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Unit-4

1. Macroeconomic aggregates

Economics
“Economics is a science which studies human behavior as a relationship between ends and scarce
means which have alternative uses”
-Lionel Robbins
Ends: Unlimited wants
Scarce: Limited resources
Economics is the study of choice
Macroeconomics deals with the economy as a whole; it examines the behavior of economic
aggregates such as aggregate income, consumption, investment, and the overall level of prices.
– Aggregate behavior refers to the behavior of all households and firms together.
Macroeconomic aggregates (or) Macroeconomic policies
Macroeconomics is the study of aggregates or averages covering the entire economy, such
as Total Employment, National Income, National Output, Total Investment, Total Consumption,
Total Savings, Aggregate Demand, Aggregate Supply and General Price level, Wage level, and
Cost structure.
SUPPLY SIDE POLICIES
Macroeconomic objectives
1) Deregulation
1. To achieve national level full employment
2) Privatization
2. To stabilize the price fluctuations in the
market 3) Promotion of free trade
3. To achieve overall economic growth 4) Small business grants
4. To develop regions economically 5) Legislation against trade union
5. To improve the standard of living of the 6) Education and skill training
people 7) Income tax rates
6. To reduce income inequalities 8) Cutting unemployment benefits
7. To control monopoly market structure
8. To avoid cyclical fluctuations in various
economic activities of the country MACRO ECONOMIC EQUILIBRIUM OR THE
EQUILIBRIUM PRICE LEVEL
9. To improve the Balance of Payment of the
country and
10. To bring social justice in various aspects.

Demand side Management

1. Fiscal policy: Changes in government

expenditure and tax to achieve particular
economic objective.
2. Monetary policy: Regulates the money
supply and credit availability in an economy.  AD represents money and goods market in
3. Legislation and laws equilibrium.
 AS represents price/output decisions of all firms in
economy.
Fiscal policy and monetary policy are followed by the
government to achieve the equilibrium .
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2. AGGREGATE-DEMAND CURVE

The Aggregate Demand (AD) curve is a curve that shows the negative relationship between
aggregate output or GDP (income) and the price level.

Deriving the Aggregate demand curve Factors affecting Aggregate Demand

Aggregate demand (C+I+G) falls when the 1. Income (higher)
price level increases because the higher price 2. Wealth (higher)
level causes the demand for money to rise, 3. Population (higher)
which causes the interest rate to rise in an 4. Interest rates (Lower)
economy. 5. Credit availability (higher)
6. Government demand (higher)
7. Taxation (Reasonable)
8. Foreign demand (higher Foreign)
9. Investment (Higher)
10. Expectations
(a) Inflationary (Stable)
(b) Income (higher)
(c) Wealth (higher)
(d) Interest rate (Lower)
All above influences outward shifters of Aggregate
Demand. If it is opposite to mentioned things
Aggregate Demand shift inwards.

Reasons for Downward sloping Aggregate demand curve

The consumption link: The decrease in consumption brought about by an increase in the interest rate
contributes to the overall decrease in output.
The real wealth effect, or real balance, effect: When the price level rises, there is a decrease in
consumption brought about by a change in real wealth.
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3. AGGREGATE SUPPLY

 Aggregate supply is the total supply of goods and services in an economy.

 The total quantity of the output the producers are willing and able to supply at prevailing price
levels in a given time period.
Shifters of Aggregate supply

Inward shifters (Left Outward shifters

Aggregate Supply shifting is negative) (Right shifting is
Decreases in positive) Increases in
 Curve shows relation between aggregate Aggregate supply Aggregate supply
quantity of output supplied by all the firms Higher cost Lower cost
in an economy and overall price level. Higher input prices Lower input prices
Economy stagnation Economic growth
 It is not a market supply curve, and it is not Poor capital More capital
simple sum of all individual supply curves. Poor labour More labour
Bad weather condition, Good weather
 Rather than an aggregate supply curve, natural disaster, war conditions
what does exist is a “price/output response”
curve
Inward shift of Aggregate supply
Short-run aggregate supply curve

Outward shift of Aggregate supply

In short run Positive relationship between Price and
aggregate output. AS slope upwards.

Long run Aggregate supply curve

Costs and the price level move in tandem in the

long run, and the AS curve is vertical
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4. NATIONAL INCOME

National income is an important parameter to measure the economic conditions of a country.

Definition

“National income is a measure of the total value of the goods and services (output) produced by
an economy over a period of time (normally a year).”

“National income estimate measures the volume of commodities and services turned out during a
given period counted without duplication.”

Basic Concepts in National Income -National Income Committee of India-

1. Gross Domestic Product (GDP): Money value of
Computation or Approaches or calculation or
all final goods and services produced in a country
methods to calculate National Income
(Domestic territory) within a year.
2. Gross National Product (GNP): GNP= GDP + 1. Product or Output Method: The market value
Money earned from abroad of all the goods and services produced in the country
3. Net National Product (NNP): NNP= GNP- by all the firms across all industries are added up
Depreciation together. Manufacturing sector + Agriculture sector +
4. Net Domestic Product (NDP): NDP= GDP – Tertiary sector
Depreciation
5. per Capita Income: National income/Population. 2. Income Method: Income method, also known
6. Personal income as factor income method, is used to calculate all
7. Disposable income income accrued to the basic factors of production
8. Supernumerary income used in producing national product. Land- Rent;
Labour – Wages and salaries; Capital –
Interest; Organization – Profit.
Difficulties to measure National Income
1. Limitation of product or output method 3. Expenditure Method: In the expenditure
1) Double counting problem method, the measures of GDP are calculated by
2) Not applicable to tertiary sector adding all the expenditures made in the economy.
3) Exclusion of non -marketed products The essential components of expenditure are:
4) Self consumption of output E=C+I+G+(X-M)
2. Limitations of Income Method
1) Exclusion of non-monetary income Uses for National Income estimation
2) Exclusion of Non Marketed Services
1. To measure size of the economy
3. Limitation under final expenditure method
2. To measure performance of the economy
Ignores Barter System
Ignores Own Consumption 3. To trace the trends of economic growth
Affected by Inflation 4. To know the structure and components of
Other difficulties National Income
Non monetized Unorganized sector 5. To make projection about future trend of
transactions economy
Multiple sources of Categorization of goods 6. To help government formulation and plans
earnings and services 7. To fix different targets for different sectors of
Inadequate data Black Money
the economy
Social Services Household Services
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4. Circular flow of macro-economic activity

It refers to the flow of goods and services or the flow of money income across different sectors
in an economy is a circular flow.
Circular flow of Macro economic activity with 2 sector model
Phases of circular flow of income
1. Production phase: Production is done Players: 1. Households 2. Firms
by using various factors of production like
land, labour, capital and organization.
2. Income phase: Factors of production get
income in the form rent, wages, interest and
profit.
3. Expenditure phase: Purchase of goods
and services by the households. Factors
(inputs) using by the firms.
Types of circular flow
1. Real flow: Like Barter system, Goods are Two sector model with savings and Investment
exchanged for goods no money circulation. It
has two types.
a. Factor flow: Household supply factors to the
firms.
b. Product flow: Firms supply goods and
services to the households.
2. Monetary flow: Money act as a medium of
exchange. It has two type.
a. Expenditure flow: Money spent by
households for buying goods and services.
b. Income flow: Income received by
households in the form of rent, wages, interest Circular flow of Macro economic activity with 3sector
and profit. model

Circular flow of Macro economic activity with 4 Players: 1. Households 2. Firms 3. Government
sector model:

Players: 1. Households 2. Firms 3. Government 4.

Foreign
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5. Fiscal policy

“Fiscal policy refers to changes in government expenditures and/or taxes (government

revenue) to achieve particular economic goals, such as low unemployment, price stability, and
economic growth” Types or instruments of fiscal policy
Objectives of Fiscal Policy
The major economic goals of fiscal policy are 1. Expansionary Fiscal Policy: Increases in government
1) To maintain average level of employment and expenditures and/or decreases in taxes to achieve
business activity. macroeconomic goals.
2) To minimize fluctuation in employment activity. 2. Contractionary Fiscal Policy: Decrease government
3) Prevent inflation expenditures and/or increases in taxes to achieve
4) Produce economy growth macroeconomic goals.
Other objectives 3. Discretionary Fiscal Policy: Deliberate change of
 To maintain economic stability in the country government expenditures and/or taxes to achieve
 To bring Price stability particular economic goals.
 To achieve full employment 4. Automatic Fiscal Policy: Changes in government
 To provide social justice
expenditures and/or taxes that occur automatically without
 To promote export and introduce import
substitution (additional) congressional action.
 To mobilize more public revenue
 To reallocate available resources Tools of fiscal policy
 To achieve balanced regional growth. 1. Revenue Expenditure:
Effects of Monetary policy – Interest Payments
– Major Subsidies
Effect of Public Expenditure on the Economy
– Defense
1. Raises the level of GNP. 2. Capital Expenditure:
2. Increases the purchase of goods and services  Expense on administration
3. Increases household incomes  Repayment of Loans
4. Increases Govt Indirect tax revenues  Extension of fresh loans to the state govt by the
central
5. Increase the flow of funds in the economy
 Loans to public enterprise
6. Increases private Income and thereby the Private  Expense on Irrigation project
Expenditure.  Sectorial development
3. Non- Tax Receipts
Effect of Public Expenditure on the Economy  Fines and Penalties
 Fees
1. Total amount received.
 Profits of PSU
2. Taxation is a measure of transferring funds from  Govt Interest
private purses to the public coffers.  Grants and Gifts
3. Withdrawal of funds from the private use. 4. Public revenue (receipts): a. Direct tax b. Non-direct tax
Has a deflationary impact on GNP Direct tax Non direct tax
Income tax Sales tax
4. Reduces Disposable income and reduces private Corporate tax Excise tax
expenditure Wealth tax Custom
Gift tax Service tax

5. Capital Receipts:
 Recovery of Govt loans
 Disinvestment of PSU
 Market Borrowings – Internal and
International sources
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6. Monetary policy

Monetary policy regulates the supply of money and availability of credit in the economy.

It deals with both the lending and borrowing rates of interest of commercial banks. In India,
Reserve Bank of India (RBI) is responsible for formulating and implementing monetary policy of
India. It was announced twice a year (slack season and busy season) but now once in a year. It
refers to the credit control measures adopted by the central bank of a country.

Objectives of Monetary policy Instruments in monetary policy

Bank rate: The rate of interest charged by the RBI against
 To achieve price stability
the commercial bank borrowings. If RBI increases the
 To attain exchange rate stability bank rate from 2% to 3% then the commercial banks rate
 To avoid the negative impacts of business cycle of interests will go up from for example 7% to 10% which
 To experience full employment position in turn reduce the public borrowings due to higher
Monetary Policy and Economic Development: interests and minimize the money circulation in the
• Economic development needs the support of country.
Reserve ratio: CRR (Cash Reserve Ratio), SLR
credit planning
(statutory Liquidity Ratio) the RBI insist on commercial
• Improving the efficiency of banking system banks to keep a certain percentage as reserve in their
• Decide interest rates hands for ensuring liquidity and regulating credit. The
• Public debt management RBI can increase the CRR from 3% to 15%. In case when
Limitations of Monetary Policy the RBI increases CRR from 10% to 12% then the
• Monetary policy operates in a broad front availability of money in the hands of banks will come
down. Thus the credit creating capacity of the commercial
• Success and failure depends on the banking
banks will be reduced and money supply in the market
system of the country also will be regulated.
• It has Institutional restrictions Open market operation: RBI selling the government
• Unorganized money market does not support the securities to the public. In that case instead of having
monetary policy money in the hands the public will receive certificates for
• Existence of non-monetized sector also defies a fixed time period and they will receive interest against
RBI’s regulation the same. But the money circulation among the public will
be reduced.
• It is not very effective in overcoming
Margin requirements: Margin requirement for
depression. mortgaging against the loans will be increased to reduce
to credit and it will be reduced to increase the credit flow.
Credit rationing: The loans and advances are provided
7. Multiplier effect only for production purpose and for essential activities to
cut down the money in circulation.
“Focusing on the extra demand and income created” Moral suasion: RBI controls the commercial banks for
creating loans and advances by persuasion through issue
Multiplier: A change in one of the components of of circular.
Aggregate Demand (AD) can lead to multiplied final Direct actions: Sometimes RBI takes direct action
change in the equilibrium level of GDP. against the credit created by the banks in contravention of
the RBI guide line to overcome the inflationary situation.
One person’s spending is another person income and
creates employment.

Multiplier=1/ (sum of propensity to save + tax +

import)