Agriculture majorly depend on monsoons .


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GROSS DOMESTIC PRODUCT

We begin with gross domestic product. GDP refers to production during a year. It is the flow of

new products during the year or a quarter, measured in dollars. When we adjust GDP for the

effects of inflation, we get real GDP, the measure of physical discussed in chapter 1.

There are three different ways to think about and measure GDP. First, we can measure spending

on goods and services by different groups-households, businesses government and foreigners.

Second, we can measure production in different industries-agriculture, mining, manufacturing,

and so on. Last, we can measure the total wage and profit income earned by different groups

producing GDP. Each of these measures has its special purpose, but they all add up to the same

thing. We consider each in turn in the next three sections.

MEASURING GDP THROUGH SPENDINGTotal spending on goods and services produced by Americans during any period can be broken

down as fallows :

Gross domestic product= consumption

+investment

+government purchase

+net exports [or exports minus imports]

Using symbols, this key identify can be written on one line :

Y=C+I+G+X

Where y=gross domestic product

C=consumption

I=investment

G=government spending

X=net exports [exportsimports ]


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CONSUMPTION

Consumption is defined as spending by households. It includes purchase of durable goods such

as washing machines, stereos and cars. Non durable goods such as food clothing and gasoline;

services such as haircuts, medical care and education. However the measurement of consumption

does not consist simply of blindly summing all purchases made by households during a given

time period

INVESTMENT

Investment is the sum of spending by firms on goods such as plant, equipment, and inventories,

and spending by households on housing. We separate total investment into fixed investment and

inventory investment.

FIXED INVESTMENT

Fixed investment is broken down into non residential fixed investment and residential fixed

investment. Non residential fixed investment is spending on structures and equipment for use in

business. Steel mills, office buildings, and power plants are best examples of structures. Trucks,

lathes, and computers are example of equipment. Residential fixed investment is spending on

construction of new houses and apartment buildings.

Net investment= gross investmentdepreciation.

We have the following relations ;

Capital stock at the end of this year= capital stock at the end of the last year

-depreciation during this year

+ gross investment during the year.

By rearranging this equation and putting in the definition of net investment, we have:

Net investment = capital stock at the end of this year

-capital stock at the end of last year

These equations hold whether we are looking at total investment or separately at non residential

investment.


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INVENTORY INVESTMENT

Now consider inventory investment, which is simply the change in the stock of inventories held

at business.

Inventory investment this year= stock of inventories at the end of the this year

-stock of inventories at the end of last year

For example, when a publisher produces and stores 10000 copies of a newly printed book in its

warehouse, the books are counted in GDP as inventory investment. Even though no one has yet

purchased the books, they must be counted in GDP because they have been produced.

GOVERNMENT PURCHASE

Government purchases are the sum of federal government and state and local government

purchases of goods and services. In 2000, state and local government purchases were 65 percent

of total government purchases. These purchases include items such as schools, road construction

and military hardware, however, it should be noted that the government purchases are only part

of the total government outlays included in the government budget .when measuring government

purchases, economists exclude transfer payments of income from the government to individuals;

this includes items such as welfare payments and interest payments on public debt. These items

are excluded since they do not reflect production.

IMPORTS AND EXPORTS

The united states has an open economy. An open economy is one with substantial interaction

with other countries. The united states has experienced a growing volume of transactions with

the rest of the world, and GDP has to take these into account. Exports are goods and services

produced in the united states and purchased by foreign consumers, business or governments.

Imports are goods and services produced abroad and purchased by united states consumers,

businesses or governments. Since exports are produced in the united states, they are counted as

part of GDP even though they are not part of domestic consumption, investment, or government

purchases. Since imports are produced abroad, they are not counted as part of GDP even though

they are part of domestic consumption, investment, or government purchases.


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THE RECENT COMPOSITION OF SPENDING

Table 2.1 breaks down us GDP for 2002. Consumption is the biggest component- about two

thirds of GDP. services is the biggest component of consumption about 59 percent. Services

[restaurants, utilities, housing, transportation, medical care and the like] have been growing as a

share of consumption. In the early 1950s, services accounted for less than a third of

consumption. Medical services have grown most rapidly

WHICH SPENDING ITEMS SHOULD BE INCLUDED?

In deciding which spending items to include in computing GDP, we must be careful to avoid

double counting. For example the purchase of a 10 year old house should not be counted; that

house was counted 10 years ago when it was constructed similarly, the purchase of the assets of

mobile oil by Exxon should not be counted; the mobile building in Pittsburgh and mobilesoffshore oil rigs were included in business fixed investment when they were built.

REAL GDP

GDP is a dollar measure of production or final goods and services during one year. Comparing

one year with another, we run into the problem that the dollar is not a stable measure of

purchasing power. For example, in the 1970s GDP rose a great deal, not because the economy

was actually growing rapidly but because the dollar was inflating. As this example suggests, the

measure of GDP,[what we have used to measure production up to this point] fails to be anadequate representation of production for comparison across time. Therefore, to correct this

discrepancy and make GDP comparisons across years, we need a measure of output that adjusts

for inflation. We want GDP in constant dollars. or as we generally call it real GDP. In contrast,

the GDP we looked at so far is sometimes called nominal GDP

MEASURING GDP THROUGH PRODUCTION: VALUE ADDED

GDP can also be computed by adding up production of goods and services in different industries.As we observed on the spending side, we must avoid counting the same items more than once.

Many industries specialize in the production OF immediate goods used in the production of other

goods. If we want each industrys production to include the contribution of those industries to

total GDP , that we want to take the production of intermediate goods into account.

The concept of value added was developed to prevent double counting and attribute to each

industry a part of GDP. The value added by a firm is the difference between the revenue the


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firms earns by selling its products and the amount it pays for the products of other firms it uses

as intermediate value goods. It is a measure of the value that is added to each product by firms at

each stage of production.

THE NATIONAL INCOME AND PRODUCT ACCOUNTS

1} gross domestic product is the production of goods and services in the united states. The

spending, value added, and factor income measures of GDP are all equal.

2} consumption, investment, government purchases and net exports are the four basic

components of spending consumption is the largest component and investment is the most

volatile component.

3} the investment component of GDP includes the replacement of depreciating capital. It is thus

gross investment. Net investment is gross investment less depreciation.

4} final sales is GDP less inventory investment. It fluctuates less than GDP

5} to avoid double counting, we measure the contribution of each industry by its value added and

do not include any goods produced in an earlier year.

SAVINGS AND INVESTMENT

Savings is defined as incomeconsumption. An important principle is that saving must equalinvestment. To see this, consider first a closed economy with no government and therefore no

taxes

Spending on GDP=consumption + investment

Income =saving + consumption

Consumption + investment =savings +consumption


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Components of GDP;

GDP (Y) is a sum ofConsumption (C), Investment (I), Government Spending

(G) and Net Exports (XM).

Y = C + I + G + (X M)

Here is a description of each GDP component:

C (consumption) is normally the largest GDP component in the economy,consisting of private (household final consumption expenditure) in the

economy. These personal expenditures fall under one of the following

categories: durable goods, non-durable goods, and services. Examplesinclude food, rent, jewelry, gasoline, and medical expenses but does not

include the purchase of new housing.

I (investment) includes, for instance, business investment in equipment, butdoes not include exchanges of existing assets. Examples include

construction of a new mine, purchase of software, or purchase of machinery

and equipment for a factory. Spending by households (not government) on

new houses is also included in Investment. In contrast to its colloquial

meaning, 'Investment' in GDP does not mean purchases offinancial

products. Buying financial products is classed as 'saving', as opposed

to investment. This avoids double-counting: if one buys shares in a

company, and the company uses the money received to buy plant,

equipment, etc., the amount will be counted toward GDP when the company

spends the money on those things; to also count it when one gives it to the

company would be to count two times an amount that only corresponds to

one group of products. Buying bonds orstocks is a swapping ofdeeds, a

transfer of claims on future production, not directly an expenditure on

products.

G (government spending) is the sum ofgovernment expenditures on finalgoods and services. It includes salaries ofpublic servants, purchase of

weapons for the military, and any investment expenditure by a government.

It does not include any transfer payments, such as social

security orunemployment benefits.
http://en.wikipedia.org/wiki/Household_final_consumption_expenditurehttp://en.wikipedia.org/wiki/Durable_goodshttp://en.wikipedia.org/wiki/Mininghttp://en.wikipedia.org/wiki/Financial_markethttp://en.wikipedia.org/wiki/Financial_markethttp://en.wikipedia.org/wiki/Savinghttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Deedhttp://en.wikipedia.org/wiki/Government_spendinghttp://en.wikipedia.org/wiki/Final_goodshttp://en.wikipedia.org/wiki/Final_goodshttp://en.wikipedia.org/wiki/Public_servantshttp://en.wikipedia.org/wiki/Transfer_paymenthttp://en.wikipedia.org/wiki/Social_securityhttp://en.wikipedia.org/wiki/Social_securityhttp://en.wikipedia.org/wiki/Unemployment_benefitshttp://en.wikipedia.org/wiki/Unemployment_benefitshttp://en.wikipedia.org/wiki/Social_securityhttp://en.wikipedia.org/wiki/Social_securityhttp://en.wikipedia.org/wiki/Transfer_paymenthttp://en.wikipedia.org/wiki/Public_servantshttp://en.wikipedia.org/wiki/Final_goodshttp://en.wikipedia.org/wiki/Final_goodshttp://en.wikipedia.org/wiki/Government_spendinghttp://en.wikipedia.org/wiki/Deedhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Savinghttp://en.wikipedia.org/wiki/Financial_markethttp://en.wikipedia.org/wiki/Financial_markethttp://en.wikipedia.org/wiki/Mininghttp://en.wikipedia.org/wiki/Durable_goodshttp://en.wikipedia.org/wiki/Household_final_consumption_expenditure


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X (exports) represents gross exports. GDP captures the amount a countryproduces, including goods and services produced for other nations'

consumption, therefore exports are added.

M (imports) represents gross imports. Imports are subtracted since importedgoods will be included in the terms G, I, orC, and must be deducted to

avoid counting foreign supply as domestic.

A fully equivalent definition is that GDP (Y) is the sum offinal consumption

expenditure (FCE),gross capital formation (GCF), and net exports (X

M).

Y = FCE + GCF+ (X M)

FCE can then be further broken down by three sectors (households,

governments and non-profit institutions serving households) and GCF by

five sectors (non-financial corporations, financial corporations, households,

governments and non-profit institutions serving households). The advantage

of this second definition is that expenditure is systematically broken down,

firstly, by type of final use (final consumption or capital formation) and,

secondly, by sectors making the expenditure, whereas the first definition

partly follows a mixed delimitation concept by type of final use and sector.

Note that C, G, and I are expenditures on final goods and services;

expenditures on intermediate goods and services do not count. (Intermediate

goods and services are those used by businesses to produce other goods and

services within the accounting year. )

According to the U.S. Bureau of Economic Analysis, which is responsible

for calculating the national accounts in the United States, "In general, the

source data for the expenditures components are considered more reliable

than those for the income components [see income method, below]."
http://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Final_consumption_expenditurehttp://en.wikipedia.org/wiki/Final_consumption_expenditurehttp://en.wikipedia.org/wiki/Final_consumption_expenditurehttp://en.wikipedia.org/wiki/Gross_fixed_capital_formationhttp://en.wikipedia.org/wiki/Gross_fixed_capital_formationhttp://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Glossary:Non-profit_institutions_serving_households_(NPISH)http://en.wikipedia.org/wiki/Final_goodshttp://en.wikipedia.org/wiki/Final_goodshttp://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Glossary:Non-profit_institutions_serving_households_(NPISH)http://en.wikipedia.org/wiki/Gross_fixed_capital_formationhttp://en.wikipedia.org/wiki/Final_consumption_expenditurehttp://en.wikipedia.org/wiki/Final_consumption_expenditurehttp://en.wikipedia.org/wiki/Supply_and_demand


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A nations economy can be divided into various sectors to define the

proportion of the population engaged in the activity sector. This categorization is

seen as a continuum of distance from the natural environment. The continuum

starts with the primary sector, which concerns itself with the utilization of raw

materials from the earth such as agriculture and mining. From there, the distance

from the raw materials of the earth increases.


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PHASES OF BUSINESS CYCLES

From the records of business cycles it is obvious that no one cycle is the same as another. In

other words, the details of cycles differ. However, all the cycles belonging to the same family

and thus have common characteristics.

According to Burns and Mitchell, every business cycle has a critical mark -off points of peak and

through. From trough to peak there is the expansion phase and from peak to trough the

contraction phase. Apart from these two relatively longer phases there are two other phases

characterised by the turning points. The upper turning point is located at the peak marks the

beginning of recession, while the lower turning point located at the trough is the venue of

revival. Both recession and revival are relatively short in duration. Thus according to Burns and

Mitchell the four distinct and closely related phases of business cycles are as fallows

ECONOMIC FLUCTUATIONS, GROWTH AND DEVELOPMENT

1} revival

2} expansion

3} recession

4} contraction

Joseph Schumpeter does not agree with Burns and Mitchell on the phases of business of business

cycle. In his opinion, peaks and trough of a cycle cannot be regarded as the critical mark-off

points. His analysis of different phases of business cycles is altogether different from that of

Burns and Mitchell. According to Schumpeter, the critical mark-off points are neighbourhoods

of equilibrium which are located at or near the points of inflection. In figure 5.1, we have

shown Schumpeters four phase business cycle. Points A B and C in this figure are points of

inflection and the neighbourhoods of equilibrium are located in their close proximity. In

Schumpeter s model, the upper half of the business cycle from A to B is divided into two parts:

(a) prosperity and (b) recession. The lower half of the business cycle from B to C similarly

consists of two phases: (c) depression (D) recovery.


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Prosperity of expansion

Certain economist prefer to call the prosperity phase the upswing or expansion because they

think that purely quantitative terms are to be preferred to over-coloured terms like prosperity and

depression. However without going into the merits of different terms, we shall use prosperity

phase, upswing and expansion phase interchangeably. It may be noted in figure 5.1 that the

prosperity or the expansion phase exists in the upper half of the cycle.

In the prosperity phase, since the wage disbursements increase rapidly, the demand for

consumption goods also grows rapidly. The supply of these goods, however in the later stages

increases with a lag and this leads to a rise in prices. Thus the prosperity phase is accompanied

by a rise in prices which gather momentum towards the later stages

This delay in price is mainly due to the fact that there is some unutilised plant capacity available

in the early stages of expansion and production can be increased without proportionate increase

in costs. But in the later stages, unutilised plant capacity is not there and thus plants have to beexpanded. Further some other bottle necks may appear.

The rise of general price level is more marked during the prosperity phase when a large

proportion of the productive activity is in the form of setting up of new factories and steel plants,

increased production of heavy engineering goods, construction of commercial and housing

complexes and work on power projects. The payrolls of these operations add substantially to the

volume of spending while supply of consumption goods fails to increase correspondingly. This

results in a substantial rise in the general price level

DISTORTIONS OF PRICE RELATIONS PRICES DONOT RISE UNIFORMILY

DURING THE PROSPERITY PHASE. GENERALLY WHOLESALE PRICES RISES

MORE

Of the wholesale prices, prices of RAW MATERIALS and semi finished goods usually

rise faster than the wholesale prices of consumption goods. These changes in different prices

disturb to some extent the symmetry of the price system, distort price relations, change price

spreads between one level and another, and bring about at the same time some more or less

considerable changes in the distribution of the national income.

Changes occur not only in the relatively prices of goods but also in the various elements of cost

structure. Some elements of cost rise rapidly while others increase slowly. raw materials prices

usually increase rather quickly.


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EXPANSION REACHES ITS HEIGHT

Entrepreneurs observing that their profits are growing rapidly, make further

investment. This cumulative expansion in periods of prosperity is sustained primarily by the slow

rise of costs. The expansion process marked by increasing investment activity usually results in

higher output level, prices and profits.

Growth of investment in the prosperity phase depends greatly on the expansion in the money

supply, especially the bank credit. The records of the past cycle show that this actually happens.

The rising share prices and with them growing spirit of confidence in the prospects of business

the commercial banks to expand credit facilities. These conditions speed up the velocity of

circulation. The increasing investment activity during the periods of prosperity results in the

growth of fixed capital such as plant, machinery and equipment. It also makes substantial

increase in wage disbursements.

THE END OF EXPANSION

During the prosperity phase, expansion itself gradually brings into the play of series of

forces which ultimately lead to the beginning of recession. The most important of these factors is

the gradual rise of costs relative to prices. In the early stages, the rising gap between the costs

and prices induces entrepreneurs to expand their activities. However, in courser of time when

gradual increase in costs relative to prices narrows down the profit margin, the expansion

process is progressively weekend

The problem of rising unit costs can be tackled if a corresponding increase in produce prices ispossible. However, in practice, this possibility meets two formidable obstacles. One of these is

the resistance of consumers; the other is the limit imposed by the diminishing elasticity of banks

consumers credit

RECESSION

The phase of recession, which is a turning period is relatively shorter. In this period while the

forces of expansion are weakened, the forces that make for contraction get strengthened. The

recession ids normally characterised by liquidation in the stock market, strains in the banking

system and some liquidation of bank loans, some fall in prices, a sharp reduction in demand for

capital equipment and abandoning of relatively new projects.

During recession, production of consumer goods does not decline immediately. Even when the

incomes of the people fall, they persist for some time with their consumption standard which

they had achieved in good times. Hence the demand for consumption goods falls with a lag. In


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contrast, the fall in the production of capital goods is dramatic. Since entrepreneurs abandon their

investment programmes, the demand for equipment, machinery and plant falls substantially and

it is natural for the capital goods manufacturing sector to respond to this situation quickly.

The fall in security prices does not merely suggest that prices and profits are going to fall in

future, but it also makes its contribution in that direction. Borrowers on stock market securityfinding that their collateral is shrinking often find it necessary to repay some of their loans. For

this purpose they may liquidate their holdings of commodities which may cause a fall in their

prices. The weaker market in securities invariably postpones new issues which implies

that corporate enterprises shelve their investment programmes at least for some time. hence , the

orders for plant, machinery, equipment or buildings are reduced

DEPRESSION OR CONTRACTION

Recession ultimately merges with depression which is the phase of relatively low economic

activity. When an economy moves from recession to depression, there is a notable fall in

production of goods and services and in employment. This decline in production is general and is

visible throughout the economy but it is by no means uniform. Usually agricultural activity

considered to be necessary for subsistence is not much affected in terms of both output and

employment. Retail business is also little affected. In contrast, the output reduction is substantial

in manufacturing, mining and construction. In the industrial sector, the worst affected industries

are those which produce machines, tools, plants, equipment and steel. In these industries,

employment falls rapidly.

During depression there is substantial reduction in the incomes of the people and thus the

demand for consumer goods also declines. Nonetheless it is far than the fall in the demand for

machines and equipment. It has been observed that during depression when incomes of most of

the households drastically fall, they make substantial reduction in their expenditure on durable

goods. This explains why the output and employment in industries producing these goods fall

rapidly. Most of the households even when their incomes fall during the depression find it

difficult to reduce the consumption of non durable goods. Therefore production and employment

are little affected in the sectors producing these goods.

Steadily declining prices of commodities continuously erode the profits of producers and tradersalike. In the later stages of depression, some firms incur losses and in an atmosphere of

pessimism have little hopes for the revival of economic activity. These are the other conditions

in which the most adversely affected firms decide to close down. Those of the firms must survive

see no reason why they should make investment. As the marginal efficiency of capital totality

collapses and its revival is not in sight, no one is willing to venture fresh investment. In this

period there is great reduction in the volume of money.


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The rate of change in prices is not the same in respect of all goods and services. Prices of certain

goods fall little while prices of others suffer a virtual collapse. These unequal changes in prices

cause distortions.

Moreover distortions also appear in cost-price relations because cost do not fall proportionately

to prices. Also all costs do not fall at a uniform rate. Some costs are rigid or fall quite slowly,whereas other costs falls steeply usually wages and salaries are sticky during the depression.

Trade union pressures and labour laws often prevent substantial reductions in wage rates. Rents,

interest rates, insurance premium and taxes are slow to move downward. These cost rigidities

while prices continue to fall during the depression wipe out the profit margin in many cases.

RECOVERY

The recovery starts when forces that work to recover the normal price relations and cost price

relations start operating effectively. Generally the beginning of recovery process is not as

dramatic as the beginning of recessionary process. The recovery is gradual. It starts from the

prices stop falling. From the records of various depressions it is clear that when inventories are

accumulated stores are exhausted with the slowing down of production, supplies reach scarcity

levels and further downward movement of prices is arrested. This is the stage where producers

see no risk in undertaking production. This stages reaches faster in those fields where production

can be controlled easily. During depression demands demand for durable goods is reduced

drastically and, in response to this, production is correspondingly cut down. But the demand for

even these goods cannot be postponed indefinitely. Therefore, once the stocks of these goods are

exhausted, the pressure for increasing their production is created. To begin with, firms use idle

capacity to increase production , this naturally generates both employment and income which

creates additional demand for consumer goods and services. At this stage marginal efficiency of

capital starts recovering. The firms begin making investment to replace depreciated equipment.

With business prospects improving, some firms opt for larger investment.

Along the restoration of the normal price relations, there is correction of distortions in cost price

relations. The lagging price which had eroded profit margins during the depression start falling.

Since financial institutions do not find attractive outlets for their funds, interest rates fall in the

later phase of depression. Long-time interest rates fixed by contract are brought down in some

cases by agreement, rents, insurance rates and taxes are also adjusted downward. Wages are

reduced under the hard reality of unemployment. Since the relatively inefficient workers lose

jobs, less efficient plants are idle, and less efficient managerial executives are dropped. The

general level of efficiency rises during the later phase of depression, which in turn lowers down

the average cost of production.


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Another sign of the beginning of the recovery, apart from the correction of distortions in cost

price relations, is revival of stock exchange activities manifested in the rising prices of securities.

Business Cycle Measurement: Economic Time Series

Business cycles have a number of key characteristics manifested by economic time series. It isthe purpose of this section to discuss those characteristics and to show how we can use them to

test the implications of economic models. In some cases those properties pertain to an individual

economic time series; in other cases, the properties apply to pairs of economic time series. But inevery case, we will use these properties as a form of testing for economic models of aggregate

economies.

In this section, we discuss a number of the business cycle characteristics of individual and pairs

of macroeconomic time series. Models of the economy have been developed to explain the

existence of these properties. As it turns out, there is some disagreement among economistsabout some of these statistical properties; there are competing explanations for the source of the

trends apparent in macroeconomic data. This difference of professional opinion has caused the

development of alternative aggregative models of the economy, consistent with each type oftrend in the data. We begin by studying the trends that can be present in macrorconomic data.

Stationarity and Non-Stationarity:

Some economic time series appear to have trends in them, i.e., they seem to have a generaltendency to rise or fall over time. Macroeconomic data fall into this category as almost all macro

data seem to be rising over time. But other series have no such tendency to rise or fall. Rather

they seem to be fluctuating about a constant value. These patterns give rise to the following two

definitions.

Definition of Stationarity and Non-Stationarity Time Series:

1) An economic time series is stationary if its average value is constant over time.2) An economic time series is non-stationary if its average value is not constant over time.

The formal statistical definitions of these concepts, used in actual practice by macroeconomists,are somewhat more complicated than the definitions above but the conditions given here are

sufficient for our purposes.

In the left panel of this.fig, an example of a stationary time series is drawn. Notice that it isfluctuating about a value that is unchanging over time. So if something causes this time series to

move away from this constant value, the series will return to it over time. This constant value isthe mean of the series and meaning that if something were to cause this series to deviate from its

mean, it will return to its mean if enough time passes.

Now consider the right panel of fig 4.3 and observe that there is no tendency for this time series

to return to a fixed value over time. The series is trending down and so, no matter how long we


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wail, this series will not settle down to a constant value if the series were to move away from its

downward trend. A non-stationary time series does not revert to a fixed average value over time.

ECONOMIC INDICATORS:

How do we know when we are in a recession? Is there any way to predict that a recession willsoon occur? The NIPA data comes out with a lag after the end of a quarter and the NBER

certifies recessions after turning points occur. These two sources of information are thus notgoing to be useful for learning about the current and future states of the economy. In addition, an

index number can be useful to policy makers if it reliably predicts the onset of a recession in

future. Therefore the timing of an economic time series can be useful for assessing the current

and future prospects of the economy.

The business cycle indicators compiled by the conference board are grouped into one of the three

categories- leading, coincident and lagging. These are described as follows:

1. Leading economic indicators: This group includes ten measures that generally indicatebusiness cyclePeaks and Troughsthree to twelve months before they actually occur.

The ten leading indicators are:- Manufactures new orders for consumer goods and materials.- An index of vendor performance- Manufacturers new orders for non-defence capital goods- The standard and poors 500 index of stock prices- New building permits for private housing- The interest rate spread between U.S. treasury bonds and federal funds - The M2 real money supply-

Average workweek in manufacturing- An index of consumer expectations- Average weekly initial claims for unemployment insurance

2. Coincident Economic Indicators: This category contains four measures that indicate theactual incidence of business cycle peaks and troughs at the time they actually occur. Infact, coincident economic indicators are a primary source of information used to

document the official business cycle turning points. The coincident indicators are: - The number of employees on non-agricultural payrolls- Industrial production- Real personal income- Real manufacturing and trade sales

3. Lagging Economic Indicators: This is a group of seven measures that generally indicatebusiness cycle peaks and troughs three to twelve months after they actually occur. The

lagging indicators are:


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- Labor cost per unit of output in manufacturing- The average prime interest rate- The amount of outstanding commercial and industrial debt- The consumer price index for services- Consumer credit as a fraction of personal income- The average duration of unemployment- The ratio of inventories to sales for manufacturing and trade

CORRELATION:

One tool used to describe business cycles is the correlation coefficientmeasures the strength of

a relationship between:

1) Two economic variables2) A single variable and its history.

Correlation Coefficient:

1) Positive correlation: When the values of two variables movie in the same direction, i.e.,when an increase in the value of one variable is associates with an increase in the value ofother variable, and a decrease in the value of one variable is associated with the decrease

in the value of the other variable, correlation is to be positive.

2) Negative Correlation: The values of two variables move in opposite directions, so thatwith an increase in the values off one variable the value of the other variable decrease,

and with a decrease in the values of one variable the values of the other variable increase,correlation is said to be negative.

PERSISTENCE AND COHERENCE:Business cycles consist of persistent co-movements in the deviations of certain

macroeconomic variables from their trends. This co-movement is called coherence.

Macroeconomic data often tend to be high or low relative to trend for some period oftime. Real GDP and other economic time series seem to move together in certain patterns

over time. There are two time series concepts that are related to these properties and these

are defined below.

Definition of Serial PersistenceAn economic time series displays series persistence if the series tends to be above or

below trend for more than one period of time.

Definitions of Co-Movements in Economic Time Series

1) Procyclic: A procyclic economic indicator is one that moves in the same direction asthe economy. So if the economy is doing well, this number is usually increasing,


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whereas if we are in a recession this indicator is decreasing. The GDP is an example

of a procyclic economic indicator.

2) Countercyclic: A countercyclic economic indicator is one that moves in the oppositedirection as the economy. The unemployment rate gets larger as the economy getsworse so it is a countercyclic economic indicator.

3) Acyclic: An acyclic economic indicator is one that has no relation to the health ofeconomy and is generally of little use. The number of home runs the Montreal Exposhit in a year generally has no relationship to the health of the economy, so we could

say it is an acyclic economic indicator. An economic indicator is acyclical if it is

neither procyclical nor countercyclical.

Inflation:

Inflation is the most experienced economic phenomenenon in India and in

the rest of the world.

J.K Galbraith have confessed their inability to provide a solution to the problems

of inflation that could be implemented effectively in all countries.

Definition:

Geoffrey Crowther defines inflation as a state in which the value of money

is, falling, i, e.prices are rising are rising.

A.C.Pigou says, Inflation is a situation in which the communitys money

income increases faster than its real income.

1.Demandpull inflation :

A situation where in an increase in aggregate demand for output either from the

government or the entrepreneurs or the households exceeds the aggregate supply of

output there by leading to an increase in general price level (inflation). For

instance, In Bangalore, normally the rent for houses or commercial premises are

always on the higher side due to the extreme demand, hence who ever has more

money would get.


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2. Costpush inflation :

A situation where in the price level increases due to a rise in the cost or

production. Even though there is no increase in aggregate demand, prices may still

rise, this may happen if the costs particularly the wage cost increases forinstance, in cities, most of the commodities are costly as compared to rural areas as

the wage / salary for the employees / workers for employees / workers is on the

higher side.

3. Structural inflation :

In this situation, the rise in the prices occurs due to increasing investment

expenditure and expansion of money supply without a corresponding increase in

the output level. For instance, recently, car manufactures announced in theincrease in car price as the increase in steel prices that has proportionate

relationship with overall increase of cost of manufacturing cars.

Causes of inflation:

The basic cause of inflation normally occurs, when aggregate demand for output

tends to be excessive in relation to the supply of output: Increase in the money

circulation; Increase in the disposable income; Increase in communitys aggregate

spending on consumption and investment or in goods. Excessive speculation andtendency to hoarding and profiteering; Increase in foreign demand the result in

exports; Increase in population as the widening gap between demand and supply.

Deficiency in capital equipment that leads to a company to invest more fund in

renovating or buying new equipment that cost would be imposed on end users.

Drought, famine, earth quake, storm, volcano eruption and other natural calamities

adversely affecting agricultural production and output of other industries.

Prolonged industrial unrest (strike or lockout of a particularly industry or

industries, nation wide truck strike that would cause stagnation of goods that wouldresult the increase in demand) affecting normal industrial output that would ensure

the match in demand and supply.


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Effects of Inflation:

The adverse effects of inflation on the economic system may be classified as

being of the following kinds:

1. Effect on production2. Effect on distribution of income3. Social and political effects4. Other general effects

1. Effect on production:

Till the level of full employment is reached, gently rising prices are to some

extent beneficial. The favorable impact on production is, however, possible only

when inflation does not tack place at too fast a rate. Running or galloping inflation

creates uncertainty which will adversely affect production. When inflation has

reached an advanced stage, its beneficial aspects disappear disadvantages of

inflation are felt in the economy.

2. Effect on distribution:

It is a notable feature of inflation that all prices do not move in the same

direction and to the same extent.

3. Business community:

All producers, traders and speculators gain during inflation because of the

emergence of windfall profits. Prices of good rise at a far greater rate than costs of

production, wages, interstates, insurance premium, and ect.are all more or less

fixed as they were contracted earlier before the production of good commenced.

4. Fixed income groups:

During times of inflation, wage earners and salaried people are the worstaffected. If they try to push up their wages through labor unions, they bring about

cost-push inflation and their position is worsened in the long run due to

unemployment and retrenchment. Those belonging to this group find their real

income dwindling with the repaid rise in prices.


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5. Debtors and creditors:

During inflation, debtors gain while creditors lose. Creditors lose because

they are paid back dues in money which has less purchasing power. Debtors gain

because they are paying back less in real terms.

6. Social and political effects:

On the political front, inflation bring about, a weakness in political discipline. The

increasing grievances and hardships of the masses in general on account of

inflation may prepare them to revolt against the established society, social values

and social order. It will create a great number of political tensions.

Control of inflation

Inflation, if not controlled in its early stage, will take the shape of hyper-

inflation which will completely ruin the economy. The different methods used to

control inflation, known commonly as anti- inflation measures, attempt mainly at

reducing aggregate demand for goods and services on the basic assumption that

inflationary rise in price is due to an excess of demand over a given supply of

goods and services. Anti-inflationary measures can be put into three broad groups:

(1) Monetary policy (2) fiscal policy and (3) direct control and other executive

measures.

(1)Monetary policy: The methods and devices used by central banks to bringappropriate changes in the supply of money and credit for ensuing monetary

stability constitute what is called monetary policy. Central banks generally

use three traditionally weapons A. Bank rate policy B. Open Market

operations and C. Variable reserve ratio

(2)Fiscal policy: Fiscal policy is a measure of control a government exercisesthrough taxation; public borrowing and spending on the functioning of the

economy. To combat inflation, fiscal measure would have to secure anincrease in taxation and decrease in government spending.

(3)Direct controls: This executive policy refers to the regulatory measuresadopted by a government to contain the harmful effects of inflation.

Important among these measures is price control. This is an effective method

during war time because both monetary and fiscal policies are more or less


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1ineffective during this period. Price control means pegging down the prices

(of goods) beyond which they should no rise. But this step is considered to

be detrimental to the consumers sovereignty, freedom and welfare.

Deflation

Deflation means a contraction of currency and credit leading to a fall in

prices. It is the opposite of inflation, another extreme currency situation, where

prices fall and the value of money rises. Deflation, according to Paul Einzig, is a

state of disequilibrium in which a contraction of purchasing power tends to cause,

or is the effect of, the price level.

Effects

Deflation has an adverse effect on the level of production, business activity

and employment. During deflation, prices fall because demand for goods services

is contracting. With a fall in prices, producers accumulate stocks, incur heavy

losses and a remedial measure retrench labor and reduce output. Pessimism grips

the business community and investors and gradually a depressionary state of affairs

develops in the economy.

Inflation versus Deflation

From the analysis given above, one may be led to believe that inflation and

deflation are exact opposites. But they are not. Inflation is a rise in prices

unaccompanied by any appreciable increase in employment, while deflation is a

fall in price accompanied by increasing unemployment.

Both inflation and deflation are socially bad, but inflation may be considered to be

better of the two evils. Keynes stated: Inflation is unjust, deflation is inexpedient.

Of the two deflations is the worse.

Inflation brings about a redistribution of income between different groups of

people in the country. This redistribution is done in such an unjust manner that the

rich gain at the expense of the poor. Deflation, on the other hand, reduces national

income through reduction in the volume of production and much loss in


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employment. It adversely affects every group in the community. The entire

community gets pauperized because of its maleficent effects.

Deflation increases the level of unemployment in the economy, where inflation at

least implies that all factors are employed in some way or the other.

Inflation can be curbed to a large extent, only occasionally does it get out of

control when the government fails to adopt appropriate monetary and fiscal

policies. But deflation, when once started, injects so much pessimism into

businessmen and bankers that it is very difficult to control it. Monetary policy

becomes useless during such pessimism. No amount of increase in money supply

can revive the piece level and business expectations in the economy during

depression.

Investment=savings

The equity of savings and investors follows from none other than the definition of

GDP and income. As long the satisfactionadhere to these definitions, there is no

possibility that investment can ever differ from savings.

Savings and investment in an open economy

Some more symbols save space in the explanation of a savings and investment inan open economy.

F= Government transfer to the private sector

Q=Interest on the government debt

T=Tax

V=Factor income and transfer payments from abroad

Sp=Private savings

SG=Government savings

SR=Rest of world savings.


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And recall that we previously defined

Y=GDP

C=Consumption

I=Investment

G=government spending

X=Net exports

PRIVATE SAVINGS: From the definition of savings, we know that the private

savings is disposal income(Y+V+F+q-T)-C

GOVERNMENT SAVINGS; Government savings incomes (tax receipts, net of

transfer payment:

SP= (T-F-Q)-G.

Government savings is also called the government budget surplus or budget

deficit. The budget is in the surplus when G is less than (T-F-Q)

Rest of the world savings:

The rest of the world savings in the United States is defined as payments received

from the United States less payments made by United Nations.

Sr=-x=Y.

SP+Sg+Sr=(Y+V+f=Q-T)-C+(T-F-Q-G)-V-X

Everything cancel out on the righty handle side except Y-C-G-X, which from the

income identity is equal to the investment.

TRANSNACTIONS WITH THE REST OF THE: the balance of payment accounts and

the exchange rate

The balance of payments accounts record transactions between Americans and

the rest of the world. International transactions are divided inn to current account


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transactions. The current accounts keep track of net exports of goods and services

net interest payments payments and international transfer such as governments

grands and remittances. The financial accounts keeps track of borrowing and

lending. When an American lends to a foreigner by load buying a bond or some

similar transactions the lending appears with a negative sign of financial accounts

The Exchange Rate;

Transactions with other countries requires the US dollar be exchanged for foreign

countries for foreign currency and so on,

During the period of from 1973 to 2002, the dollar generally fell relatively to theyen. As we will see this this was a result the higher rate of inflation in the united

states yean Japan during these years.

MEASURING INFLATION:

The national level income and product accounts accounts discussed at the

beginning of the year this year chapter But two other measures inflation and

employment are released to the public at more frequent intervals of and from the

basis of most policy initiatives data on inflations and employment are released

every month.

Fig2.5shows the rate of inflation the percent changes in the us price level as

measured by the CPL since 1960 but as shown in the 2.5gained momentum

The government puts out another major price index in additional to the CPI it is

called producer price index(pip).instead of measuring the prices actually paid byconsumers the pip measures the priceless charged by producers at various stages

in the production process.


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Deflators;

The construction of data on nominal and real GDP results in another type of price

index. The purpose of measuring real GDP is to get rid of the price effects in

nominal GDP. Therefore, the ratio off nominal GDP to real GDP is a measures of

prices IT IS CALLED THE GDP IMPLICT PRICE DEFLACTOE FOR EXAMPLE IN

2000NOMINL GDP was 9872billion.

Inflation, Price INDEXES AND DEFLATORS

1. Inflation is the rate of increase in the price of level. The pric level is an average

of all prices in the economy

2. There are two types of measures of the price level indexes and deflators. The

consumers prices index (CPI) and the producer.

3. The CPI is used for cost of living adjustments in many unions contracts and in

many government programs.

MEASUING EMPLOYMENT AND WAGES;

Employment falls along with the production during recession and rises again

during recovery. Over the long haul employment grow along with GDP.

The household survey called the current population survey, is completed is

conducted each month by the because of the census and the data are tabulated

The establishment of survey interview employees to find out number of people

on the patrol at each workplace. The survey excludes farm employees, because it

is based on payroll, it also omits people who are self employed total non

agriculture payroll employment was million people in December2002


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Hours per week and hours;

The numbers of hours worked each other varies among workers and over time

some people normally work only a few hours a week and other work 60-

70hours.The average worker one put in to about 34hours per week, while the

average factor works puts in about 41 hours

For all these reasons employment by itself is not a complete measure of labor

input to the economy. total hours of work the number of people of labor to the

economy. Total of work people working multiplied by the hours of work of the

average worker is a better measuring.

Review and practiceMajor points

1. There are there ways to measure and think about the spending side, the

production side

The production side and the income side. the components of spending are

consumption, investments, governments spending and net exports.

2. Real GDP is the physical volume of production after of rising princess have beenremoved. Real GDP growth has about 3.2percent have been removed about

35years

3.Value added by a firm id the different between the revenue of the firm and its

purchase of goods and service from other firms.

4. Depreciation is the loss of capital from wear and tear.Net investments is the

investments less depreciation.

5.Conceptually,income and productions are equal.

6. The international accounts called the balance of payments accounts consists of

current year account and a financial account.


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7.The exchanges rates is crucial for international transactions. It is the price of

dollars in terms of foreign currency. when the exchanges can be bought with each

dollar. This makes foreign goods cheaper in terms of dollars.

8. An important implications of the number of dollors required to purchase aprivate savings plus the government surplus the capital inflow from abroad.

9.The consumer price index is the number of dollars required to purchase a

market basket of goods and service typically of the consumption patterns of

Americans.

10.Priceindex called deflators can be calculated by dividing of a components of

nominal GDP by the same component of real GDP. The consumption deflator is

widely used by economists as an alternative to the CPI.

Key terms and concepts

Consumption nominal

Investments value added

Fixed investments national income

Inventory investments personal income

Residential fixed investment disposal personal income

Capital stock budget surplus

Depreciations current account

Net investments financial accounts

Government purchase exchange rates

Imports euro

Exports price index


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Intermediate goods deflators

Final goods consumers price index(CPI)

Real GDP Producer price index

KINDS OF PRICE INDICES;

Price Indices: The numerical value that summarizes price level is called as price indices. The

main purpose of Price Indices is it helps in explaining the purchasing Power or

Inflation/Deflation from one period to another. There are two types of Price Indices: Wholesale

Price Index (WPI): It is an indication of price movements in all markets other than the retail

market. It is worked out for a whole country or for a very large area and the prices are collected

from the wholesale dealers. Consumer Price Index: is a price index with special reference to a

class or category of people for whom it is meant and the items to be included in calculating index

numbers vary from one group to another.

Types of Consumer Price Index: At present in India apart from WPI, three different indices of

consumer prices are available: Consumer Price Index for Industrial Workers (CPI-IW);

Consumer Price Index for Urban Non-manual Employees (CPIUNME); Consumer Price Index

for agricultural Laborers (CPIAL). The inflation rate in economy varies from WPI to CPI. For

e.g. in 1998-99 the inflation rate as per WPI was 6.3% and as per CPI it was 15.3%. It also varies

between three type of CPI as mentioned above.

Relationship between Price Indices and inflation: Inflation is estimated through Price Indices.

Earlier inflation was estimated in terms of wholesale price. However from the point of view of

consumers, retail prices are far more relevant and thus today inflation is measured in terms of

CPI.


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Employment

Structure of employment in India

The structure of employment may be studied by recognizing the followingcharacteristics:

a) Distinction between organized and unorganized sector.

b) The relative share of self-employment, regular salaried employment and casual

labour.

It would be of interest to examine the structure from these two points of view.

Organized Vs. unorganized sector employment

The organized usually refers to employment in the public sector and in private

sector establishments employing 10 or more persons. It is commonly believed that

wages in the organized sector are much higher than in the unorganized sector.

Moreover, the organized sector being regulated also provides greater job security

and other benefits. Within the organized sector, jobs in the public sector receive

much higher wages and accompanying benefits than those in the private sector forsimilar skills. Besides this, public sector offers greater job security.

Self-employed, regular salaried and casual labour

Data on the basis of category of employment is considered separate for rural and

urban areas here. In rural areas, in 1999-2000, 56 percent of the workers were self-

employed, about 7 percent were regular salaried workers and 37 percent were

casual labourers. The proportion of self-employment in rural areas was around 63

per cent in 1977 and it has shown a decline over the last two decades and there has

been in regular salaried and casual labour workers which is a reflection of marginal

cultivators into agricultural labourers.


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The situation is very different in urban areas. The share of self-employment though

significant has remained more or less about 43 percent during the entire period

1977 to 2005. The regular salaried workers have been around 40 percent and only

18 percent are casual labours.

Quality of employment

Quality of employment in an economy can be judged by certain indicators. Some

of the important indicators are:-

1. Wages received by the workers.2. Number of days during the year for which casual labourers were employed.3. Share of workers engaged in organized and unorganized sectors.4. Proportion of workers engaged in self-employment,regular salaried and

casual labours.

5. Distribution of work opportunities amongprimary, secondary and tertiaryactivities.

6. Productivity of workers based on their levels of skills and educationalattainments.

Measurement of employment

It is important to know the meaning of the following three concepts which have

been used in measuring employment in India:

1. Labour force participation rate(LFPR):Labour force means economically active population from

which labours apply comes for production and so it includes both

employed and unemployed persons. LFPR means the number of personf


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in labour force for every thousand person in the economically active

population LFPR does not include children, students, retired old person

etc.

2. Work force participation rate(WFPR):Work force refers to the part of labour force which is actually

employed. The WFPR means the number of persons or the number of

person days employed per thousand persons or person days.

3.

Unemployed rate of persons unemployed(PU):Unemployment rate refers to the no. of persons unemployed per

thousand persons in the labor force.

Employment rate in India

Employers in all seven industry sectors forecast an increase in staffing levels

during quarter 3,2011. The most optimistic hiring intensions are reported in the

whole sale and retail trade sector, with a net employment standing at plus 51

percent. Services sector employers report bullish hiring plans with the result of 48

percent, and dynamic hiring prospects are evident in the finance, insurance and real

estate sector and the mining and construction sector, with 47 percent and 46

percent respectively. The manufacturing sector stands at 45 percent.

Employment in different sectors has been explained as follows


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1. Finance, insurance and real estate:With a net employment of +47%, employers forecast vigorous

hiring activity in Quarter 3, 2011. While a declined by 7 percentage

points when compared with the previous quarter, it is 11 percentage

points stronger year-over-year. Based on unadjusted survey data,

employers report bullish hiring plans for Quarter3 2011.

2. Mining and constructionSector employers anticipate a vigorous hiring pace in quarter 3,

2011 reporting a net employment of +46%. The assumption declines

by 5 percentage points quarter over quarter, but is unchanged when

compared with quarter 3, 2011. Based on unadjusted survey data,

employers report bullish hiring intentions for the coming quarter.

3. ManufacturingJob seekers are likely to benefit from a dynamic labor

market in quarter 3, 2011 according to employers who report a net

employment of +45%. Hiring prospects are considerably weaker quarter

over quarter with employers reporting an 11 percentage point decline

.

4. Public administration and educationEmployers forecast a brisk hiring pace in quarter three , 2011

reporting a net employment of 34%. However hiring propects are

considerably weaker when compared with quarter 2, 2011. That

declined by 20% points year over year their was 5% decrease in

points. Based on unadjusted survey of survey data, employers predict


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solid head count growth in the coming quarter despite a sharp quarter

over quarter decline.

5. Services sector employers anticipate a booming labour market inquarter3, 2011 reporting a net employment of 48%. While there was a

decline by 2% points quarter over quarter it is 5% points stronger year

over year. Based on survey data employers forecast a dynamic hiring

pace in the coming quarter.

UNEMPLOYMENT

Losing a job can be the most distressing economic event in personals life.

Most people rely on their labour earnings to maintain their standard of living ,and

many people also get a sense of personal accomplishment from working. A job

loss means a lower living standard in the present, anxiety about the future and

reduced self-esteem . It is not surprising ,therefore , that politicians campaigningfor office often speak about how their proposed policies will help create jobs .

In previous chapters we have seen some of the forces that determine the

level and growth of a countrys standard of living . A country that saves and

invests a high fraction of its income, for instance, enjoys more rapid growth in its

capital stock and GDP than a similar country that saves and invests less . An even

more obvious determination of a country s standard of leaving is the amount of

unemployment it typically experiences . People who would like to work but cannot

find a job are not contributing to the economys production of goods and services .Although some of unemployment in inevitable in a complex economy with

thousands of firms and millions of worker , the amount of unemployment various

substantially over time and cross countries . When a country keeps its workers as

fully employed as possible , it achieves a higher level of GDP than it would if it

left many of its workers standing idle .


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We begin the chapter by looking at some of the relevant facts that describe

unemployment . In particular, we examine three questions

How does the govt. measure the economys rate of unemployment? What problem arise in interpreting the unemployment data ? How long are the unemployed typically without work ?

IDENTIFYING UNEMPLOYMENT

Lets start by examining more precisely what the term employment means.

HOW IS UNEMPLOYMENT MEASURED?

Measuring unemployment is the job of the bureau of labor statistics(BLS),

which is part of the department of labor. Every month, the BLS produces data on

unemployment and on other aspects of labor market, including types of

employment, length of the average work week, and the duration of unemployment.

These data come from a regular survey of about 60,000 households, called the

current population survey.

Based on the answers to survey questions, the BLS places each adult (age 16

and older) of each surveyed household in to one of three categories:

1)EMPLOYED:This category includes those who worked as paid employees, worked in their

own business, or worked as unpaid workers in a family members business.

Both full time and part time workers are counted. This category also includes

those who were not working but who had jobs from which they weretemporarily absent because of, for example, vacation, illness, or bad weather.

2)UNEMPLOYED:


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This category includes those who were not employed , were available for

work and had tried to find employment during the previous fore weeks . It also

includes those waiting to be recalled to a job from which they had been lay off.

3)NOT IN THE LABOUR FORCE :This category includes those who fit neither of the first two categories,such as a full-time students , homemaker or retiree .

The labore-Market Experiences of Various Demographic

Group:

Demographic Group Unemployment

Rate(%)

LabourForce

participation (%)

Adult (ages 20 and older )

White-male 8.8 75.3

White-female 6.8 60.4

Black-male 16.3 69.6Black-female 11.5 63.4

Teenagers(16-19ages)

White-male 25.2 40.3

White-female 18.4 40.9

Black-male 46.0 26.4

Black-female 33.4 27.4

Labor-Force Participation of Men and Women in the U.S. Economy Women's rolein American society has changed dramatically over the past century. Social

commentators have pointed to many causes for this change. In part, it is

attributable to new technologies, such as the washing machine, clothes dryer,

refrigerator, freezer, and dishwasher, which have reduced the amount of time

required to complete routine household tasks. In part, it is attributable to


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improved birth control, which has reduced the number of children born to the

typical family. This change in women's role is also partly attributable to

changing political and social attitudes, which in turn ma y have been facilitated

by the advances in technology and birth control. Together these developments

have had a profound impact on society in general and on the economy in

particular.

Nowhere is that impact more obvious than in data on labor-force participa-

tion. Figure 3 shows the labor-force participation rates of men and women in the

United States since 1950. Just after World War II, men and women had very

different roles in society. Only 33 percent of women were working or looking

for work, in contrast to 87 percent of men. Over the past several decades, the

difference between the participation rates of men and women has gradually

diminished, as growing numbers of women have entered the labor force and

some men have left it. Data for 2009 show that 59 percent of women were in the

labor force, in contrast to 72 percent of men. As measured by labor-force

participation, men and women are now playing a more equal role in the economy.

The increase in women's labor-force participation is easy to understand, but

the fall in men's may seem puzzling. There are several reasons for this

decline. First, young men now stay in school longer than their fathers and

grandfathers did. Second, older men now retire earlier and live longer.

Third, with more women employed, more fathers now stay at home to raise

their children. Full- time students, retirees, and stay-at-home dads are all

counted as being out of the labor force.

Does the Unemployment Rate Measure What We Want It To?

Measuring the amount of unemployment in the economy might seem astraightforward task, but it is not. While it is easy to distinguish between a

person with a full- time job and a person who is not working at all, it is much

harder to distinguish between a person who is unemployed and a person who is

not in the labor force. Movements into and out of the labor force are, in fact,

common. More than one-third of the unemployed are recent entrants into the


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labor force. These entrants include young workers looking for their first jobs.

They also include, in greater numbers, older workers who had previously left

the labor force but have now returned to look for work. Moreover, not all

unemployment ends with the job seeker finding a job. Almost half of all spells of

unemployment end when the unemployed person leaves the labor force. Because

people move into and out of the labor force so often, statistics on

unemployment are difficult to interpret. On the one hand, some of those who

report being unemployed may not, in fact, be trying hard to find a job. They

may be calling themselves unemployed because they want to qualify for a

government program that financially assists the unemployed or because they

are actually working but paid "under the table" to avoid taxes on their

earnings. It may be more realistic to view these individuals as out of the labor

force or, in some cases, employed. On the other hand, some of those whoreport being out of the labor force may want to work. These individuals may

have tried to find a job and may h a v e g i v e n u p a f t e r a n

u n s u c c e s s f u l s e a r c h . D i s c o u r a g e d workers, do not show up in

unemployment statistics, even though they are truly workers without jobs.

Because of these and other problems, the BLS calculates several other

measures of labor underutilization, in addition to the official unemployment

rate. These alternative measures are presented . In the end, it is best to view

the official unemployment rate as a useful but imperfect measure of

joblessness.

How Long Are the Unemployed without Work?

In judging how serious the problem of unemployment is, one question to

consider is whether unemployment is typically a short-term or long-term

condition. If unemployment is short term, one might conclude that it is not a

big problem. Workers may require a few weeks between jobs to find the

openings that best suit their tastes and skills. Yet if unemployment is long term,

one might conclude that it is a serious problem. Workers unemployed for many

months are more likely to suffer economic and psychological hardship.


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Because the duration of unemployment can affect our view about how big

problem unemployment is, economists have devoted much energy to

studying data on the duration of unemployment spells. In this work, they

have uncovered a result that is important, subtle, and seemingly

contradictory: Most spells of unemployment are short, and most

unemployment observed at any given time is long-term.

To see how this statement can be true, consider an example. Suppose that you

visited the government's unemployment office every week for a year to

survey the unemployed. Each week you find that there are four unemployed

workers. Three of these workers are the same individuals for the whole year,

while the fourth person changes every week. Based on this experience, would you

say that unemployment is typically short-term or long-term?

Some simple calculations help - answer this question. In this example, you

meet a total of 53 unemployed people over the course of a year; 52 of them

are unemployed for one week, and 3 are unemployed for the full . 'ear. This

means that 52/55, or 95 percent, of unemployment spells end in one week. Yet

whenever you walk into the unemployment office, three of the four people

you meet will be unemployed for the entire year. So, even though 95 percent

of unemployment spells end in one week, 75 percent of the unemployment

observed at an

y

moment is attributable to those individuals who areunemployed for a full year. In this example, as in the world, most spells of

unemployed are short land most unemployment observed at any given time is

long-term.

This subtle conclusion implies that economists and policymakers must be care -

ful when interpreting data on unemployment and when-designing policies to

help the unemployed. Most people who become unemployed will soon find

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Module 4 Macro business environment