Macroeconomics with Basic

Concepts and Circular

Revision Notes
Macroeconomics refers to that branch of economics Capital Goods: All goods which are used in the
that deals with economic problems or economic production of other goods either as fixed assets or as
issues at the level of an economy as a whole, e.g. it inventory/stock are called Capital Goods.
deals with aggregates like national income, general Final Goods: Those goods which are purchased
price level, etc. either for final consumption by consumers (consumer
Consumption Goods: Goods which are used by the goods) or for investment by producers (capital goods)
consumers to satisfy human wants directly are called are final goods.
consumption goods.
Intermediate Goods: Those goods and services which (iii) Domestic economy is a closed economy (no
are purchased as raw material for further production exports and imports).
or for resale in the same year. (iv) There is no government in the economy.
Stock: Stock is a quantity measurable at a particular Production in the producing sector generates income
“point of time”, e.g. wealth, assets, money, inventory, for the households who are owners of the factors of
etc. A stock variable is nothing but an accumulated production. Expenditure by the households generates
sum of flows. demand for further production. These movements keep
Flow: Flow is a quantity that can be measured over a chasing each other continuously moving in a circle.
specific “period of time”, e.g. national income, change
in stock, etc.
Gross Investment: Total addition made to physical
stock of capital during a period of time. It includes
depreciation. It is also known as Gross Capital
Formation.
Net Investment: Net addition made to the real stock
of capital during a period of time.
Depreciation: It means fall in value of fixed capital
goods due to normal wear and tear, expected
obsolescence and efflux of time.
Circular flow of income: Circular flow of income Significance of Circular Flow of Scan to know
refers to the flow of activities of production, income Income: (i) It reflects structure more about
generation and expenditure involving different of an economy, (ii) It shows this topic
sectors of the economy. interdependence among different
2-Sector Model of Circular Flow: It is assumed that: sectors, (iii) It shows injections
(i) Domestic economy comprises only 2 sectors, the and leakages from flow of money,
(iv) It helps in estimation of Circular Flow of
producers and the households. Income
national income and related
(ii) The households spend their entire income, so
aggregates.
that there is no savings.
 National Income Accounting
Topic-2
Concepts Covered  Methods of calculating National Income and their precautions.

Revision Notes
National Income: National Income is the sum total Precautions while using Value Added Method:
of factor incomes earned by normal residents of a (i) The value of intermediate goods should not be
country. included.
Measurement of National Income: (a) In the form of (ii) Purchase and sale of second hand goods should
flow of goods and services, (b) In the form of income not be included.
flow, (c) In the form of expenditure flow. (iii) Imputed or estimated value of self-consumed
goods should be included but self-consumed
services should not be included.
Amazing Fact (iv) Own account production should be included.
(v)  Commission earned on account of sale and
India’s GDP in 2020 stood at 2.62 lakh crores
purchase of second hand goods is included.
USD.
Income Method: It measures national income in term
Value Added Method or Production Method: The of payments made in the form of wages, rent, interest
national income is estimated by the contribution of and profit to the primary factors of production, i.e.,
each producing enterprise to produce in the domestic labour, land, capital and enterprise respectively for
territory of the country in an accounting year. For their productive services in an accounting year.
measuring national income by this method, we have Net Domestic Income or Net Domestic Product at
to estimate the following components: Factor Cost: Compensation to Employees + Operating
Net Domestic Product at Market Price (NDPMP): Surplus + Mixed Income from Self Employment.
Gross Valued Added by [Primary Sector + Secondary National Income = Net Domestic Income + Net
Sector + Tertiary Sector] - Depreciation Income from Abroad.
Net National Product at Factor Cost (NNPFC) or NI: Precautions while using Income Method:
NDPMP - Net Indirect Tax + Net Income from Abroad. (i)  Income from illegal activities like smuggling,
Value Added Method (Product Method): Gross Value theft, gambling, etc., should not be included.
Added at Market Price (GVAMP) = Sales + Change in (ii) Imputed rent of owner occupied structure and
Stock - Intermediate Consumption. value of production for self-consumption is
GDPMP =GVAMP of all sectors + Depreciation + Net included but value of self-consumed services like
Indirect Taxes those of housewife is not included.
OR (iii) Brokerage on the sale/purchase of shares and
Value of output - Intermediate consumption bonds is to be included
NVAFC = GVAMP - Depreciation - Net Indirect Taxes (iv) Income in terms of windfall gains should not be
(NIT) included.
 (v) Transfer earning like old age pensions, Real Gross Domestic Product: When the goods and
unemployment allowances, scholarships, pocket services are produced by all producing units in the
expenses, etc. should not be included. domestic territory of a country during an accounting
Expenditure Method: By this method, the total year and valued at base year’s prices or constant
sum of expenditures on the purchase of final goods price, it is called real GDP or GDP at constant prices.
and services produced during an accounting year Gross National Product: It is defined as the total value
within an economy is estimated to obtain the value of all final goods and services produced in a country
of GDP. Final Expenditure: It is the expenditure on in a particular year, plus the income which is earned
the purchase of final goods and services, during an by its citizens who are located abroad and minus the
accounting year. It is broadly classified into four income of non-residents located within the country.
categories: GNPMP = GDPMP + Net Factor Income from Abroad
(i) Private final consumption expenditure, Net National Product at Factor Cost (NNPFC): It is the
(ii) Government final consumption expenditure, sum total of factor incomes (rent + interest + profits
(iii) Investment expenditure, + wages) earned by normal residents of a country
(iv) Net exports, i.e., difference between exports and during the period of an accounting year. It is also
imports during an accounting year. known as the National Income.
Computation of National Income (by expenditure NNPFC = GNPFC - Depreciation
method) NNPFC = GDPMP - Depreciation + NFIA OR
- Net Indirect Tax. Where, GDPMP = Private Final
NNPFC = NDPFC + NFIA
Consumption Expenditure + Government Final
Consumption Expenditure + Gross Domestic Capital Net National Product at Market Price (NNPMP): It
Formation + Net Exports (Exports - Imports). Where, refers to market value of final goods and services
Gross Domestic Capital Formation = Gross Domestic produced during the year inclusive of Net Factor
Fixed Capital Formation + Change in Stock (Closing Income from Abroad but exclusive of depreciation.
Stock - Opening Stock)
Precautions while using Expenditure Method:
(i) Only final expenditure is to be taken into account
to avoid error of double counting.
(ii) Expenditure on second hand goods is not to be
included.
(iii) Expenditure on transfer payments by the
government is not to be included.
(iv)  Imputed value of expenditure on goods
produced for self-consumption should be taken
into account.
(v) Expenditure on shares and bonds is not to be
included in total expenditure.
Gross Domestic Product (GDP): It is the total value of
all the final goods and services by all the enterprises
(both resident and non-resident) within the domestic
territory of a country in a particular year.
Gross Domestic Product at Market Price (GDPMP):
Private Final Consumption Expenditure (C) +
Government Final Consumption Expenditure
(G) + Investment Expenditure (I) or Gross Capital
Formation + Net Exports (X - M).
Net Domestic Product at Market Price (NDPMP) =
GDPMP - Depreciation
Net Domestic Product at Factor Cost (NDPFC) =
GDPMP - Indirect Taxes + Subsidies
National Income = GDPMP - Depreciation - Net
Indirect Taxes + Net Income from Abroad
Nominal Gross Domestic Product: When the goods
and services are produced by all producing units in the
domestic territory of a country during an accounting
year and valued at current year’s prices or current
prices, it is called Nominal GDP or GDP at current
prices.
 Key Words Factor Income: These are incomes received by the
owners of factors of production for rendering their
Net Factor Income from Abroad (NFIA): This factor services to the producers.
is the difference between the income earned from Transfer Payments: These are all those unilateral
abroad for rendering factor services by the normal payments corresponding to which there is no value
residents of the country to the rest of the world and addition in the economy, e.g., gifts, donations, etc.
the income paid for the factor services rendered by Double Counting: Counting the value of the same
non-residents in the domestic territory of a country. product more than once in calculation of National
Income

Example 1
Find Net Value Added at Factor Cost: Solution:
S. Items (` in crore) NVAFC = (ii × iii) + (vi) - (i) - (v) - (iv)
No = [Output × Price] + [Change in Stock]
(i) Intermediate Cost 15,000 - [Intermediate Cost] - [Excise Duty] -
(ii) Output Sold (units) 9,000 [Consumption of Fixed Capital]
(iii) Price per unit of output 4 = [` 9,000 × 4] + [- ` 1,000] - [` 15,000] - [` 4,000]
- [2,000]
(iv) Consumption of Fixed 2,000
Capital = ` 36,000 - ` 1,000 - ` 15,000 - ` 4,000 - ` 2,000
(v) Excise Duty 4,000 = ` 36,000 - ` 22,000
(vi) Change in stock (-)1,000 NVAFC = ` 14,000 crore
 GDP deflator GDP and Welfare
Topic-3
Concepts Covered  Why GDP is not an appropriate indicator of Welfare

Revision Notes
GDP Deflator: The GDP (gross domestic product) GDP and Welfare: In general, Real GDP and Welfare
price deflator, also known as the GDP deflator or are directly related with each other. Even though
the implicit price deflator, measures the changes higher GDP implies more production of goods and
in prices for all the goods and services produced in services, it does not necessarily mean that the people
an economy. It shows the change in GNP with the were better off. Thus, higher GDP not necessarily
change the price levels. The GDP price deflator is mean higher welfare.
a more comprehensive inflation measure than the Welfare means material well-being of the people.
Consumer Price Index (CPI) index because it isn’t It depends on many economic factors like national
based on a fixed basket of goods. The GDP price income, consumption level, quantity of goods, etc., and
deflator measures the changes in prices for all the non-economic factors like environmental pollution, law
goods and services produced in an economy. Using and order, etc. The welfare which depends on economic
the GDP price deflator helps economists compare factors is called economic welfare and the welfare
the levels of real economic activity from one year which depends on non- economic factor is called non-
to another. economic welfare. The sum total of economic and non-
GDP Deflator – Normal GDP / Real GDP *100 economic welfare is called social welfare.
(b) Composition of GDP: GDP does not exhibit
Amazing Facts the structure of the product. If the increase in
GDP is mainly due to increased production of
Negative Externalities can be profitable war equipment and ammunitions, then such an
for a company for the short run growth. increase cannot improve welfare in economy.
(c) Distribution of GDP: When GDP is unevenly
GDP is not an appropriate indicator for Welfare: distributed, increase in GDP does not increase
GDP may be a good indicator of economic growth but welfare.
not of economic welfare or economic development (d) Non-monetary exchanges: Many activities in
because of: an economy are not evaluated in monetary
(a) Externalities: Externalities refer to benefits or terms, they are not included in GDP, due to
harms of an activity caused by a firm or an indi- non-availability of data. However, such activities
vidual, for which they are not paid or penalized. influence the economic welfare of people of the
For example, environmental pollution caused by economy.
industrial plants is a negative externality and
building a flyover is a positive externality.