Macroeconomics Study of economics at aggregate level. 1 Macroeconomics Measurement National Output(Q) or Income (Y) or Expenditure(Z) Price Levels or Inflation (P) Unemployment (U) and Poverty Policy Monetary Policy (RBI) Fiscal Policy ( Central Govt.) CSO:NAS in India 2 1
Q I. National Output Concept and Measurement 3 National Output: Introduction National output is the nation s aggregate output of goods and services during a given year. Nations Total Production/Output(Q) Total Income (Y) Total Expenditure(Z) For an economy as a whole during a given year, Output Income Expenditure because: All output produced is for transaction purpose Every transaction has a buyer and a seller. Every rupee of spending by some buyer is a rupee of income for some seller. 2
National Output: The Circular Flow of Income and Expenditure Economy an integrated system of production, exchange and consumption, it has two types of decision makers 1. Producers(Seller): Sales goods and services; receives income. 2. Consumer ( Buyer): Buys goods and services; made expenditure Buy and sell goods and services Production flow ( Income) Money Flow ( Expenditure) Economic Agents are both buyer and seller 1. Individual/Households/Society 2. Firms/Industry 3. Government 4. External Sector Total Output= Total Income = Total Expenditure at a point of time 5 Govt Purchse and Subsidies Wages, Salaries and transfer Payment Direct and indirect Taxes Government Direct Taxes Revenue Spending Goods & Services sold Market for Goods and Services (Goods Flow) Goods & Services bought Firms Investment Capital Market Savings Households Inputs for production Rent, wages, interest and profit Payments for imports Receipts from exports Market for Factors of Production (Factor Flow) Foreign Sector Land, Labor, Capital and Entrepreneur Income Export of man power Foreign Remittance 3
National Output: Concepts & Measurement 1 GDP: GDP M, and GDP F 2 NDP: NDP M, and NGP F 3 GNP: GNP M, and GNP F 4 NNP : NNP M, and NNP F (= National Income) 5 Private Income 6 Personal Income 7 Personal Disposable Income All Output are express with current and constant prices. Output at Current Price is called Nominal Output Output at Constant Price is called Real Output. 1.1.The Gross Domestic Product (GDP) GDP is the total market value of all final goods and services produced within country s borders during a given period of time (generally a year) irrespective of ownership of resources. Ex. Phillips produces tube light with in India; GDP of India TATA produces car in UK; GDP of UK but GNP of India. Does not include: Intermediate goods, Ex. Intel chips Goods produced in the past Non market production Black market: hawkers selling coconut Underground economy: drugs, prostitution, Household production: self consumption item, not sold in mkt 8 4
1.1.The Gross Domestic Product (GDP) Current Prices=> ( Nominal term) Constant Prices=> ( Real Term) 9 1.1. GDP: ( GDP F and GDP M ) a. GDP M (GDP at Market Prices): When the output of all final goods and services are valued at market prices and the values thus obtained are added is known as GDP M. It includes Indirect Taxes (Ti) and net of Subsidies (S) GDP M =GDP F + (Ti-S) b. GDP F (GDP at Factor Costs/Prices): GDP F =GDP M - (Ti-S) => GDP F =GDP M Ti+S 10 5
1.2. Net Domestic Product(NDP): NDP is obtained by subtracting depreciation from GDP NDP F =GDP F - depreciation NDP M =GDP M - depreciation 11 1.2 Gross National Product (GNP): GNP is the monetary value of all final goods and services (Σpiqi) that are currently produced in a year and valued at market price. 1. Produced by National owned Resources only Ex. visiting Prof, banks profits, Indian company produces out side India included 2. Sold through the official market Self consumption- included Rent on owner-living houses is computed included Do it yourself activities excluded Black economy: legal/illegal difficult to estimate: excluded 3. Not resold or used in further productions Final goods: Included: Intermediate goods, Non-productive transactions: such as (i) Public and private transfer payment, (ii) buying and selling of securities, and Second hand sales: Excluded 12 6
1.2 GNP : GNP M and GNP F A) GNP at Market Price (GNP M ): When the output of all final goods and services are valued at market prices (current price) and the values thus obtained are added is known as GNP M. It includes Indirect Taxes (Ti) and net of Subsidies (S) GNP M = GNP F +Ti-S B) GNP at Factor Cost (GNP F ): GNP F = GNP M T i +S For National Income identity purpose we use the following identity GNP F C + I +G+X-M Hence GNP GNI GNE 13 1.3. Net National Product (NNP) NNP is total value of final goods and services produced in the economy during a year after deducting depreciation plus net income from abroad NNP F =GNP F -depreciation NNP M =GNP M -depreciation NNP F is known as National Income 14 7
1.4 Private Sector s Income a.private Income: Income earned by households Pvt.I=NNP F IAD-END+NDI+TAD+OTA b. Personal Income: Income received by households: PI=Pvt.I-RE-CT c. Personal Disposal Income: Income available for dispose PDI=PI-HDT-MAD IAD- Income from entrepreneurship and property accruing to govt administrative deps ex. Railways END- earnings of Govt non-departmental enterprises (PSUs) NDI- National Debt Interest TAD- Current Transfer from Govt administration Dept OTA- Other net current transfer from abroad RE- retained earnings of nations s private corporate sector CT- corporate tax HDT- Household direct tax MAD- Miscellaneous receipts of govt administrative dept ex. Fines, fees 15 16 8
How is GDP and GNP Related???? GNP= GDP + Net Income from abroad. => GDP=GNP- GDP + Net Income from abroad Similarly, 1. GNP F =GDP F + Net income from abroad GNP M =GDP M + Net income from abroad 2. GDP F =GNP F -Net income from abroad GDP M =GNP M -Net income from abroad We know that GDP F =GDP M -Ti + S A region's GDP is one of the ways of measuring the size of its local economy whereas the GNP measures the overall economic strength of a country. 17 Nominal & Real GDP: ( GDP at Current and Constant Price) All Output are expressed with Current and Constant prices. Output at Current Price is called Nominal Output Output at Constant Price is called Real Output. GDP F with Constant Price is called as Real GDP which is used to measure the growth rate of the economy. GDP F with Current Price is called as Nominal GDP. 18 9
Nominal & Real GDP: ( GDP at Current and Constant Price) Current Prices=> ( Nominal term) Constant Prices=> ( Real Term) 19 The GDP Deflator The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. It tells us what portion of the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. Calculations: GDP deflator = Real GDP 20XX Nominal GDP Real GDP Nominal GDP GDP deflator 100 20XX 20XX 100 20 10
Nominal Vs Real GDP(GDP F ) GDPF at current prices(base Year 1999-2000) GDP F at Constant Price(1999-2000) 6000000 5000000 4000000 3000000 2000000 1000000 0 1950-51 1953-5 4 1956-57 19 59-60 1962-63 160.00 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 Nominal GDP in cr. 1965-66 1968-69 1971-72 1974-75 1977-78 1980-81 1983-84 1986-87 1989-90 1992-93 1995-96 1950-51 1954-55 1998-99 2001-0 2 2004-05 20 07-08 4000000 3500000 3000000 2500000 2000000 1500000 1000000 500000 0 GDP Deflator 1950-51 19 53-5 4 1956-57 19 59-6 0 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03 2006-07 Growth Rates (GDP) Real GDP in Cr. 19 62-63 1965-66 19 68-6 9 1971-72 19 74-7 5 1977-78 19 80-8 1 1983-84 19 86-8 7 19 89-9 0 1992-93 19 95-9 6 1998-99 20 01-0 2 2004-05 20 07-0 8 21 Growth rate: (Y t -Y t-1 )/Y t-1 *100 Economic Growth rate is measured in terms of real GDP growth rate 12 10 8 6 4 2 0-2 -4 1950-51 -6 1953-54 1956-57 1959-60 1962-63 1965-66 1968-69 1971-72 1974-75 Real GDP Growth Rate 1977-78 1980-81 1983-84 1986-87 1989-90 1992-93 Trend Line Real GDP Growth Rate i.e. GDP at FC (constant price) base year (1999 2000) 1995-96 1998-99 2001-02 2004-05 2007-08 22 11
Real Growth Rate of different measurement of National Income accounting (constant price) base year (1999 2000) 12.0 10.0 8.0 6.0 4.0 2.0 0.0-2.0 1951-52 -4.0-6.0-8.0 1954-55 1957-58 1960-61 1963-64 1966-67 1969-70 1972-73 1975-76 1978-79 1981-82 1984-85 1987-88 1990-91 1993-94 GDPFC NDPFC GNPFC NNPFC 1996-97 1999-00 2002-03 2005-06 2008-09 23 Business Cycle Potential or Natural Real GDP growth rate 24 12
Business Cycle Trough: High unemployment, low demand, unused productive capacity, low profits, low investments and lack of confidence about economic prospects Peak: top of cycle high capacity utilisation shortage of skill labour and raw material excess demand, etc Recovery or Expansion: employment, income, consumer spending, demand, etc. increases Business opinions changes from pessimism to optimism Recession or contraction: is downturn in economic activity. Recession is fall in real GDP for two quarters. Depression Recession that is deep and long lasting is Depression. Demand, production and employment falls Boom and Slump: Non- technical but descriptive terms. Falling half of cycle is slump. Rising half of cycle is often called boom. 25 National Output: The Methods of Measurement 26 13
2.0. India s National Output: Methods of Measurement Base year 1937 15 1946 35 1951 88 1956 201 No of Items to calculate GDP 1960 312 (for monthly) 124 ( for annual) 1970 352 Annual Series(1950-51) Quarterly Series (since 1997 Q1) No Series Less than Quarterly is available IIP used as proxy for GDP India uses Laspeyer s Methods to calculate IIP Weights are based on value added methods 1980-81 352( new included old deleted) 1993-94 543 2004-05 682 27 2.0 National Output: Methods of Measurement a. Product Methods (GNP): GNP is the value added by the various industries and activities of the economy in a particular year. Q=f(L,N,K,O)= Σp i Q i a. Income Methods (GNI): We added up the income earned by the owners of factors of productions in a particular year Y=(R L)+(w N) + (i K) + (profit E) b. Expenditure Methods (GNE): We added up the final expenditure of all residents (eco agents) in a country. Z= (C+I+G+X-M) National Income Identity: Q Y Z 28 14
2.1. Product Methods: GDP F =ΣP i Q i Pi= Price of final good i Qi= Output of final good i A. Primary (i) Agriculture + (ii) forestry and Fishing + (iii) Mining and Quarrying B. Secondary (i) Manufacturing + (ii) Electricity, gas and water supply + (iii )Construction C. Tertiary (Services) Trade, hotels and restaurant Transport, storage and communication Banking and insurance Real estate, dwelling and business services Public administration and defense Other services 29 30 15
2.1. Net Product Methods: Value Added Approach 31 32 16
2.2. Income Approach: A. Compensation of employee (W) B. Operating surplus rent (R) interest (i) profits and dividends (Profit) C. Mixed Income (self employed) Transfer payments, employees benefit, pensions etc not included here as income. GDP F = R+W+i+Profit + Mixed Income 33 34 17
2.3. Expenditure Approach: A. Private Consumption (C) B. Investments (gross) (I) C. Government Expenditure (G) D. Exports (X) E. Imports (M) (minus) GDP M = C+I+G+X M 35 36 18
Sectoral Contributions of GDP at FC at Const Price (%) 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 Agriculture & Allied Activities Agriculture Industry Mining & Quarrying Manufacturing Electricity, Gas & Water Supply Services Construction Trade, Hotels, Transport & Communication Financing, Insurance, Real Estate & Business Services Community, Social & Personal Services Sectoral Contributions of GDP at FC at Const Price (%) 38 19
Is GDP A Good Measure Of Economic Well-being? GDP is the best single measure of the economic wellbeing of a society. GDP per person tells us the income and expenditure of the average person in the economy. Higher GDP per person indicates a higher standard of living. GDP is not a perfect measure of the happiness or quality of life, however. 39 Is GDP A Good Measure Of Economic Well-being? Some things that contribute to well-being are not included in GDP. The value of. The value of a clean environment. The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work. GDP Measures the Size of the Pie but Not How the Pie Is Divided Up 40 20
Did World War II Bring Prosperity? Implications for Managers -Movement in national Income helps the manager to figure out the state of the economy -Component of the national income helps to determine the production, distribution, demand structure etc. of the economy. -Expenditure pattern indicates the role of govt in economic activity -Role of govt enhances private competitions -Pattern of govt finances thorough direct and indirect axes affects the disposable income of the households thereby their consumption pattern -Level of imports and exports provides information to the managers about the demand pattern and the potential customers in the international markets 42 21
P II. Price Levels: Concept & Measurement GDP Deflator, WPI, CPI, PPI 43 Price Data Bulk Transactions Implicit Small Transaction WPI Deflator CPI Data Sources : Central Statistical Organization(CSO) National Sample Surveys Organization (NSSO) Director of Economics and Statistics (DES) Labor Bureau (LB) National Buildings Organization (NBO) Indian Bureau of Mines (IBM) Reserve Banks of India (RBI) Director General of Commercial Intelligence and Statistics (DGCIS) Office of the Coal Controller and Textile Commissioner (OCC&TC)tec. 44 22
Measuring Price Changes: Price Indices GDP Deflator Implicit Price Index. Calculated from Nominal and Real GDP WPI (676 item with 2004 05 base year) started since 1902 AC All commodities (by Office of Economic Advisor, Ministry of Industry) PA Primary articles.»fa Food articles.»nf Non food articles.»minerals. FPL& L i.e. Fuel, power, light & lubricants MP Manufactured products CPI (200+) (1970s) UNME Urban non manual employees ( by CSO) IW Industrial workers. AL Agricultural labors. (Labor Bureau) RL Rural Labors Producer Price Index (PPI) ( Dr Abhijit Sen Suggestions) Includes only manufacturing goods 45 Price Index in India 46 23
Measuring Price Changes: Index Number Basic Concepts: Index No: It is a statistical device (measure) to express average changes in related variables. Price Index: Measures relative changes in average prices over time. India Uses Laspeyres Method 47 Measuring Price Changes: CPI Average Prices Quantity Sold 1992 1994 % Change 1992 1994 Food Rs 12 Rs 14 17 % 4 5 Housing 9 10 11 % 3 3 Fun 4 5 25 % 3 4 Machines 20 20 0 % 2 2 Calculations: Laspeyer s Method CPI = (Σp t q 0 / Σp 0 q 0 )x 100 Σp t q 0= = 1992 Quantities x 1992 Prices = 4 Rs.12 + 3 Rs.9 + 3 Rs.4 = Rs.48 + Rs.27 + Rs.12 = Rs.87 Σp 0 q 0 = 1992 Quantities x 1994 Prices = 4 Rs.14 + 3 Rs.10 + 3 Rs.5 = Rs.56 + Rs.30 + Rs.15 = Rs.101 CPI: - Machines not included. - Base year (1992) quantities (market basket) rather than base year prices used. CPI for 1994 is = Σp t q 0 / Σp 0 q 0 x 100 = (101 / 87) = 116.09 => 1.16% 48 24
Measuring Price Changes: Chain base methods 49 Measuring Price Changes: Inflation Rate Inflation ( ) is the rate of changes in price levels: Inflation ( ) rate: CPI Inflation: P P t t P P P t 1 P t 1 t 1 t 1 100 Inflation from 1993 to 1994: = (CPI 1994 CPI 1993 ) 100 CPI 1993 = (116.09 113.59) 100 = 0.022 113.59 = 2.20% 50 25
Measuring Price Changes: Methods Existing (1981-82) series Total: 447 commodities i) Primary article: 93( Food 93, non food 28 and minerals 21) ii) Fuel, power etc: 20 iii) Manufactured Items: 334 WPI Weights Existing (1993-94) series Total: 435 commodities i) Primary article: 98( Food 98, non food 25 and minerals 19) ii) Fuel, power etc: 19 iii) Manufactured Items: 318 Weights are assigned in proportion to their share in the total value of transaction (output) 52 in the economy. 26
WPI Weights Weight No. of items No. of Quotations Major Group / Group 2004-05 1993-94 2004-05 1993-94 2004-05 1993-94 All Commodities 100.00 100.00 676 435 5482 1918 I Primary Articles 20.12 22.02 102 98 579 455 II Fuel & Power 14.91 14.23 19 19 72 72 III Manufactured Products 64.97 63.75 555 318 4831 1391 Weights are assigned in proportion to their share in the total value of transaction (output) in the economy. 53 CPI Weights Weights are assigned as the ratio of total consumption expenditure of estimated number of 54 families allocated to a center in the state to the sum of all such expenditures over all centers in the country 27
CPI Weights 55 Inflation Rate in India 56 28
Types of Inflation >10% in P per year >100% in P with in a year Prices rise with Govt interruption slow Increase in price < 3% 3 to 7%per year in P prices rise without any Govt interruption 57 Extremely rapid or out of control inflation. Hyper Inflation There is no precise numerical definition to hyperinflation. The most famous example of hyperinflation occurred in Germany between January 1922 and November 1923. Germany: WPI 140% in 1921 4100% 1922 500% 1923 Hungary: 1945-46 the inflation rate was 20,000% Country 1989 1990 1980-1991 Argentina 3079.8% 2314.0% 416.9% Brazil 1287.0% 2937.8% 327.6 Peru 3398.6% 7481.7% 287.3% Sources: CMIE World Economy and India's place, Oct 1993. 58 29
Core vs Headline Inflation: Core Inflation: Core inflation is generally a chosen measure of inflation that excludes the more volatile price categories e.g. food and energy prices, otherwise it will give a false measure of inflation. Usually calculated from CPI excluding energy and food product from CPI Headline Inflation: A measurement of price inflation that takes into account all types of inflation that an economy can experience. Unlike core inflation, headline inflation also counts changes in the price of food and energy. Because food and energy prices can rapidly increase while other types of inflation can remain low, headline inflation may not give an accurate picture of how an economy is behaving. Headline inflation is more useful for the typical household because it reflects changes in the cost of living, while core inflation is used by central banks because core inflation is less volatile and shows the effects 59 of supply and demand on GDP better. Threshold Inflation and Stagflation Threshold Inflation: " acceptable rise in prices purported to reflect changes in relative prices necessary to attract resources to growth sector. Threshold level of inflation can be described as that inflexion point beyond which the output growth is not optimal Chakravarty Committee Report : 4% C Rangarajan : 6 to7% Stagflation A condition of slow economic growth and relatively high unemployment accompanied by inflation. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. We have seen that this happened in later 2008. At least some central banks have expressed concern over inflation even as the global economy seems to be slowing down. 60 30
Relation between Inflation and Interest Rates Interest rates reported in the media are nominal rates Real interest rate = nominal interest rate -(expected) inflation rate A 10-year Treasury bond paying 6.08% p.a. with 1.6% annual inflation rate has a real return of? Real return = 6.08% - 1.6% = 4.28% Causes of Inflation Price is determined when AD=AS 1. Demand pull inflation (AD>AS) may be due to : a)increase in money supply (M) b)increase in government purchases (G) or cut in Tax (T) c)increase in exports (X) or decrease in Import (M) 2. Cost push inflation may arise due of : a)increase in money wage rates (W) b)increase in money prices of raw materials (P). c)decrease in supply ( Supply shocks) 31
Structuralists Theories of Inflation a. Food Scarcity: Low monsoon Causes of Inflation b. Resources Imbalance: ( imbalance between demand and supply of industrial inputs) c. Balance of Payment deficits (M>X) Heavily dependent on imports of capital goods, raw materials, oil etc. d. Infrastructural Bottlenecks Scare and unequal distribution of Electricity, means of transport, etc. e. Social and Political Constraints Corruption, Black money, Trade unions and wage bargain Methods of Controlling Inflation 32
Methods of Controlling Inflation U III. Measurement of Employment (E) and Unemployment (U) 66 33
Definition of Unemployment Definition: An Unemployed person is Not working, willing and able to work Actively seeking a job and willing to accept a job at the prevailing market wage Not counted as unemployed Unable or unwilling to work, underage, college students, home makers, retired, in the military. Measurement: Total labor force (L) = Employed persons (E)+ Unemployed persons Civilian noninstitutional population (16 and over)= Total labor force (L) + Not in labor force 67 Unemployment Rates Unemployment Rate (percent) = Unemployed * 100 Total Labor Force Participation Rate (percent) = Total Labor Force * 100 Civilian Population 68 34
Employment - Unemployment U.S. Unemployment Rate Great Depression (1929-1933) 25% Unemployment rate, % 20% 15% 10% 5% World War II (1941-1945) 1973-1975 recession 1981-1982 recession 1990-1991 recession Fairfax Co., VA. U.S. 0% 1930 1940 1950 1960 1970 1980 1990 2000 Source: Bureau of Labor Statistics www.bls.gov 69 Types of Unemployment Frictional Unemployment - where people become unemployed between jobs. Due to imperfect information. Structural Unemployment - caused by changes to the structure of industry in the economy e.g. the decline of the coal, iron and steel industries. The mismatch between skills of labor and skills demanded. Seasonal Unemployment - unemployment that results from the normal seasonal change in aggregate economic activity. e.g. holiday resorts Cyclical Unemployment - stable labor force in an unstable economy. Unemployment that results from a decline in aggregate economic activity Demand Deficient Unemployment where AD is less than AS Technological Unemployment caused where people are put out of work by changes in technology Real Wage or Classical Unemployment caused by wage rates being held above market clearing levels 70 35
Natural Rate of Unemployment Natural Rate of Unemployment: consistent with frictional, structural, and seasonal unemployment. Full Employment Output: total output of economy when unemployment is at the natural rate. During the business cycle total output fluctuates around the full employment level leading to changes in the cyclical unemployment. 71 Thank You All 72 36