Macroeconomics I Some Basic Concepts -Consumption Goods -Capital Goods -Final Goods -Intermediate Goods -Gross Investment and Depreciation -Stocks and Flows I lntersectoral Flows I Circular Flow of Income I Concepts Relating to National Income I Methods of Calculating National Income -Value Added or Product Method -Income Method -Expenditure Method I Real and Nominal GDP I GDP and Welfare UNIT POWER POINTS 1. Macroeconomics Macroeconomics is the study of economic problems or economic issues (like unemployment and poverty) at the level of an economy as a whole. 2. Some Basic Concepts Consumption Goods These are those goods which are directly used for the satisfaction of human wants. Example: Ice cream and milk used by the households. Capital Goods These are those goods which are used as fixed assets by the producers in the production of other goods and services. Example: Tractors used by the farmers. National Income and Related Aggregates 7 Final Goods These are those goods which have crossed the boundary line of production and are ready for use by their final users. Example: Car used by the households, machine used by the producers. Intermediate Goods These are those goods which are within the boundary line of production and not ready for use by their final users. These goods are purchased for further sale, or are to be used as raw material by the producers. Example: Wood purchased by a carpenter to make chairs or wood purchased by a timber merchant for resale. Gross Investment It refers to the expenditure by the producers (during an accounting year) on the purchase of all such goods which add to their stock of capital, as well as expenditure on the replacement of existing fixed assets (owing to their depreciation). It includes (i) net investment which is expenditure by the producers on the purchase of all such goods which add to their existing stock of capital, and (ii) depreciation which is expenditure by the producers on the replacement of existing fixed assets owing to their depreciation. Gross Investment = Net investment+ Depreciation Depreciation It refers to loss of value of fixed assets (capital goods) in use, on account of their normal wear and tear (as well as accidental damages and expected obsolescence). Stock and Flow Concepts All variables in economics (like income, consumption, capital and investment) are classified either as stock variables or flow variables. Stock variables are those which are measured at a point of time. Examples: Capital and wealth. Flow variables are those which are measured per unit of time period. Examples: Income per month, investment per year. 3. lntersectoral Flows Intersectoral flows refer to the flow of goods and services as well as the flow of money among different sectors of the economy. The flows of goods and services are called 'real flows' while the flow of money is called 'money flows' across different sectors. These flows (both real as well as money flows) point to intersectoral interdependence or the dependence of one sector on the other. These intersectoral interdependences are satisfied through a system of mutual exchanges, and mutual exchanges lead to intersectoral flows of money as well as of goods and services. These flows are the essence of modern economic activity as the entire economic activity revolves around these intersectoral flows. To illustrate, factor services flow from households to the producers without which production activity is not possible. Likewise, factor incomes flow from producers to the households without which consumption activity is not possible. 4. Circular Flow of Income Circular flow of income (also called circular flow of money) is a concept that brings out how income flows across different sectors of the economy. It shows how household (the owners of the factors of production) render their factor services to the producers (or the producing units) and in return receive payments in terms of factor incomes (rent for land, interest for capital, wages for labour and profit for 8 Xam idea Economics-XII entrepreneurship). It also shows how income (in the form of rent, interest, profit and wages) is spent on the purchase of goods and services from the producing units. In the entire process of production, income generation and expenditure, money flows continuously from one sector to the other. The process never stops; hence is called circular flow of money or circular flow of income. 5. Concepts Relating to National Income Domestic Income and National Income What is common in them? Both domestic income and national income include factor incomes only (rent, interest, profit and wages). What is the difference? While domestic income is the sum total of factor incomes generated within the domestic territory of a country, national income is the sum total of factor incomes generated by normal residents of a country, within the domestic territory or in the rest of the world. Gross and Net Concepts Generally, gross variables in national income accounting are inclusive of depreciation, like gross investment which is the sum total of net investment and depreciation. Net variables are exclusive of depreciation. Market Price and Factor Cost Market price includes the impact of indirect taxes (taxes on goods and services) and subsidies. While indirect taxes raise the market price, subsidies tend to lower it. Factor cost refers to the cost of factors of production, independent of net indirect taxes (Indirect taxes - Subsidies). Value Addition and Income Generation In economics, 'value addition' is the synonym of production. If Mr. X buys wood for� 500, converts it into a chair and sells it for� 800, value added = � 800 -� 500 = � 300 which is what production means. Who adds value? Yes, value is added by the factors of production, viz., land, labour, capital and entrepreneurship. Accordingly, all value added is distributed among the factors of production as factor incomes, viz., rent, wages, interest and profit. It implies that income generated must be identical with value added during a period of time. 6. Methods of Calculating National Income Circular flow of income model suggests three different methods of estimating national income: (i) Product Method, also called Value Addition Method, (ii) Income Method, and (iii) Expenditure Method. Detailed explanation of these methods is as under: (i) Value Added Method or Product Method According to this method, domestic income is calculated as domestic product. Domestic product (or Gross Value Added at market price) is estimated as the sum total of value added by all the producing units within the domestic territory of the country, during the year of accounting (= market value of final goods and services produced in the economy during the period of an accounting year). Gross value added at market price is converted into net value added at market price by deducting depreciation from 'gross value added'. Net value added at market price is converted into net value added at factor cost by deducting net indirect taxes. Finally, net factor income from abroad is added to net value added at factor cost to find national income. (ii) Income Method According to this method, domestic income is calculated as the sum total of factor incomes (rent + interest + profit + wages) generated within the domestic territory of a country during the period of an accounting year. Net factor income from abroad is added to domestic income to find national income. National Income and Related Aggregates 9 (iii) Expenditure Method According to this method, domestic product is estimated as the sum total of expenditure (consumption expenditure and investment expenditure) on the purchase of final goods and services produced within the domestic territory of the country, during the year of estimation. Expenditure on Final Goods = Market value of the final goods and services produced in the economy during the period of an accounting year = GDP MP = GV AMP Gross value added at market price is converted into net value added at market price by deducting depreciation. Net value added at market price is converted into net value added at factor cost by deducting net indirect taxes. Finally, net factor income from abroad is added to net value added at factor cost to find national income. GDP at Market Price or Gross Value Added National Income and Related Aggregates GNP (market price) + net factor income from abroad C _o �a o. E Cll :::, u"' + C 0 u - net factor GNP income from abroad GDP (factor cost) c:----------�■ \-a.c\o� k (\e\ \ �O� i('co��o -a.O ,, ,· ·> NDP a. • 0c, ••••• ,, ,. ,/ (factor cost) ,�;, _______ .,,,.. c,'-. &,0 c,,,,r ,,--·: c, ;..�0 s" / ,,' .• �;, -� '> .§)/ ,.V e, / '< X C:J,/ ,, 0" ' 6'0 ,,, ·,,0 �" ·' ,, -�<:>' -::,'