Introduction to Macroeconomics

Subhalaxmi Mohapatra

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Introduction to Macroeconomics

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Learning Objectives
This chapter introduces you to

the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic
analysis

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Important issues in Macroeconomics

Macroeconomics, the study of the economy as a whole, addresses many topical issues:

Why are call centers located in India? why textiles

made in Bangladesh? Why do we buy so much in China? Why does cost of living keep rising? Why do goods prices rise? Are gas/ oil / gold prices really that high? What causes recessions? Can the government do anything to combat recessions? Should it? Why does recession in US affect India?
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Important issues in macroeconomics

Macroeconomics, the study of the economy as a whole, addresses many topical issues:

What is the government budget deficit?

How does it affect the economy?

What causes unemployment? Why are millions

of people unemployed, even when the economy is booming?

Why do people migrate?

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Important issues in macroeconomics

Macroeconomics, the study of the economy as a whole, addresses many topical issues:

Why is US so rich? Why are so many countries

poor? What policies might help them grow out of poverty? What is the best way to measure well being Why do government intervene in an economy? ...........................
Introduction to Macroeconomics

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Why learn macroeconomics? 1. Macro economy affects societys wellbeing.

Each one-point increase in the unemployment rate is associated with:

920 more suicides 650 more homicides 4000 more people admitted to state mental
institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness
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Why learn macroeconomics? 2. Macro economy affects your well-being.

change from 12 mos earlier
4 3 2 1 0 -1 -2 -3 1965 -5 -7 1970 1975 1980 1985 1990 1995 2000 2005 1 -1 -3 3

CHAPTER 1 Introduction to Macroeconomics mean wage (right scale) slide 6 unemployment rate inflation-adjusted

percent change from 12 mos earlier

In most years, wage growth falls 5 when unemployment is rising.

Why learn macroeconomics? 3. Macro economy affects politics.

The popularity of the political party often rises when the economy is doing well and falls when it is doing poorly.

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Microeconomics

study of economics actions of individuals. Includes individual prices, quantities and

markets, thus it studies how resources are allocated to the production of particular goods and services and how efficiently they are distributed. It does not necessarily study the allocation of resources to the economy as a whole.

Thus it looks into the micro aspects of the

economy,
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Macro economics
Study of aggregates or averages covering the
entire economy.

The aggregates or averages includes Total employment, National income and output Total investment, Total consumption and
savings Aggregate supply, Aggregate demand General price level, Wage level Thus, macro economics studies the broader aspects of the economy and studies the behavior of an economy as a whole.
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Next, you will learn

the meaning and measurement of the most important macroeconomic statistics:

Gross Domestic Product (GDP)

Real GDP and Nominal GDP

The Consumer Price Index (CPI) Calculating Inflation

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Gross Domestic Product: Expenditure and Income

Two definitions:

Total expenditure on domestically-produced

final goods and services.

Total income earned by domestically-located

factors of production.

Expenditure equals income because every rupee spent by a buyer becomes income to the seller.
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The Circular Flow

Income (Rs) Labor

Households

Firms

Goods

Expenditure (Rs)
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Value added
definition: A firms value added is the value of its output minus the value of the intermediate goods the firm used to produce that output.

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Exercise:
A farmer grows a bushel of wheat

and sells it to a miller for Rs. 2.00. The miller turns the wheat into flour and sells it to a baker for Rs. 6.00. The baker uses the flour to make a loaf of bread and sells it to an engineer for Rs.12.00. The engineer eats the bread.

Compute & compare value added at each stage of production and GDP
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Final goods, value added, and GDP

GDP = value of final goods produced
= sum of value added at all stages of production.

The value of the final goods already includes the

value of the intermediate goods, so including intermediate and final goods in GDP would be double-counting.

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The expenditure components of GDP

consumption

investment government spending net exports

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Consumption (C)
definition: The value of all goods and services bought by households. Includes:

durable goods
last a long time ex: cars, home appliances nondurable goods last a short time ex: food, clothing services work done for consumers ex: dry cleaning, air travel.
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Investment (I)
Spending on goods bought for future use Includes: business fixed investment Spending on plant and equipment that firms will use to produce other goods & services. residential fixed investment Spending on housing units by consumers / landlords. inventory investment The change in the value of all firms inventories. Note: Investment is spending on new capital
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Stocks vs. Flows

Flow
Stock

A stock is a quantity measured at a point in time. E.g., The Indian capital stock was Rs.26 billion on January 1, 2006. A flow is a quantity measured per unit of time. E.g., Indian investment was Rs.2.5 billion during 2006.
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Now you try:

Stock or flow?

the balance on your credit card statement how much you study economics outside of
class

the size of your compact disc collection the inflation rate

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Government spending (G)

G includes all government spending on goods
and services..

G excludes transfer payments

(e.g., unemployment insurance payments), because they do not represent spending on goods and services.

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Net exports: NX = EX IM
def: The value of total exports (EX) minus the value of total imports (IM).

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An important identity

Y = C + I + G + NX
aggregate expenditure

value of total output

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GDP: An important and versatile concept

We have now seen that GDP measures

total income total output total expenditure the sum of value-added at all stages
in the production of final goods

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GNP vs. GDP

Gross National Product (GNP):

Total income earned by the nations factors of production, regardless of where located. (ownership)

Gross Domestic Product (GDP):

Total income earned by domestically-located factors of production, regardless of nationality. (GNP GDP) = (factor payments from abroad) (factor payments to abroad) =NFIA (net factor income from abroad)
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Discussion question:

In your country, which would you want to be bigger, GDP, or GNP? Why?

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Other Measures of Income

GDP at factor cost =GDP at market price indirect

taxes + subsidies.

GDP at market price + net factor income from abroad

= GNP at market price

NNP: found out by deducting depreciation charges

from national income. NNP = GNP depreciation

NDP = GDP depreciation Note: factor cost = market price indirect tax +
subsidies
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Example: National Income Accounting

Particulars Rs. In Crore 400 1200

The following
particulars are given for the economy for the year 2008-09.

GDP at factor cost 6000 Subsidies Factor income received from abroad Factor income paid abroad Indirect taxes Gross investment Net investment

Compute
1800 800 800 400

Depreciation NDP at factor cost GNP at factor cost GDP at market price NNP at market price
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CHAPTER 1 Introduction to Macroeconomics

Example: National Income Accounting

Particulars NDP at Market Price Rs. In Crore 16,939

The following
particulars are given for the economy for the year 2008-09.

Net factor income -46 from abroad Depreciation 900

Compute
NDP at factor cost National income or
NNP at Factor cost GNP at factor cost

Subsidies Indirect taxes

354

2136

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Example: National Income Accounting

Particulars NDP at Market Price Rs. In Crore 88,750

The following
particulars are given for the economy for the year 2008-09.

Net factor income -260 from abroad Depreciation 5220

Compute
GNP at factor cost

Subsidies Indirect taxes

1820 10,825

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Real vs. nominal GDP

GDP is the value of all final goods and services

produced.

nominal GDP measures these values using

current prices.

real GDP measure these values using the prices

of a base year.

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Real vs. nominal GDP

GDPt = Pit Qit

i1 n

RGDPt = PiBQit
i1

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Practice problem, part 1

2006 P good A Rs.30 Q 900 P Rs. 31 2007 Q 1,000 P Rs.36 2008 Q 1,050

good B Rs.100 192

Rs.102

200

Rs.100

205

Compute nominal GDP in each year. Compute real GDP in each year using 2006 as
the base year.
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Answers to practice problem, part 1

nominal GDP multiply Ps & Qs from same year 2006: Rs.46,200 = Rs.30 900 + Rs.100 192 2007: Rs.51,400 2008: Rs.58,300

real GDP multiply each years Qs by 2006 Ps 2006: Rs.46,200 2007: Rs.50,000 2008: Rs.52,000 = Rs.30 1050 + Rs.100 205
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Real GDP controls for inflation

Changes in nominal GDP can be due to:

changes in prices. changes in quantities of output produced.

Changes in real GDP can only be due to changes in quantities, because real GDP is constructed using constant base-year prices.

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GDP Deflator

The inflation rate is the percentage increase in

the overall level of prices.

One measure of the price level is

the GDP deflator, defined as

Nominal GDP GDP deflator = 100 Real GDP

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Practice problem, part 2

Nom. GDP 2006 2007 2008 Rs.46,200 51,400 58,300 Real GDP Rs.46,200 50,000 52,000

GDP deflator

Inflation rate
n.a.

Use your previous answers to compute

the GDP deflator in each year.

Use GDP deflator to compute the inflation rate

from 2006 to 2007, and from 2007 to 2008.
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Answers to practice problem, part 2

Nominal GDP
2006 2007 2008 Rs.46,200 51,400 58,300 Real GDP Rs.46,200 50,000 52,000

GDP deflator
100.0 102.8 112.1

Inflation rate
n.a. 2.8% 9.1%

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Problem: The following table gives price and output for the years 2007 and 2010.

What is the
value of GDP Deflator for the year 2010?
Goods 2007 Quantity 2010 Price Quantity (Rs) 2.00 6.00 5.00 4.00 3.00 35 65 60 40 50 Price (Rs) 2.50 8.00 6.00 5.00 4.50
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What is the
average annual inflation

P Q R S T

30 55 45 35 40

Calculating price indices

There are two main methods to calculate price

indices, the Paasche index and the Laspeyres index

Paasche index is Laspeyres index

where P is the change in price level, p0 and q0 are the prices and quantities in the base year (usually the first), pt and qt those in the year t.

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Example
Item

Calculate Total expenditure

in 1999-2000 and 2007-08 Weights for each product Relative changes in price of each products Laspeyre Price Index

Quantity Price (1999(19992000) 2000) In Rs.

10 kg 20 kg 10 mtr 10 ltrs 7.5/kg 5/kg 15/mtr 12/ltrs

Price (200708)
In Rs. 9/kg 7/kg 20/mtr 39/ltrs

Pulses Rice Cotton Petrol

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Example
Item

If the price of rice and

milk in 2006-07 increased by 20% and 30% respectively, what would be the retail price index for the year 2006-07
Rice

Quantity in 2001-02

Price (in Rs) in 2001-02

20kg

10/kg

Wheat

10kg

8/kg

Milk

40ltrs

6/ltr

Cloth

15mtrs

20/mtr

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Wholesale Price Index

It is the oldest statistical series. It measures the level of prices at the wholesale
or producer stage.

It is an indicator of movement in wholesale

prices of 676 commodities in all trade and transactions.

It is widely used in business and industry circles

and by govt. and is generally taken as an indicator of the rate of inflation in the Indian economy.

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Wholesale Price Index

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Consumer Price Index (CPI)

A measure of the overall level of prices The CPI measures changes in retail prices of selected
goods and services on which a homogeneous group of consumers spend a major part of their income

the CPI measures the cost of buying a standard

basket of goods at different times. The market basket includes the goods and services purchased for day- to-day living. is also called cost-of living index. There are 3 distinct series of CPI:

CPI for industrial workers CPI for agricultural labourers CPI for rural labourers
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CPI Versus WPI

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Thank You
CHAPTER 1 Introduction to Macroeconomics
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