Chapter 1 & 2 (Macro Economics) - Chapter Notes - Commerce PDF Download

INTRODUCTION

MACRO-ECONOMICS :: It is a branch of economics that studies economic problem (problem of choice and scarcity) relating to ECONOMY AS A WHOLE.
The word “Macro” is derived from Greek word “MAKROS” meaning large

Thus it is study of aggregates & averages of entire economy . Such aggregates are : national income , total employment , aggregate saving and investment , AD and AS

Macroeconomics is not necessarily restricted only to broad aggregates. True or False ? Give reasons.
Ans :: TRUE , In macroeconomics, we also divide the broad aggregates into
sub - aggregates. We study separately the behaviour of these sub-aggregates.
FOR EXAMPLE :: National income is a broad aggregate. We divide this aggregate into two
parts : (i) consumption expenditure and
(ii) investment expenditure.
We study and analyse the behaviour of these two sub-aggregates also

SCOPE / AREA OF STUDY / VARIABLES /COMPONENTS OF MACRO-ECONOMICS

(1) THEORY OF NATIONAL INCOME : Macro-Economics studies the concept of national income ,its method of measurement, related concepts and social accounting
(2) THEORY OF EMPLOYMENT : Its studies problem relating to employment and unemployment ,different types of unemployment, factors determining level of employment like aggregate demand, aggregate supply, agg. saving and consumption, aggregate investment.
(3) THEORY OF MONEY : In this function of money, supply of money and various concept and theories related to money is studied.Banking structure of the country form part of this study
(4) THEORY OF GENERAL PRICE LEVEL : Problem concerning inflation or general rise in price and deflation or general decrease in price are studied.Causes for change in price level is also studied
(5) THEORY OF ECONOMIC GROWTH : Study of problem relating to fuller utilisation and growth of economics (increase in per capita income) ,welfare of public is done .Monetary and Fiscal policies of the government are also studied therein
(6) THEORY OF INTERNATIONAL TRADE : Under this trade relation of country , foreign exchange rate determination , BOP situation , Tariff and protection issue is studied.

TWO SCHOOL’S OF THOUGHT RELATING TO MACRO ECONOMICS STUDY

(1) CLASSICAL SCHOOL :: It includes economist like Ricardo, Mill, J.B says.They believe in “Supply creates Demand” and thus conclude that unemployment will disappear automatically in a free economy.
According to them Full employment is an automatic phenomenon and thus there is no need of govt interference . In other words (i) Unemployment and (ii) Disequilibrium will be of temporary nature

Note: The classical economists thus believed that free economy is the best economy as it offers maximum employment , highest level of income and automatically reaches the state of equilibrium

(2) KEYNESIAN SCHOOL :: Great Depression of 1929-33 (when prices/ profit and investment falls drastically) has shown that classical approach was not practical.Lord Keynes then advocated a new theory in his book “General Theory of Employment , Interest and Money” published in 1936 which says that “Demand Creates Supply” and thus unemployment will not automatically disappears Govt. must interfere and undertake invest.
and production to generate employment

Note: Thus J.M.Keynes believed that a market economy / free economy needs to be regulated by the government . Otherwise it might suffer the cycle of inflation and deflation , causing economic instability in the country.

(Ques ) Micro and Macro Economics are two sides of the same coin (complementary to each other) ?

OR

(Ques) Micro and Macro Economics are not exclusive but interdependent branch of economics. Explain ?

The statement is TRUE

(A) MACRO- ECONOMICS DEPENDS UPON MICRO-ECONOMICS ::
Macroeconomics is nothing but aggregate of micro-economics and hence is dependent upon micro-economics

• Aggregate saving and aggregate investment is influenced by saving at individual or household level
• National income is sum total of factor income of all normal resident of a country

i.e N Y = Σ Y

• AD is sum total of demand of all goods and services in the economy i.e AD = Σ d

(b) MICRO- ECONOMICS DEPENDS UPON MACRO-ECONOMICS :: Microeconomics decision by an individual unit always have a macro context

• Consumption plan of household depends upon Taxation policy of country which is a macro variable.
• Wage rate in a particular industry is affected by overall wage rate in a economy as a whole

(Ques ) Micro and Macro Economics are not logically related ? OR
(Ques ) Why do we need separate study of Macro-economics ?

Ans.) Micro economics deals with problem at individual level or relating to single unit where as Macro economics is study of economy as an whole .Thus there are certain problem like GROWTH AND DEVELOPMENT that cannot be handled at micro level and therefore we need separate
branch of economics to deal with it.
This can be understood with example known as Micro-Macro Paradox’s
 

PARADOX OF SAVING/ THRIFT :: Saving is considered Virtue at micro level as every individual must save part of income for future prosperity but if all the individual starts saving it will result in fall in investment in the country , thus fall in production and employment and this will slow down the growth of economy
 

PARADOX OF FARMER / POVERTY :: If a single farmer produces paddy or wheat , then he will try to produce as much as possible to reach the maximum level of profit. But if all the farmers starts Producing paddy or wheat then there will be excess supply of paddy or wheat in relation to demand and thus price of wheat will start falling .

STRUCTURE OF MACRO-ECONOMY & CIRCULAR FLOW OF INCOME AND PRODUCT

ECONOMIC AGENT :: These are those INDIVIDUAL OR INSTITUTIONS who take economic decisions . These include
(a) Consumer
(b) Producer and
(c) Government

STRUCTURE :: It refers to study of different sectors of the economy. On the basis of circular flow of income and product ,a macro economy is classified into following sectors
(1) PRODUCERS SECTOR engaged in the production of goods and services or value adding activities This sector hires FOP (LLCE) from household for factor payment of rent, interest and wages.
(2) HOUSEHOLD SECTOR engaged in consumption of goods and services and also are the owner of FOP
(3) THE GOVERNMENT SECTOR engaged in activities like taxation and subsidies.
It also acts as

• Welfare agent like maintaining law and order, providing public utility services (hospitals, roads , educational institution
• Producer

(4) REST OF WORLD SECTOR / EXTERNAL SECTOR engaged in export and import and receipt and payment of factor and transfer earnings ( related with flow of capital between domestic and other countries )
 

(5) FINANCIAL SECTOR (SYSTEM) engaged in activity of borrowing and lending
MEANING OF CIRCULAR FLOW :: The flow of
- goods and services                 and                          - factor service
- and their corresponding flow of payment and receipts across different sectors ( producer, consumer,government ) is called circular flow of income and product
CIRCULAR FLOW OF INCOME AND PRODUCT IN TWO- SECTOR
 MODEL
ASSUMPTION
(1) Household are the owners of factor of production (FOP) and production sector
hires this FOP and thus only two sector in the economy
(2) Closed economy that is economy having no relation with outside world
(3) NO government sector is there
(4) Similarly firm sells to household all that is produced
(5) Whatever earned is consumed i.e there is no financial sector to channelize
saving and invest in an economy ( Y = C )

(1) REAL FLOW // PHYSICAL FLOW :: It involves flow of goods and services
across different sectors. It includes
(a) Flow of Factor services(of land, labour,capital) from Household sector to Producing sector
(b) Flow of Goods and Services from Producing Sector to Household Sector
 

(2) MONEY FLOW // NOMINAL FLOW :: It involves flow of money across
different sectors.It includes
(c) Flow of factor income(rent,wages/salaries,interest,profit) from Producing Sector to Household Sector
(d) Flow of consumption expenditure (money value of final goods and services) from Household Sector to Producing Sector (as household spent their entire income on purchases)

Thus it can be observed and concluded that MONEY FLOW ARE OPPOSITE TO or RECIPROCAL OF REAL FLOW

CIRCULAR FLOW OF INCOME AND PRODUCT IN TWO - SECTOR MODEL WITH FINANCIAL SECTOR / SYSTEM

ASSUMPTION : Point (1), (2), (3) , (4)
Household and producers generally save part of their income and this has caused the emergence of financial system in the economy.
Financial system refers to existence of financial intermediates in form of banks,insurance companies,stock market and other financial institutions dealing with money matters.Money flows into this system from savers(lenders) and then flows from financial sector to investors(borrowers)

Y = C+S (factor income generated in process of production during the year) since under this model all leakage is equal to injection i.e S = I
Y = C+I (shows expenditure on purchase on goods and services during the year

This is called TRIPLE IDENTITY of circular flow
(1)Value of goods and services produced in an economy during a given accounting
period - { shown by Flow (b) } This is NATIONAL PRODUCT

(2) Income generated in for of Rent, interest, wages and Profit during given accounting
period - { shown by Flow (c) } This is NATIONAL INCOME

(3) Expenditure on purchase on goods and services during the year- shown by Flow (d).
This is NATIONAL EXPENDITURE

THREE SECTOR MODEL (ONLY WITH MONEY FLOW) 

ECONOMIC INTERDEPENDENCE

• between household and govt. on one hand and
• between firm and govt. on other hand brings out the role of govt. as a regulator and as an agent of promoting general welfare of the public of the country

FOUR SECTOR MODEL (ONLY WITH MONEY FLOW )

Today every economy depends upon another economy for trade purposes (export and import of goods and services), this globalisation has given rise to relation with outside world known as external sector or Rest Of The World
NET TRANSFER PAYMENT(INCOME) refers to difference between transfer receipt from ROW in from of gifts etc and transfer payment made to ROW.

• It is shown as money flow from ROW to the household sector

NET FACTOR PAYMENT(INCOME) refers to difference between Factor income received from ROW in from of Rent,Wages,Interest,Profit, and Factor payment made to ROW.

• It is shown as money flow from ROW to the household sector

THE BASIC PRINCIPLE OF CIRCULAR FLOW OF INCOME //
 WHY CIRCULAR FLOW NEVER STOPS

(1) In the exchange process Seller receives the same amount that the Buyer spends .The receipt of one sector is equal to payment to other sector .
(2) Real flow (in terms of goods and services) in one direction have a corresponding Money flow in opposite direction e.g corresponding to flow of factor services from household sector to producing sector ,there is flow of factor income from producing sector to household sector

STOCK AND FLOW VARIABLES

MUTUAL DEPENDENCE BETWEEN STOCK AND FLOW

(1) Stock influences the flow :: For example - greater the Stock of Capital , greater is the flow
of goods and services
(2) Flow influences the stock :: For example - monthly increase in supply of money leads to
an increase in the quantity of money
With inflow - stock will go up
With outflow - stock will come down

• Thus Net Flow will determine the position of Stock

(a) Suppose a tank is being filled with water coming from tap. The amount of water flowing into and out of the tank per minute is flow concepts but how much water there is at a particular point of time is a stock concept.
(b) Capital at a point of time is a stock but addition to the stock of capital i.e capital formation during a year is a flow

DIFFERENT PHASES // ASPECTS OF CIRCULAR FLOW & REQUIREMENT OF DATA

As we know total value added in an economy is equal to income generated which is
further equal to aggregate expenditure .
Thus production generates income and income generates expenditure and exp. causes
further production. This is called TRIPLE IDENTITY of circular flow

PHASE OF PRODUCTION :: It refers to value addition in terms of goods and services.It is a real flow but when measured at market price it becomes money flow
Data Required : Output by all producing sector , Depreciation (Replacement cost) , Intermediate consumption ,Indirect taxes
PHASE OF DISTRIBUTION:: It refers to flow of factor income in form of rent, interest, wages/salaries, profit from producing sector to household sector and thus is a money flow. Data Required : All Factor Income (rent, interest, wages/salaries, profit)
PHASE OF DISPOSITION:: It means expenditure on goods and services by household
and other sectors in the economy.It is Money flow from other sectors to producing sector.
Data Required : (a) Expenditure on consumption
(b) Expenditure on Investment