MACROECONOMICS Flashcards
Economics is the study of
how societies use scarce resources to produce valuable goods and services and distribute them among different individuals.
major subfields of economics
Economics is divided into two major subfields, Microeconomics and Macroeconomics
Microeconomics
is the study of decisions that people and businesses (individual economic agents) make regarding the allocation of resources and prices of goods and services. For example, the study of what mix of products an individual purchases with a given amount of money is part of microeconomic study.
Macroeconomics
is the study of the national economy as a whole. Macroeconomics examines a wide variety of areas such as how total investment and consumption in the economy are determined, how central banks manage money and interest rates, what causes international financial crises, how an increase/ decrease in net exports would affect a nation’s capital account and why some nations grow rapidly while others stagnate.
What are three problems of Economic Organization (the three problems)
What commodities are to be produced and in what quantity?
How are the goods to be produced?
For whom are the goods to be produced?
Economic Systems
A market economy is one in which individuals and private firms make the major decisions about production and consumption. A system of prices, of markets, of profits and losses, of incentives and rewards determines what, how and for whom. The extreme case of a market economy, in which the government keeps its hands-off economic decisions, is called a laissez-faire economy.
By contrast, a command economy is one in which the government makes all important decisions about production and distribution.
Mixed economy- pvt public participation
Sectors of (mixed) Economy
Private Sector:
All the enterprises owned by the private individuals or group of individuals belong to the private sector. The private sector consists of companies/firms/enterprises in India which are not owned by the government.
Government Sector:
This sector includes public administration, police, defence, framing of laws and enforcing them. Apart from imposing taxes and spending money on various infrastructure and healthcare services and education etc., government also undertakes production activity through its companies like Coal India Ltd. (CIL), National Thermal Power Corporation (NTPC) etc. So, all the companies owned by the Central or State Governments i.e. Public Sector Undertakings (PSUs) also belong to the government sector.
Household Sector:
A group of persons who normally live together and take food from a common kitchen constitutes a household. The size of a household is the total number of persons in the household. We should always remember that households consist of people. These people work in firms as workers and earn wages. They are the ones who work in the government departments and earn salaries and they are the owners of firms and earn profits. So, all the human beings (population) belong to household sector.
External Sector:
This sector consists of the exports and imports of goods and services flowing into the country or out of the country. It also includes the financial flows from and into the domestic country.
“factors of production” or the “inputs of production”
1.Entrepreneur: The person who takes the risk and starts a new business. This person takes the risk to bring in capital, labour and natural resources together in the form of an enterprise and in return expects “Profit”. The entrepreneur is a human being and he belongs to the household sector.
2. Capital: But from an economic point of view, only the physical capital goods are considered as capital. So, capital includes the building, machinery, equipment etc. The return for the capital is called “Interest”.
3. Natural Resources: Natural resources include land and raw materials which are naturally available and are not produced through manmade processes. The return for the natural resources is called “Rent”.
4. Labour: It is the human labour which may be physical or mental i.e., it can be unskilled, semi-skilled or skilled. When a human being provides his labour to the enterprise, in return he/she expects “wages”. The labour (who is providing the labour services) is a human being and belongs to the household sector
Types of Goods
Intermediate goods-These are semi-finished goods which have been produced by a process but cannot be used as it is and need to go through further production process to be converted into a final good. For example, steel sheets.
Final goods-These goods do not undergo any further transformation in the production process. Final goods can be of two types consumption goods and capital goods.
Types of final goods
consumption and capital
Consumption Goods:
Goods which are consumed by the ultimate consumers or meet the immediate need of the consumer are called consumption goods. They can be of three categories.
(i) Durable Consumption Goods: Consumption goods which do not get exhausted immediately but last over a period of time are called consumer durables. Life of consumer durables is generally more than 3 years. For examples home appliances, consumer electronics, furniture etc.
(ii) Non-Durable Consumption Goods: Consumption goods which get consumed immediately and whose life is generally less than 3 years. For example, cosmetics, food, fuel, paper, clothing etc.
(iii) Services: Services are intangibles and are a kind of consumption goods only, as, it is consumed immediately. For example, education, banking, telecom, healthcare etc.
Capital Goods:
A particular good will be capital in nature only if it possesses the following three characteristics:
(i) It is a produced durable output of a man-made process
(ii) It again acts as an input for further production process (to be sold in the market)
(iii) While acting as an input, it does not get transformed or consumed
For example, Tractor.
In strict sense the economists consider only the physical capital as the capital but in today’s world intangible capital is increasingly becoming important. So, capital can be divided into three categories.
(i) Physical Capital (capital goods)
(ii) Financial Capital (money)
(iii) Intellectual Capital (patents, copyrights etc.)
Can a consumption good be a capital good?
Yes depends on the context. Eg toaster sold to restaurant vs individual
Can an intermediate good be a final good?
Yes depends on the context. The distinguishing characteristic whether a good is final or intermediate is “the last transaction in the market”.
Investment
That part of the final output which comprises of physical capital goods is called gross investment. So, investment in a country is not measured as money put in a business or any economic activity but it is basically that portion of the final output (GDP) which consists of capital goods.
Gross Capital Formation means
Investment in the economy is also called Gross Capital Formation.
Gross Capital Formation = Gross Fixed Capital Formation (machinery + equipment + new construction + intellectual property) + Net acquisition of valuable Metals like gold, silver, platinum, gems and stones + Change in stock/inventory
Depreciation
Depreciation is also defined as consumption of physical capital.
Net Investment
Gross Investment - Depreciation
Gross Domestic Product
The total final value of goods and services produced within the domestic territory of a country in a specified time period (generally a financial year) is called Gross Domestic Product.
Methods of GDP calculation
Value added-The value added method for calculating Gross Domestic Product (GDP) measures the value added at each stage of production in the economy. It sums up the value contributed by each producer in the production process.
Expenditure method-GDP by all sectors of the economy = Private consumption (C) + Private investment (I) + Government Investment and Consumption (G) + exports (X) - imports (M)
Income method- Income Method
Income method-The sum of the final goods produced in the economy must be equal to the income received by all the four factors of production i.e., wages, rents, interests and profits. GDP = Profit + Interest + Rent + Wages
Domestic territory of a country includes
domestic territory may be defined as the political frontiers of the country including its territorial waters, ships, aircrafts, fishing vessels operated by the residents of the country, embassies and consulates located abroad etc.
GDP Calculation Methodology by NSO
NSO calculates GDP by Value Added Method and Expenditure Method both. Under Value Added Method, it calculates the value addition done by various economic activities viz:
Agriculture, Forestry and Fishing
Mining and Quarrying
Manufacturing
Electricity, Gas, water supply and other utility services
Construction
Trade, Hotels and transport, and communication and services related to broadcasting
Financial, Insurance, real estate and professional services
Public administration and defence and other services
Under Expenditure Method, it adds up the various components of expenditure viz:
Private (Final) Consumption Expenditure (it is basically household expenditure)
Government (Final) Consumption Expenditure
Gross Fixed Capital Formation (Investment expenditure of private and government)
Net of Exports and Imports
Gross National Product (GNP)
GNP = GDP + Net factor income from abroad (NFIA)
Aka gross national income
Does GNP include remittances and transfer payments
No, since this implies it is coming from non residents
What is NFIA
amount earned by Indian residents abroad- amount earned by non-residents within domestic territory
National Disposable Income
= National Income + Net Transfer payments
National Income
NNPmp
Factor cost
Cost of factors of production
Market Price
Factor Cost + (indirect taxes - subsidies)
GDP calculation by India
In India (since January 2015 onwards) we calculate GDP at Market Prices rather than at Factor Cost. National Statistical Office (NSO) under the Ministry of Statistics and Programme Implementation (MoSPI) has changed the base year for calculation of GDP to 2011-12. (as per global best practices and IMF’s World Economic Outlook projections )
Per capita GDP
If the population of the country in any particular year say 2020-21 is P and the GDP is Y then per capita (i.e. per person) GDP will be Y/P
Nominal and Real GDP
Real GDP growth measures growth in quantity only and nominal GDP measures growth in value (which includes quantity and prices both). For Real GDP, a base year is to be taken to keep prices constant
Productivity of capital
output/input(capital). Higher the better.
Capital output ratio
capital/output because we need to know how much of capital to add to increase output i.e GDP. the higher the less better.
ICOR
Incremental Capital Output Ratio =investment % in GDP/ %change in GDP
ICOR represents how efficiently the new/additional capital is being used in a country to produce output.
What does the ICOR depend upon
The incremental capital output ratio is a catch-all expression. It depends upon a multiple number of factors such as governance, quality of labour which again depends on education and skill development levels, and technology etc.
Potential GDP
Potential GDP is the real value of goods and services that can be produced when a country’s factors of production are fully employed. It is the maximum SUSTAINABLE LEVEL of output that an economy can produce. When an economy is operating at its potential (trend), there are high levels of utilisation of the labour force and the capital stock.
Actual GDP is subject to business cycle swings i.e. the cycles of upturn and downturn. During downturn, the actual GDP falls below the potential level and during upturn, the actual GDP rises above the potential GDP level.
Economic (growth) slowdown
is generally considered as the phase when GDP growth rate of the economy is declining but it may still be positive.
Recession
Technically, a recession is defined as (at least) two consecutive quarters of negative economic growth as measured by a country’s real GDP.
Economic depression
A severe and protracted recession is called depression.
India and recession
India has faced recession five times in 1957-58 (-1.2%) [Drought], 1965-66 (-3.66%) [drought/war], 1972-73 (-0.32%) [drought/Oil crisis] and 1979-80 (-5.2%) [Drought/political instability] and 2020-21 (-6.6%) [Covid-19].
Nominal Exchange Rate (NER) and depends upon
Price of one currency in terms of another currency
Written as abroad/domestic. Therefore if $1 = Rs. 70, means NER is “$.014 per Rs”. Demand/supply of the currency.
