Basic concepts of microeconomics

1. MACRO ECONOMICS

2. Meaning of Macroeconomics….
• Macro economics deals with total or aggregate level of output, aggregate level
of consumption, aggregate level of investment, aggregate level of
employment and general price level in economy.
• Macroeconomics (from the Greek prefix makro- meaning "large" and
economics) is a branch of economics dealing with the performance, structure,
behavior, and decision- making of an economy as a whole, rather than
individual markets. This includes national, regional, and global economies.

3. Macroeconomic Concerns….
• Three of the major concerns of macroeconomics are:
– National Income
– Inflation
– Unemployment

4. National Income and Growth
• Growth refers to change in the level of economic activity from one year to
another year.
• Growth means that poor and developing countries wish to attain a rise in their
national income and per capita income.
• Aggregate output is the total quantity of goods and services produced in an
economy in a given period.
• The aggregate output is the main measure to see how well an economy is doing.

5. Unemployment
• Unemployment refers to the situation where the population of a country do
not find work to earn their livelihood.
• Unemployment represents that ratio of labor force which fails to get
employment.
• The currently 6.8% of Indian population is unemployed (As on 25 Jan 2021)
• The unemployment rate is a key indicator of the economy’s health. The
existence of unemployment seems to imply that the aggregate labor market is
not in equilibrium.

6. Inflation
• Inflation is an increase in the overall price level.
• Hyperinflation is a period of very rapid increases in the overall price level.
Hyperinflation is a rare phenomenon.
• Deflation is a decrease in the overall price level. Prolonged periods of deflation can be
just as damaging for the economy as sustained inflation.
Problem of Unemployment:
• During 1930 the phenomena of unemployment got a lot of attractions. Policy makers
presented their ideas to remove unemployment .
• So Government tried to provide better social and economic service dueto which
Government expenditures went on increasing.

7. Scope of Macroeconomics
Scope of
macro
economics
Theory of
national
income
Theory of
employment
Theory of
money
Theory of
general price
level
Theory of
economic
growth

8. Scope of Macroeconomics
(i) In National Income: The study of macroeconomics is very important for evaluating the
overall performance of the economy in terms of national income. With the advent of the
Great Depression of the 1930s, it became necessary to analyze the causes of general
overproduction and general unemployment.
(ii) In Economic Growth: The economics of growth is also a study in macroeconomics. It is
on the basis of macroeconomics that the resources and capabilities of an economy are
evaluated. Plans for the overall increase in national income, output, and employment are
framed and implemented so as to raise the level of economic development of the
economy as a whole.

9. Scope of Macroeconomics
(iii) In Monetary Problems:
It is in terms of macroeconomics that monetary problems can be analysed and
understood properly. Frequent changes in the value of money, inflation or deflation,
affect the economy adversely. They can be counteracted by adopting monetary, fiscal
and direct control measures for the economy as a whole.
(iv) In Business Cycles:
Further macroeconomics as an approach to economic problems started after the
Great Depression. Thus its importance lies in analyzing the causes of economic
fluctuations and in providing remedies.

10. Scope of Macroeconomics
(iii) In Monetary Problems:
It is in terms of macroeconomics that monetary problems can be analysed and
understood properly. Frequent changes in the value of money, inflation or deflation,
affect the economy adversely. They can be counteracted by adopting monetary, fiscal
and direct control measures for the economy as a whole.
(iv) In Business Cycles:
Further macroeconomics as an approach to economic problems started after the
Great Depression. Thus its importance lies in analyzing the causes of economic
fluctuations and in providing remedies.

11. Macroeconomics Variables
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Aggregate demand is the total demand in terms of goods and assets at a given
price by all the people in an economy.
Aggregate demand consists of two components, aggregate demand (AD) for
consumer goods (C) and aggregate demand for capital goods (I). Thus we can
write the above equation as:
AD = C + I
Aggregate supply is the total national output produced and supplied by all the
factors of production in an economy.
Aggregate supply consists of supply of consumer goods and capital goods.
AS = C + I

12. Stocks and Flows
Stock may be defined as any economic variable which has been accumulated at a
specific point of time, like money, assets and wealth.
Flow includes the variables which increases (inflows) and decreases (outflows) the
stock, like income, consumption, saving and investment over a period of time.
STOCK INFLOW OUTFLOW
INVENTORY INCOMING GOODS OUGOING GOODS
BANK BALANCE DEPOSITS WITHDRAWALS
POPULATION BIRTH + IMMIGRATION DEATH + EMIGRATION

13. INTERMEDIATE AND FINAL GOODS
Intermediate goods (and services) are items purchased by firms for using them in
production of some other goods of utility.
Final goods are demanded by the final consumer for using these goods as they are.

14. GOVERNMENT EXPENDITURE AND REVENUE
Government expenditure refers to outlay on national defense, road building and
maintenance, railways, national health, and free education and salary of government
employees.
All government current expenditure is included in national output.
There is another type of expenditure, known as transfer payments, which refers to
payments made to certain sections of society as a social welfare measure. It is an
exchange of purchasing power from one group of people to another.
These include unemployment compensation, retirement pension, etc.
Since the receiver of such payments (such as old, unemployed, handicapped and
needy families) do not contribute to national output therefore such payments are
referred to as transfer payments and they are not treated as a part of the
government’s current output of goods and services.

15. CIRCULAR FLOW OF ECONOMIC
ACTIVITIES AND INCOME – TWO
SECTOR ECONOMY

16. • It is the flow of money income or the flow of goods and services
across different sectors of an economy in a circular form.
• The circular flow of income shows the connection or linkages
between different sectors of the economy.
• It can be explained with the help of economic models.
• The circular flow model is a picture of market economy in action. It
tells how the money flows in the economy.
What is Circular Flow of Income ?

17.  Two sector model
 Three sector model
 Four sector model
Types of Circular Flow Models

18. It consists of household sector and the industrial sector.
• Household sector demand goods and services and they provide labour resources to
the business sector.
• Industrial sector produce and supply goods and services to the household sector
Businesses demand resources for production: land, labour, capital, and
entrepreneurs.
TWO SECTOR ECONOMY

19. Two Sector Economy Model
Household sector
Firms/ industrial sector
Factor Services
Factor Incomes
Spending
Products
Labour
Capital
Entrepreneur
Land
Wages/Salaries
Interest
Profit
Rent

20. Three Sector Economy
It is called the closed economy model.
It includes the
• household sector
• industrial sector
• government sector – the government collects taxes to provide resources and
services to the people

21. Three Sector Economy
Product
Markets
Factor
Markets
goods & services… ….goods & services
….consumption spending….
….salaries, wages, rent, dividends…..
land, labor, capital……
Government sector
Household sector
industrial sector

22. CIRCULAR FLOW OF
ECONOMIC ACTIVITIES AND
INCOME – FOUR SECTOR
ECONOMY

23. GOVERNMEN
T
HOUSEHOLD
S
FOREIGN
NATION
FIRMS
Taxes
Taxes
Remittance for
purchases or
Subsidiaries
Salaries
Imports Imports
Exports Exports
Financial
Market
Savings Investments
Factor Inputs
Factor Payment
Goods &
Services
Consumption
Expenditure
CIRCULAR FLOW OF ECONOMIC ACTIVITY AND INCOME – FOUR SECTOR ECONOMY

24. Difference between Leakages
and Injection

25. Leakages Injections
• These flow variables have a negative
impact on the process of production (
or the process of income generation).
• These cause positive impact on the
process of production or income
generation.
• These are withdrawals from circular
flow of income.
• These are additions to the circular flow
of income.
Effect on economy : Leakages
• Reduce flow of income/production
• Reduce demand of goods and services
Effect on economy : Injections
• Add to production capacity of the
economy.
• Generate demand of goods and
services.
• Examples: Saving, taxation and
imports, etc.
• Examples: investments, exports,
consumption expenditure, etc.
Difference between leakages and Injections

26. Uses of Circular Flow of Income
• It gives the clear picture of the market economy.
• It helps in the calculation of national income.
• Formulation of trade policies which promotes the exports and reduces the imports.
• It explains the importance of monetary policy by establishing equilibrium between
savings and investment.

27. Concept of National Income

28. “National income or product is the final figure you arrive at when you apply the
measuring rod of money to the diverse apples, oranges, battleship and machines
that any society produces with its land, labor and capital resources.”
- Paul A. Samuelson
National Income National Income Committee of India 1951 defines National Income
as follows: “ A national income estimate measures the volume of commodities and
services turned out during a given period counted without duplication.
National Income

29.  Gross Domestic Product (GDP)
• GDP at factor cost
• GDP at market price
 Gross National Product (GNP)
 Net Domestic Product (NDP)
 Net National Product (NNP)
 Per capita income
 Per capita disposable income
Components of National Income

30. CONCEPT OF –
GDP
, GNP
, NDP
, NNP

31. GROSS DOMESTIC PRODUCT (GDP)
GDP is the sum of money values of all final goods and services produced within the
domestic territories of a country during an accounting year.
It includes income from exports and payments made on imports during the year.
However, it does not include the earning of nationals working abroad as also of the
foreign nationals working in our country.

32. GROSS DOMESTIC PRODUCT (GDP): Real V/s Nominal GDP
In order to deal with the ambiguity inherent in the growth rate of GDP, macroeconomists have created
two different types of GDP, nominal GDP and real GDP.
• Nominal GDP is the sum value of all produced goods and services at current prices. This is the GDP
that is explained in the sections above. Nominal GDP is more useful than real GDP when comparing
sheer output, rather than the value of output, over time.
• Real GDP is the sum value of all produced goods and services at constant prices. The prices used in
the computation of real GDP are gleaned from a specified base year. By keeping the prices constant in
the computation of real GDP, it is possible to compare the economic growth from one year to the next
in terms of production of goods and services rather than the market value of these goods and services.
• In this way, real GDP frees year-to-year comparisons of output from the effects of changes in the
price level.

33. GDP DEFLATOR
The Gross Domestic Product (GDP) deflator is a measure of general price inflation. It
is calculated by dividing nominal GDP by real GDP and then multiplying by 100.
Nominal GDP is the market value of goods and services produced in an economy,
unadjusted for inflation (It is the GDP measured at current prices). Real GDP is
nominal GDP, adjusted for inflation to reflect changes in real output (It is the GDP
measured at constant prices).
GDP Deflator = Nominal GDP x 100
Real GDP

34. GROSS NATIONAL PRODUCT (GNP)
GNP is the aggregate final output of citizen and businesses of an economy in a year.
The difference between GDP and GNP arises because of the fact that a part of any country’s
total output is produced by factors which are actually owned by other nation(s). Thus, Net
Factor Income from Abroad (NFIA) is the difference between income received from abroad for
rendering factor services and income paid towards services rendered by foreign nationals in
the domestic territory of a country.
GNP is defined as the sum of Gross Domestic Product and Net Factor Income from Abroad.
GNP = GDP + NFIA
Thus GNP of India would count goods and services produced by all Indians, regardless of
where they work.
NOTE: GNP will be less than GDP when a country makes more payment than it receive from
abroad.

35. NET DOMESTIC PRODUCT AND NET NATIONAL PRODUCT
While calculating GDP and GNP we ignore depreciation of assets or capital
consumption; else they would not reveal complete flow of goods and services
through various sectors. But in reality the process of production uses up a
certain amount of fixed capital by way of wear and tear by a process termed as
depreciation, or capital consumption allowance.
In order to arrive at NDP and NNP, we deduct depreciation from GDP and GNP.
The word “net” refers to the exclusion of that part of total output which
represents depreciation, wear and tear and replacements during the year of
accounting.
Hence, NDP = GDP – Depreciation
And NNP = GDP – Depreciation + NFIA
Or NNP = GNP – Depreciation

36. CONCEPT OF-
PI, PDI AND PER CAPITA INCOME

37. PERSONAL INCOME
Personal income is the total income received by the individuals of a country
from all sources before direct taxes in one year.
Personal income can include not only wages, but also a number of additional
incomes (for example, dividends on securities, transfers, pensions, social
benefits, rent, and so on).
Personal income is calculated before deducting personal taxes charged to the
subject.
Personal income is an indicator that shows the real well-being of people and
their ability to pay (before taxes)

38. PERSONAL DISPOSABLE INCOME
Personal Disposable Income is the income which can be spent on
consumption by individuals and families.
Personal disposable Income = Personal Income – Personal Taxes
A worker’s disposable personal income (DPI) is how much money they have to
spend after subtracting taxes, including income tax, Social Security tax,
and Medicare tax. Individuals can either spend or save disposable personal
income.

39. PER CAPITA INCOME
The average income of the people of a country in a particular year is called
per capita income.
Per capita income is income per head of a country for a year.
National Income
Per capita Income = ---------------------------
Total Population

40. 1. GNP is the sum of value added of all firms in same period that is the total value of final
goods and services produced. GNP is a monetary measure because there is no other way
of adding up different sorts of goods and services produced except with their money
value.
2. GNI values national output as a sum of total payments made to the factors of production
for their services in production or alternatively, the earnings received by various factors.
3. GNE values national output by taking the value of expenditure on goods and services
produced (that is, aggregate expenditure on consumption and investment).
The terms “Gross National Product, Gross National Income and Gross National Expenditure”
may be used synonymously. In principle, these three variants will always be equal, that is GNP=
GNI = GNE. However, in practice, for some statistical data problem, this may not happen, and
statistical discrepancy may arise.
MEASUREMENT OF NATIONAL INCOME

41. NATIONAL INCOME
CALCULATION – PRODUCT
METHOD

42. As per the product method of estimating national income, also called
national income by Industry of Origin.
The product method adds up the market value of all final goods and services
produced in the country by all firms across all industries.
PRODUCT METHOD

43. This method involves the following steps:
1. The economy is divided on basis of industries, such as agriculture, fishing, mining,
large scale manufacturing, small scale manufacturing, electricity, gas, etc.
2. The physical units of output are then interpreted in money terms, i.e., by taking
market price of all the products
3. The total values thus obtained are then added up.
4. The indirect taxes are subtracted and the subsidies are added. This gives the GDP
or GNP, as the case may be, depending upon what data are being used.
5. The net value is calculated by subtracting depreciation from the total value thus
obtained, in order to arrive at NNP.
A word of caution to be repeated here is that goods produced in a particular year and
only in their final form are to be considered.
Steps to calculate National Income by Product Method

44. Product Method
Gross value added in the primary sector at
Market Price
+
Gross value added in the Secondary Sector at
Market Price
+
Gross Value Added in the Tertiary Sector at
Market Price
GDP at Market Price – Depreciation
NDP at Market Price - NIT
NDP at Factor cost + NFIA
NNP at Factor cost
Calculation of NNP at FC

45. LIMITATIONS OF PRODUCT METHOD
• Problem of double counting
• Not applicable to tertiary sector
• Exclusion of Non Marketed products

46. National income by Product Method can be calculated in two ways:
• Final Product Method
• Value Added Method
Types of Product Methods

47. If a manufacturer sells a mobile phone to a retailer for Rs. 3000 and the retailer
sell it to the consumer at Rs. 5000, how much has the mobile contributed to
GDP? Is it Rs. 8000? No. if we do that, it would be double counting. Instead we
would either count the final value (Rs. 5000) or the value added at each stage
(Rs.3000 by the manufacturer and Rs.2000 by the retailer). The sum of all such
values added by all industries in the economy is known as Gross Value Added
(GVA) at basic prices.
EXAMPLE

48. NATIONAL INCOME
CALCULATION – INCOME
METHOD

49. According to the Income method, it is the net income received by all citizen of
the country in a particular year that is added up, i.e., total rents, net wages, net
interest and net profits. However, income received in the form of transfer
payment is not included.
This is the GDP at factor; now we add the money sent by the citizens of the
nation from abroad and deduct the payments made to foreign nationals
(individuals and firms) we get Gross National Income (GNI)
INCOME METHOD

50. 1. The economy is divided on the basis of income groups, such
as wages/salary earners, rent earners, profit earners, and so
on.
2. Income of each of these groups is calculated.
3. Income of all the earners is added, including income from
abroad and undistributed profits.
From (3), income earned by foreigners and transfer payment
made in the year are subtracted. In other words,
GNP at factor cost = Rent + Interest + Profits + other Income +
(Income from Abroad – Payments made to foreigners) – Transfer
Payments.
Income method involves the following steps:

51. Income Method
COE (Compensation of Employees)
+
OS (Operating surplus)
+
MI (Mixed Income)
Net Domestic Income
Net Factor Income from Abroad
National Income (NNP at Factor Cost)
Calculation of NNP at FC

52. Limitations of Income Method
• Exclusion of Non Monetary Income
• Exclusion of Non Marketed Services

53. Calculation of National Income –
Expenditure Method

54. We have seen that whatever is earned is spent either on consumption or on
investment. Therefore, it is possible to calculate national income by
expenditure method.
According to the expenditure method, the total expenditure incurred by the
society in a particular year is added together to get the year’s national
income; such expenditure includes personal consumption expenditure, net
domestic investment, government expenditure on goods and services, and net
foreign investment.
Expenditure Method

55. This concept rests on the assumption that national income equals national
expenditure.
• Consumption expenditure
• Investment Expenditure
• Government Expenditure
• Net Exports
Steps of calculating National Income by Expenditure Method

56. Precautions Regarding Expenditure Method
• Only final expenditure
• Expenditure on second-hand goods
• Expenditure on share and bonds
• Expenditure on transfer payment by the government

57. Expenditure
Method
Private Final Consumption Expenditure
+
Government Final Consumption Expenditure
+
Gross Domestic Fixed Capital Formation
+
Change in Stock or Inventory Investment
+
Net Exports (Export – Import)
GDP at Market Price – Depreciation
NDP at Market Price - NIT
NDP at Factor cost + NFIA
NNP at Factor cost

58. NATIONAL INCOME –
DIFFICULTIES AND LIMITATION

59. Difficulties in the measurement of National Income
• Non Monetized Transactions
• Unorganized Sector
• Multiple Source of Earning
• Categorization of Final Goods and Services
• Inadequate Data

60. Limitations in the measurement of National Income
The three main limitations to national income accounting are:
Errors in Measurement: Black Market and underground activities are not included when calculating GDP. This is
because there is no way to accurately measure black market activity. In the United States, this is a relatively small
percentage of the total GDP; however, in many other less developed countries, it can go as high as 70% of the
country's total GDP. Another big measurement error is inflation. It is adjusted according to base prices and
various other things and the range of possible inflation can be as much as 1% to 15% in some places.
Subcategories that are Misrepresented: The various interpretations of what should be included in consumption
or government spending plays a big part in the overall determination of GDP. Decisions are made about what is to
be included where, but minor discrepancies will always arise.
Welfare is NOT Measured: GDP only measures the market activity and does not take welfare into account. The
economic activity of a country could rise, while welfare could possibly have fallen. Different situations may occur
that have a negative impact on the people which cause them to increase spending, therefore increasing the GDP.