Key Points - introductory Macro Economics

Key Concepts

- Macro Economics: Its meaning
Consumption goods, capital goods, final goods, intermediate goods, stock and flow, gross investment and depreciation.
Circular flow of income
Methods of calculation of national income
Value added method (product method)
Expenditure method
Income method
Concepts and aggregates related to national income
Gross national product
Net National product
Gross and Net domestic product at market price and at factor cost.
National disposable income (Gross and net)
Private income
Personal income
Personal disposable income
Real and Nominal GDP
GDP and welfare

Macro Economics: - Macroeconomics is the study of aggregate economic variables of an economy.
Consumption goods:- Are those which are bought by consumers as final or ultimate goods to satisfy their wants.
Eg: Durable goods car, television, radio etc.
Non-durable goods and services like fruit, oil, milk, vegetable etc.
Semi durable goods such as crockery etc.
Capital goods – capital goods are those final goods, which are used and help in the process of production of other goods and services. E.g.: plant, machinery etc.
Final goods: Are those goods, which are used either for final consumption or for investment.
It includes final consumer goods and final production goods. They are not meant for resale.
So, no value is added to these goods. Their value is included in the national income.
Intermediate goods intermediate goods are those goods, which are used either for resale or for further production. Example for intermediate good is- milk used by a tea shop for selling tea.
Stock: - Quantity of an economic variable which is measured at a particular point of time.
Stock has no time dimension. Stock is static concept.
Eg: wealth, water in a tank.
5. Flow: Flow is that quantity of an economic variable, which is measured during the period of time.
Flow has time dimension- like per hr, per day etc.
Flow is a dynamic concept.
Eg: Investment, water in a stream.
Investment: Investment is the net addition made to the existing stock of capital.
Net Investment = Gross investment – depreciation.
Depreciation: - depreciation refers to fall in the value of fixed assets due to normal wear and tear, passage of time and expected obsolescence.
Circular flow in a two sector economy.
Payment for goods and services (Money Flow)
Firms
Supply of goods and services (Real Flow)
House hold
Supply of Factors of Production (Real Flow)
Payment for Factor services (Money Flow)
Producers (firms) and households are the constituents in a two sectors economy.
Households give factors of production to firm and firms in turn supply goods and services to households.
Related aggregates
Gross Domestic product at market price
It is the money value of all final goods and services produced during an accounting year with in the domestic territory of a country.
Gross National product at market price:
It is a money value of all final goods and services produced by a country during an accounting year including net factor income from abroad.
Net factor income from abroad:
Difference between the factor incomes earned by our residents from abroad and factor income earned by non-residents with in our country.

Components of Net factor income from abroad
- Net compensation of employees
- Net income from property and entrepreneurship (other than retained earnings of resident companies of abroad)
- Net retained earnings of resident companies abroad

Formulas
- NNP Mp = GNP mp - depreciation
- NDP Mp = GDPmp - depreciation
- NDP Fc = NDP mp – Net indirect taxes (indirect tax – subsidies)
GDP Fc = NDP fc + depreciation
NNP Fc = GDP mp - depreciation + Net factor income from abroad – Net indirect taxes (NNP FC is the sum total of factor income earned by normal residents of a country during the accounting year)
NNP fc = NDP fc + Net factor income from abroad.

Concept of domestic (economic) territory
Domestic territory is a geographical territory administered by a government within which persons, goods and capital circulate freely. (Areas of operation generating domestic income, freedom of circulation of persons, goods and capital)

Scope identified as
- Political frontiers including territorial waters and air space.
- Embassies, consulates, military bases etc. located abroad but including those locates within the political frontiers.
- Ships, aircrafts etc., operated by the residents between two or more countries.
- Fishing vessels, oil and natural gas rigs etc. operated by the residents in the international waters or other areas over which the country enjoys the exclusive rights or jurisdiction.

Resident (normal resident): Normal resident is a person or an institution who ordinarily resides in that country and whose center of economic interest lies in that country. (The Centre of economic interest implies :-( 1) the resident lives or is located within the economic territory. (2) The resident carries out the basic economic activities of earnings, spending and accumulation from that location 3. His center of interest lies in that country.
Relation between national product and Domestic product.
Domestic product concept is based on the production units located within domestic (economic) territory, operated both by residents and non-residents.
National product concept based on resident and includes their contribution to production both within and outside the economic territory.
National product = Domestic product + Residents contribution to production outside the economic territory (Factor income from abroad) - Non- resident contribution to production inside the economic territory (Factor income to abroad)

Methods of calculation of national income
I - PRODUCT METHOD (Value added method):
- Sales + change in stock = value of output
- Change in stock = closing stock – opening stock
- Value of output - Intermediate consumption = Gross value added (GDPMp)
- NNP Fc (N.I) = GDPMp (-) consumption of fixed capital (depreciation) (+) Net factor income from abroad ( -) Net indirect tax.

Income method:
1. Compensation of employees.
2. Operating surplus.
Income from property
Rent & Royalty
Income from Entrepreneurship
Interest
Profit
Corporate
Tax
Corporate dividend
Savings (Net retained earnings)

3. Mixed income of self-employed.
- NDP fc = (1) + (2) + (3)
NNP fc = NDP fc (+) Net factor income from abroad
GNP mp = NDP fc + consumption of fixed capital + Net indirect tax (Indirect tax – subsidy)

Expenditure method:
1. Government final consumption expenditure.
2. Private final consumption expenditure.
3. Net Export.
4. Gross domestic capital formation.
Gross Domestic fixed
+
Capital formation
GDPmp = (1) + (2) + (3) + (4)
Change in stock
NNP fc = GDPmp - consumption of fixed capital + NFIA- Net indirect taxes
Note: If capital formation is given as Net domestic capital formation we arrive at NDPmp.
Capital formation = Investment

CALCULATION OF NATIONAL DISPOSABLE INCOME, PRIVATE INCOME,
PERSONAL INCOME AND PERSONAL DISPOSABLE INCOME
Private Income includes factor Personal Income
National
Disposable income as well as Transfer income income (Earned income +
Unearned income)

It is the income from all the sources (Earned
Income as well as transfer payment from abroad) available to resident of a country for consumption expenditure or saving during a year.
NNPFC + Net Indirect tax + Net current transfer from abroad
=Net
National disposable income. (Gross National Disposable Income includes depreciation)
Factor income from net domestic product accruing to private sector includes income from enterprises owned and controlled by the private individual.
Excludes:1. Property and entrepreneurial income of the Gov. departmental enterprise

2. Savings of the Non-departmental Enterprise.
Factor Income from NDP Accruing to private sector = NDPFC (-) income from properly entrepreneurship accruing to the govt departmental Enterprises (-) savings of Non departmental enterprises.
Private Income Includes
* Factor income from net domestic product accruing to private sector.
+ Net factor income from abroad
+ Interest on National Debt
+ Current transfer from Govt.
+ Current transfer from rest of the world.
PI is the income Actually received by the individuals and households from all sources in the form of factor income and current transfers.
Personal income = Private
Income (-) corporation tax. (-) Corporate Savings OR
Undistributed profits
Personal disposable income
Personal income (-) Direct
Personal tax (-)
Miscellaneous
Receipts of the govt.
Administrative department (fees and fines paid by house hold.)
....................................................................................................
One Mark questions.

1. When will the domestic income be greater than the national income?
Ans: When the net factor income from abroad is negative.

2. What is national disposable income?
Ans.It is the income, which is available to the whole economy for spending or disposal
NNP Mp + net current transfers from abroad = NDI

3. What must be added to domestic factor income to obtain national income?
Ans. Net factor income from abroad.

4. Explain the meaning of non-market activities
Ans. Non marketing activities refer to acquiring of many final goods and services not through regular market transactions. E.g. vegetable grown in the backyard of the house.

5. Define nominal GNP
Ans. GNP measured in terms of current market prices is called nominal GNP.

6. Define Real GNP.
Ans. GNP computed at constant prices (base year price) is called real GNP.

7. Meaning of real flow.
Ans. It refers to the flow of goods and services between different sectors of the economy. Eg.
Flow of factor services from household to firm and flow of goods and services from firm to household.

8. Define money flow.
6. It refers to the flow of money between different sectors of the economy such as firm, household etc. Eg. Flow of factor income from firm to house hold and consumption expenditure from house hold to firm.

4 Mark Questions

1. Distinguish between GDPMp and GNP FC
Ans. The difference between both arise due to (1) Net factor income from abroad. and 2) Net indirect taxes. In GDPMp Net factor income from abroad is not included but it includes net indirect taxes.
GNP FC = GDPMp + net factor income from abroad – net indirect taxes

2. Distinguish between personal income and private income
Ans. Personal income: -It is the sum total of earned income and transfer incomes received by persons from all sources within and outside the country.
Personal income = private income – corporate tax –corporate savings (undistributed profit)
Private income consists of factor income and transfer income received from all sources by private sectors within and outside the country.

3. Distinguish between nominal GNP and real GNP
Ans. Nominal GNP is measured at current prices. Since this aggregate measures the value of goods and services at current year prices, GNP will change when volume of product changes or price changes or when both changes.
Real GNP is computed at the constant prices. Under real GNP, value is expressed in terms of prices prevailing in the base year. This measure takes only quantity changes. Real GNP is the indicator of real income level in the economy.

4. Explain the main steps involved in measuring national income through product method
Ans. a) Classify the producing units into industrial sectors like primary, secondary and tertiary sectors. b) Estimate the net value added at the factor cost. c) Estimate value of output by sales + change in stock d) Estimate gross value added by value of output – intermediate consumption e) Deduct depreciation and net indirect tax from gross value added at market price to arrive at net value added at factor cost = NDP Fc f) Add net factor income received from abroad to NDP Fc to obtain NNP FC which is national income

5. Explain the steps involved in calculation of national income through income method a) Classify the producing enterprises into industrial sectors like primary, secondary and tertiary. b) Estimate the following factor income paid out by the producing units in each sector i.e.
*Compensation of employees
*Operating surplus
*Mixed income of self employed
c) Take the sum of the factor income by all the industrial sectors to arrive at the NDP Fc (Which is called domestic income) d) Add net factor income from abroad to the net domestic product at factor cost to arrive at the net national product at factor cost.

6. Explain the main steps involved in measuring national income through expenditure method. a) Classify the economic units incurring final expenditure into distant groups like households, government, firms etc. b) .Estimate the following expenditure on final products by all economic units
- Private final consumption expenditure
- Government final consumption expenditure
- Gross domestic capital formation
- Net export (Sum total of above gives GDPMp) c) Deduct depreciation, net indirect taxes to get NDP Fc d) Add net factor income from abroad to NDP Fc to arrive at NNP FC.

7. What are the precautions to be taken while calculating national income through product method (value added method) a) Avoid double counting of production, take only value added by each production unit. b) The output produced for self-consumption to be included c) The sale & purchase of second hand goods should not be included. d) Value of intermediate consumption should not be included e) The value of services rendered in sales must be included.
8. Precautions to be taken while calculating national income through income method. a) Income from owner occupied house to be included. b) Wages & salaries in cash and kind both to be included. c) Transfer income should not be included d) Interest on loans taken for production only to be included. Interest on loan taken for consumption expenditure is non-factor income and so not included.
9. Precautions to be taken while calculations N.I under expenditure method. a) Avoid double counting of expenditure by not including expenditure on intermediate product b) Transfer expenditure not to be included c) Expenditure on purchase of second hand goods not to be included.
 

1.. Write down the limitations of using GDP as an index of welfare of a country
1. The national income figures give no indications of the population, skill and resources of the country. A country may be having high national income but it may be consumed by the increasing population, so that the level of people’s wellbeing or welfare standard of living remains low.
2. High N. I may be due to greater area of the country or due to the concentration of some resources in out particular country.
3. National income does not consider the level of prices of the country. People may be having income but may not be able to enjoy high standard of living due to high prices.
4. High N. I may be due to the large contribution made by a few industrialists
5. Level of unemployment is not taken into account.
6. National income does not care to reduce ecological degradation. Due to excess of economic activity which leads to ecological degradation reduces the welfare of the people.
Hence GNP and economic welfare are not positively related. Income in GNP does not bring about increase in economic welfare.
 

6. 1.. ‘Machine purchased is always a final good’ do you agree? Give reason for your answer
Whether machine is a final good or it depends on how it is being used (end use). If machine is bought by a household, then it is a final good. If machine is bought by a firm for its own use, then also it is a final good. If the machine is bought by a firm for resale then it is an intermediate good.
1.. What is double counting? How can it be avoided?
Counting the value of commodities at every stage of production more than one time is called double counting.
It can be avoided by a) taking value added method in the calculation of the national income. b) By taking the value of final commodity only while calculating N.I

6 Mark questions
1. State whether following is true or false. Give reason for your answer. a) Capital formation is a flow
True, because it is measured over a period of time. b) Bread is always a consumer good.
False, it depends upon the end use of bread. When it is purchased by a household it is a consumer good. When purchased by restaurant for making sandwich, it is an intermediate (producer) good. c) Nominal GDP can never be less that real GDP
False. Nominal GDP can be less than the real GDP when the prices in the base year is more than the current year. d) Gross domestic capital formation is always greater than gross fixed capital formation.
False, gross domestic capital formation can be less than gross fixed capital formation if change in stock is negative.

2. Why are exports included in the estimation of domestic product by the expenditure method? Can the gross domestic product be greater than the gross national product? Explain
Expenditure method estimates expenditure on domestic product i.e., expenditure on final goods and services produced within the economic territory of the country. It includes expenditure by residents and non-residents both. Exports though purchased by non residents are produced within the economic territory and therefore a part of domestic product.
Domestic product can be greater than national product, if the factor income paid to the rest of the world is greater than the factor income received from the rest of the world i.e, when net factor income received from abroad is negative.

3. How will you treat the following while estimating domestic product of India? a) Rent received by resident Indian from his property in Singapore.
No, it will not be included in domestic product as this income is earned outside the economic territory of India. b) Salaries of Indians working in Japanese Embassy in India
It will not be included in domestic product of India as embassy of Japan is not a part of economic territory of India.
 c) Profits earned by branch of American bank in India.
Yes, it is included as part of domestic product since the branch of American bank is located within the economic territory of India. d) Salaries paid to Koreans working in the Indian embassy in Korea
Yes, it will be part of domestic product of India because the income is earned within the economic territory of India. Indian embassy in Korea is a part of economic territory of India.

4.How are the following treated in estimating national income from expenditure method? Give reason. a) Purchase of new car by a household: purchase of car is included in the national income because it is final consumption expenditure, which is part of national income. b) Purchase of raw material by purchase unit: purchase of raw material by purchase unit is not included in the national income because raw material is intermediate goods and intermediate goods and service are excluded from the national income. Purchase of raw material, if included in national income will result in double counting. c) Expenditure by the government on scholarship to student is not included in the national income because it is a transfer payment and no productive service is rendered by the student in exchange.

5. Are the following item included in the estimating a country‘s national income? Give reason.
1. Free cloth given to workers: free cloth given to worker is a part of wages in kind i.e. compensation to employee such compensation to employee is paid for the productive services in the economy, it is included in the national income.
2. Commission paid to dealer in old car: commission paid to dealer in old car is included in the estimation of national income because it is the income of the dealer for his productive services to various parties.
3. Growing vegetable in a kitchen garden of the house: growing vegetable in a kitchen garden of the house amount to production, though not for sale for self-consumption. It is included in the national income because it adds to the production of goods.

Personal income = Private Income – Corporation Profit Tax – Savings of private corporate sectors