Some Basic Concepts of Macroeconomics
• ‘An Enquiry into Nature and Cause of Wealth of Nations’ has been written by Adam smith.
• Resources alone cannot make a country rich.
• Resources are used in generating a flow of production and how, as a consequence, income & wealth are generated from that process.
• Such an item that is meant for final use and will not pass through any more stages of production or transformations is known as a final good.
• Consumer durable goods are a category of consumer goods that do not wear out quickly, and their fore, have to be purchased frequently. Example include bicycles and refrigerators.
• Goods that are purchased by their ultimate consumers are known as consumer goods. This includes services which are consumed but for convenience we may refer to them as consumer goods.
• All final goods and services produced in an economy in a given period of time are either in form of consumer goods, both durable and nondurable, or capital goods.
• As final goods, they do not undergo any further transformation in economic process.
• Some goods may be used by other producers as material inputs, are known as intermediate goods.
• To have a comprehensive idea of total flow of production in economy, we need to have a quantitative measure of aggregate level of final goods produced in economy.
• Income, output, or profits are concepts that make sense only when a period is specified.
• If a new machine is added or a machine falls into disuse and is not replaced, these are known as stocks.
• Stocks are defined at a particular point in time.
• Flow variable refers to that variable which is measured over a period of time. This is a dynamic concept.
• That part of our final output that comprises capital goods, constitutes gross investment of an economy.
• deletion, which is made from value of gross investment to accommodate regular wear and tear of capital, is known as depreciation.
• Depreciation is, thus an annual allowance for wear and tear of a capital good.
• incomes that people earn as owners of factors of production, are used by them to meet their demand for goods and services.
• process of production in an economy generates factor payments for those involved in production and generates goods and services as outcome of production process.
Circular Flow of Income and Methods of Calculating National Income
• There may fundamentally be four kinds of contributions that can be made during production of goods and services.
• aggregate consumption by households of economy is equal to aggregate expenditure on goods and services produced by firms in economy.
• When income is being spent on goods and services produced by firms, it takes form of aggregate expenditure received by firms.
• When aggregate revenue received by firms is paid out to factors of production it takes form of aggregate income.
Goods and Services Expenditure Income Factor Services [Land, Labour, Capital & Enterprise]
• description of functioning of an imaginary economy is known as macroeconomic model.
• Real flow refers to flow of factor services from households to firms and corresponding flow of goods and services from firms to households.
• Money flow refers to flow of factor of payments from firms to households for their factor services and corresponding flow of consumption expenditure from households to firms for purchase of goods and services produced by firms.
Product or Value Added Method
• In production method, we calculate aggregate annual value of goods and services produced if a year is unit of time.
• term that is used to denote net contribution made by a firm is known as its value-added.
• Raw materials that a firm buys from another firm that is completely used up in process of production are known as intermediate goods.
• value-added of a firm is distributed among its four factors of production, namely, labour, capital, entrepreneurship, and land.
• Therefore wages, interest, profits, & rents paid out by firm must add up to value-added of firm.
• Value-added is a flow variable.
• Replacement investment is same as depreciation of capital.
• If we include depreciation added then measure of value-added that we obtain is known as Gross Value Added.
• If we deduct value of depreciation from gross value added we obtain Net Value Added.
• In economics, stock of unsold finished goods, semi-finished goods, or raw materials which a firm carries from one year to next is known as inventory. Inventory is a stock variable.
• In addition, stock of capital of a firm is called investment.
• income Method measures national income from perspective of factor income.
• expenditure method is most common way to calculate national income. expenditure method formula for national income is C + I + G [X – M], where consumer spending is denoted by C, investment is denoted by I, government spending is denoted by G, X stands for exports and imports is represented as M.
• This method measures national income as sum total of final expenditure incurred by households, business firms, government and foreigners.
• total final expenditure is equal to gross domestic product at market price.
• This method is called Income Disposal Method
Factor Cost, Basic Prices And Market Prices
• In India, most highlighted measure of national income has been GDP at factor cost.
• Central Statistics Office [CSO] of Government of India has been reporting GDP at factor cost and market prices.
• In its revision, in January 2015 CSO replaced GDP at factor cost with GVA at basic prices, and GDP at market prices, which is now known as only GDP, is now most highlighted measure.
• Production taxes and subsidies are paid or received in relation to production and are independent of volume of products such as land revenues, stamps & registration fees. Product taxes and subsidies, on other hand, are paid or received per unit or product, for example, excise tax, service tax, export & import duties.
• Factor cost includes only payment to factors of production, it does not include any tax.
• To arrive at market prices, we have to add to factor cost total indirect taxes less total subsidies.
• To arrive at market prices we have to add product taxes and fewer product subsidies to basic prices.
Nominal and Real GDP
• Real GDP is calculated in a way such that goods and services are evaluated at some constant set of prices or constant prices.
• Nominal GDP, on other hand, is simply value of GDP at current prevailing prices.
• ratio of nominal GDP to real GDP gives us an idea of how prices have moved from base year to current year.
• year whose prices are being used to calculate real GDP is known as base year.
• ratio of nominal to real GDP is a well-known index of prices. It is known as GDP Deflator.
• Consumer Price Index [CPI] is index of prices of a given basket of commodities that are bought by representative consumer.
• index for wholesale prices is known as Wholesale Price Index [WPI].
• goods purchased by consumers do not represent all goods that are produced in a country.
• GDP deflator takes into account all such goods and services.
• CPI includes prices of goods consumed by representative consumer, hence it includes prices of imported goods. GDP deflator does not include prices of imported goods.
• weights are constant in CPI – but they differ according to production level of each good in GDP deflator.
GDP and Welfare
• There are three reasons which forbid taking real value of GDP instead of nominal GDP as an index of well-being of people.
• three factors are uniform distribution of GDP, Non-monetary exchanges and Externalities.
Some Macroeconomic Identities
• macroeconomic variable which takes into account additions and subtractions of foreign earnings is called Gross National Product [GNP].
• If we deduct depreciation from GNP measure of aggregate income that we obtain is known as Net National Product [NNP].
• Market price includes indirect taxes.
• When indirect taxes are imposed on goods and services, their prices go up.
• Indirect taxes accrue to government.
• National Income received by a household is known as Personal Income.
• A part of profit earned from National Income is not distributed among factors of production, it is known as Undistributed Profits.