Macroeconomics:

Issues and Measurement

 What is Macroeconomics

• Macroeconomics is concerned with the behaviour of the

economy as a whole.
• It studies aggregate phenomena, such as
➢ Economy’s total output of goods and services
➢ Business cycles (recessions and booms )
➢ Inflation rates , Interest rates, Money supply
➢ Balance of payments, and exchange rates
➢ How governments can use their policy (monetary
and fiscal) instruments to help stabilize the
economy.
 Why Do We Need Macroeconomics

• Macroeconomics deals with major economic issues and

problems of the day
• Macroeconomics enables us to study events that affect
the economy as a whole without getting into too much
detail about specific products and sectors.

• We have to reduce the complicated details of the

economy to manageable essentials.
Economic growth rate
 Growth rate of the economy

➢ the rate at which the Gross Domestic Product (GDP)

is increasing
➢ Economic growth rate in Year t = (GDPt - GDP t-1) / GDP t-1

➢ What causes GDP to grow over time?

1) The available amount of resources (labour & capital)
2) Efficiency of production
 Gross Domestic Product (GDP)

• Value of all the goods and services produced

within a country (within the domestic territory) in
a given period of time (say, in a quarter or year )
The Circular Flow of Income, Output, and Expenditure

Domestic
households

Financial
System
Abroad

Government

Domestic
producers
 The Circular Flow of Income, Output, and Expenditure

• Individuals provide labour to firms and they buy the firms’ output.

• Leakage from the circular flow: Saving, Taxes and Imports

• Injections into the circular flow: Investment (I), Government

consumption (spending) (G) and Exports (X)

• Macroeconomic equilibrium level of national activity (GDP):

Injections must equal Leakages.
The Circular Flow of Income, Output, and Expenditure

National output or income can be measured from:

• the expenditure side in terms of expenditure on the
final output,
or
• the product/output side in terms of value added
or
• the income side factor incomes generated.
 Gross domestic product

• Gross domestic product, [GDP] can be calculated in three

different ways:
– [1] Product method (value added method): as the sum of all
values added by all producers of both intermediate and final
goods
– [2] Income method: as the income claims generated by the
total production of goods and services;
– [3] Expenditure method: as the expenditure needed to
purchase all final goods and services produced during the period.
 Value added through stages of production

Value Added = Value of Output – Value of Intermediate Consumption

Example: Bread you buy at E shop

 Value added through stages of production

Value Added = Value of Output – Value of Intermediate Consumption

 GDP concepts

• GDP and SDP

• GDP and GNP
• Net GDP
• GDP at Market price
• GDP at Factor cost
• Personal disposable income
• Percapita income
 GDP and GNP (or GDI and GNI)

• India GDP measures production that is located in the India,

• but India Gross National Product [GNP] measures income
accruing to India residents.
• The difference is due to net income from overseas.
• GNP=GNI=GNE
India 2022-23
GDP: 2,72,40,712 crores (Current price)
GNP: 2,67,99,146 crores
 GDP at Market price and Factor cost

• GDPmarket price
• Suppose GDP at market price = 110 million
• Excise and sale tax = 10 million
• GDPfactor cost: GPDmarket price – Net Indirect Taxes
• Net Indirect Taxes= Indirect Taxes(i.e. taxes on
production and sales)-subsidy
• GDPfactor cost is the total payments (income) to all the
factors of production (the one we derived through
circular flow)
• Here, GDPfactor cost: 110 – 10= 100 million
 Net GDP

Net GDP: GDP at factor cost- Depreciation

Depreciation: the value of the amount of capital used up (i.e.

wear and tear) in producing the output
• Percapita income
1) Percapita GDP= GDP/size of population
2) Percapita GNP= GNP/size of population
(Percapita income= GNP/size of population)
• Percapita incomemarket price
• Percapita incomefactor cost

• State Domestic Product: SDP

Gross Value Added at Current Basic Prices, by Sector, UK 2011
Expenditure-based GDP and Its Components, UK, 2011
Income-based GDP and Its Components, UK, 2011
 India: National income estimation
1. Primary:
(i) Agriculture;
(ii) forestry and logging;
(iii) fishing; and
(iv) mining and quarrying;
2. Secondary:
(v) Manufacturing: a) registered and b) unregistered
(vi) construction;
(vii) electricity, gas and water supply.
3. Transport, Communication and Trade:
(viii) transport, storage and communication: a) railways, b) transport by other means and storage, c)
communication
(ix) trade and hotels and restaurants;
4. Finance and Real Estate:
(x) banking and insurance;
(xi) real estate and ownership of dwelling and business services;
5. Community and Personal Services:
(xii) public administration and defence
(xiii) other services.
 India: National and state income

• https://www.indiabudget.gov.in/

• https://mofapp.nic.in/economicsurvey/eco
nomicsurvey/index.html
 International comparison of GDP

• In US Dollar
• Purchasing power parity index (from the World bank
data site)
International comparisons of living standards
“GOODS AND SERVICES . . .”
– GDP includes both tangible goods (food, clothing, cars) &
– intangible services (haircuts, doctor visits, music concert)

“PRODUCED . . .”: GDP includes goods and services currently produced.

– Flow concept
– It does not include transactions involving items produced in the previous
years.
Eg. Tata produces and sells a new car, the value of the car is included in
GDP.
– When one person sells a used car to another person, the value of the
used car is not included in GDP. But the sales/transaction service, new
spares etc. included (though used car dealer/true value shops etc)
 Interpreting National Income and Output

GDP IS THE MARKET VALUE . . .”

– GDP adds together different kinds of products and services into a
single monetary measure of the value of economic activity
• GDP also measure everything including even those that do not
contribute to human welfare (examples: gun, tobacco, alcohol)
• GDP excludes production that takes place in the underground
economy or that does not pass through markets.
• Household works (non-compensated) excluded: (maid vs.
housewife; security guard vs. own guarding)
 GDP = market value of all final goods
and services produced within a
country in a given period of time
““OF ALL . . .”
- Comprehensive measure
– It includes all items produced in the economy and sold legally in markets

Excludes items that are produced and consumed at home and,

therefore, never enter the marketplace
▪ Vegetables you buy at the grocery store are part of GDP, but Vegetables
you grow in your garden are not
▪ Your lunch at home not part of GDP (except intermediate goods) but at
restaurant
▪ Ironing your dress at hostel is Not part of GDP but giving at Laundry
 Why do we care about GDP
• GDP is one of the best measures available of the total economic activity
within a country.
• It is particularly valuable when changes in GDP are used to indicate
how economic activity has changed over time.

• When judging whether the economy is doing well or poorly, it is natural to

look at the total income that everyone in the economy is earning.

• GDP is a measure of how well the overall economy is performing

• Inequality: Gini coefficient
• Gini coefficient ranges from zero to 1; zero
indicating perfect equality and 1 indicating the
perfect inequality
Nominal and real GDP at market prices (1900-2013)
 Summary

• We now know how to measure and interpret the various concepts related to
the nation’s income and output, of which the gross domestic product (GDP)
is the most commonly used aggregate measure.

• GDPFC in 2018: 110

• GDPFC in 2017: 100
• Growth rate= 10%
• Economic growth rate in Year t = (GDPt- GDP t-1) / GDP t-1
 Nominal
Nominal and and
Real Real
GDP GDP

• Nominal GDP reflects changes in both prices and quantities.

• GDP at current prices: “Nominal GDP measures the value of
output in a given period in the prices of that period”
• GDP at constant prices: “Real GDP measures changes in
physical output in the economy between different time
periods by valuing all goods produced in the 2 periods at the
same prices.
• Appropriate comparisons of nominal and real measures yield
implicit deflators.
 Inflation: increase in the overall level of prices

How do we measure prices?

For the macro economy, we need a measure of overall prices =
price index (Focus is not price but the price level)
• Inflation is the rate of change in prices
• the price level is the cumulative of past inflation
 Inflation and Prices
• Inflation, , is the rate of change of prices:  t = Pt − Pt −1
Pt −1
where Pt is today’s price and Pt-1 is last period’s price

• Additionally, Pt = Pt −1 + ( Pt −1 *  ) , or today’s price equals

last year’s price, adjusted for inflation

• If  > 0, prices are increasing over time → inflation

• If  < 0, prices are decreasing over time → deflation

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 Inflation Measurement
• 1) GDP deflator

• 2) Consumer price index (CPI)

• 3) Whole sale price index (WPI)

• 4) Producer price index (PPI)

➢ Producer (e.g., farmer):PPI ……

➢ Wholesaler: WPI……

➢ Retailer: CPI

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 Nominal and Real GDP
• Nominal GDP reflects changes in both prices and quantities.

• GDP at current prices: “Nominal GDP measures the value of output in a given period in the
prices of that period”

• GDP at constant prices: “Real GDP measures changes in physical output in the economy
between different time periods by valuing all goods produced in the 2 periods at the same prices.

• Appropriate comparisons of nominal and real measures yield implicit deflators.

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 2. Consumer price index
CPI measures the cost of buying a fixed basket of goods and services representative of the
purchases of consumers (rural and/or urban consumers)

1. Survey consumers to determine composition of the typical consumer’s “basket” of goods.

2. Every month, collect data on prices of all items in the basket; compute cost of basket

3. CPI in any month equals:

Cost of basket in that month

100 
Cost of basket in base period

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India: CPI

▪ The number of items in CPI basket include 448 in rural and

460 in urban.
▪ The items in CPI are divided into 6 main groups as follows:
▪ Weighted CPI

Item Group Weightage

Food and beverages 54.18
Pan, Tobacco and Intoxicants 3.26
Clothing & Footwear 7.36
Fuel & Light 7.94
Miscellaneous 27.26
Total 100
From GoI website
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1/20/2025
Climate Finance and Sustainability: ECO921
Climate Finance and Sustainability: ECO921

https://www.indiabudget.gov.in/budget2019-
20/economicsurvey/doc/vol2chapter/echap04_vol2.pdf
Core Inflation
• Core Inflation corresponds to the
component of inflation that is likely to
continue for a long period. Thus, core
inflation captures the underlying trend of
inflation and is, therefore, more stable.
• Unlike the non-core component of inflation,
core inflation is not affected by temporary
shocks. In India, core inflation is generally
measured by excluding highly volatile
components from the headline inflation.
• By their very nature, food and fuel have been
highly volatile. Therefore, we arrive at core
inflation by removing food and fuel
components from the headline inflation.

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GDP deflator and CPI
• GDP deflator measures the prices of all goods and services produced
• whereas the CPI measures the prices of only the goods and services bought by
consumers.
Thus, an increase in the price of goods purchased only by firms or the government
will show up in the GDP deflator
but this will not be reflected in the CPI.
How does CPI differ from GDP deflator?

1. GDP deflator measures the prices of much wider group of

goods than the CPI does [CPI measures prices of a more
limited basket of goods and services (only household
goods and services)]
2. The bundle of goods in the consumer basket is fixed (i.e.,
same from year to year), while that of the GDP deflator is
allowed to vary in each year (what is being actually
produced)
3. CPI includes prices of imports, while GDP deflator only
considers the goods produced domestically
 CPI vs. GDP Deflator
The “basket of goods”
• CPI: fixed
• GDP deflator: composition of goods changes every year

• Implication
• Suppose a major earthquake in North-east India affects entire tea production.
• The quantity of tea produced =0, and the price of tea remaining in market increases.
• Tea is no longer part of GDP, the increase in the price of tea does not show up in the
GDP deflator.
• Since CPI is computed with a fixed basket of goods that includes tea, the increase in
the price of tea causes a substantial rise in the CPI
Problems in CPI
1) Substitution bias:
• The CPI uses fixed weights, so it cannot reflect consumers’ ability to
substitute toward goods whose relative prices have fallen.
Thus, CPI overstates the impact of the increase in tea prices on consumers
2) Introduction of new goods ignored (Cinema theater vs Home theater)
3) Unmeasured quality change (quality of car in 1990 Vs in 2022)
(Labour department normally accounts these quality changes in CPI calculation)
Price Indexes: PPI
• PPI measures the cost of buying a fixed basket of goods and services representative of a
firm
Captures the cost of production for a typical firm
Market basket includes raw materials and semi-finished goods

• PPI is constructed from prices at an earlier stage of the distribution process than the CPI

• PPI signals changes to come in the CPI and is thus closely watched by policymakers

→Over long periods of time, the two measures yield similar

values and trends for inflation

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• WPI

• PRIMARY ARTICLES (Weight 22.62%)

• FUEL & POWER (Weight 13.15%)

• MANUFACTURED PRODUCTS (Weight 64.23%)

• India: There are total 676 items in WPI, and inflation is computed taking 5482 Price
quotations.

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The Wholesale Price Index (WPI) was the main index for measurement of inflation
in India till April 2014 when RBI adopted new Consumer Price Index (CPI)
(combined) as the key measure of inflation

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