UNIT 5

OUTLINES

Nature and characteristics of Indian economy, concepts of LPG, elementary

concepts of National Income, Inflation and Business Cycles ,Concept of N.I.

and Measurement., Meaning of Inflation, Types and causes , Phases of

business cycle .Investment decisions for boosting economy (National income

and per capita income)

Introduction

Macro economics is the study of aggregate economic behaviour of the economy as

a whole. Macro economics deals with the output, (total volume of goods and

services produced) levels of employment and unemployment, average prices of

goods and services. It also deals with the economic growth of the country, trade

relationship with other countries and the exchange values of the currency in the

international market.

The major factors influencing these outcomes are international market forces like

population growth, consumption behaviour of the country, external forces like,

natural calamities, political instability and policy related changes such as tax

policy, government expenditure (budget) money supply and various other economic

policies of the country. Therefore it is essential to know the aggregate demand

and aggregate supply of the country.

Aggregate demand: The total quantity of output demanded at prevailing price

levels in a given time period, ceteris paribus.

Aggregate supply: The total quantity of the output the producers are willing and

able to supply at prevailing price levels in a given time period.

These two summarizes the market activity of the economy. But the economy is

disturbed by unemployment, inflation and business cycles.

Various economic policies like Fiscal policy and monetary policy are followed by

the government to achieve the equilibrium between aggregate demand and

aggregate supply.
The following chapters will help us to understand the Macro Economic concepts,

their behaviour and its impact on the economy. Thus, an understanding of macro

economics and policies is of utmost importance to managers. Managers have to

cope with the economic environment at two levels - firm level and macro level.

Objectives Of Economic Policies

The major macro level economic policies framed by the government

of India to achieve the objectives are:

1. To achieve national level full employment

2. To stabilize the price fluctuations in the market

3. To achieve overall economic growth

4. To develop regions economically

5. To improve the standard of living of the people

6. To reduce income inequalities

7. To control monopoly market structure

8. To avoid cyclical fluctuations in various economic activities of the

country

9. To improve the Balance of Payment of the country and

10. To bring social justice in various aspects.

11. Now let us understand the various macroeconomic concepts.

National Income

The purpose of national income accounting is to obtain some measure of the

performance of the aggregate economy. The major concepts used in the national

income calculation are Gross Domestic Product (GDP), Gross National Product

(GNP), Net National Product (NNP), personal income and Disposable income.

Gross Domestic Product is the total market value of all final goods and services

currently produced within the domestic territory of a country in a Financial /

accounting year. It measures the market value of annual output of goods and

services currently produced and counted only once to avoid double counting. It
includes only final goods and services. It includes the value of goods and services

produced within the domestic territory of a country by nationals and non

nationals.

Gross National Product is the market value of all final goods and services

produced in a year. GNP includes net factor income from abroad.

GNP = GDP + Net factor income from abroad [NFIA] (income received by

Indian’s abroad – income paid to foreign nationals working in India)

Net National Product at market price is the market value of all final goods and

services after providing for depreciation.

NNP = GNP – Depreciation

Depreciation means fall in the value of fixed capital due to wear and tear.

NNP at factor cost is called as National Income:

National income is the sum of the wages, rent, interest and profits paid to

factors for their contribution to the production of goods and services in a

year.
NNP at Factor Cost or National Income [NI] = NNP at Market Price – Indirect Tax [IT] + Subsidies[S]

= Factor Income Domestic[FID] + Net Factor Income from Abroad[NFIA]

Personal income (PI) is the sum of all incomes earned by all individuals

/ households during a given year. Certain incomes are received but not

earned such as old age pension etc.,

Personal Income [PI] = National Income [NI] – [Social Security Contribution(SSC) + Corporate Tax(CT) +

Undistributed Corporate Profits(UP)] + Transfer Payments[TP].

Disposable income is calculated by deducting the personal taxes like

income tax, personal property tax from the personal income (PI).
Personal Disposable Income [PDI] = Personal Income [PI] – Personal Taxes [PT]

= Consumption [C] + Saving [S]

Supernumerary income: the expenditure to meet necessary living costs

deducted from disposable consumer income is called as supernumerary

income.

The economy is divided into different sectors such as agriculture, fisheries,

mining, construction, manufacturing, trade, transport, communication and other

services. The gross production is found out by adding up the net values of all

the production that has taken place in these sectors during a given year. This

method helps to understand the importance of various sectors of the economy.

Approaches To Calculate National Income

The Income Approach

The income of individuals from employment and business, the profits of the firms

and public sector earnings are taken into consideration.

National Income is the income of individuals + self employment

+ profits of firms and public corporate bodies + rent + interest (transfer

payments, scholarships, pensions are not included) this includes the sum

of the income earned by individuals from various input factors such as

rent of land, wages and salaries of employees, interest on capital, profits of

entrepreneurs and income of self employed people. This method indicates

the income distribution among various income groups of people.

Income in case of various factors of production are considered. Land corresponds

to the rental income; Labour corresponds to wages, salaries,bonus comission etc.;

capital corresponds to interest,dividends; & entrepreneurs corresponds to profit,

royalties etc.

The Expenditure Approach

In this approach national income is calculated by using the expenditure of

individuals, private, government and foreign sectors. i.e. the sum of all the

expenditure made on goods and services during a year.

i.e.

GNE or Gross National Expenditure = C H + C G + C B + I G + I B + E R + NFI

NNE or Net National Expenditure = GNE - ER

NDE or Net Domestic Expenditure = NNE - NFI

National Income = Expenditure Of Individuals + Govt. + Private Firms

+ Foreigners

GDP = C + I + G + (X-M)

Where,

C = expenditure on consumer goods and services by individuals and households

I = expenditure by private business enterprises on capital goods

G = government expenditure on goods and services (government purchase)

X-M = exports – imports

GNE or Gross National Expenditure = Household Consumption Ezpenditure [C H] + Govt. Consumption Ezpenditure

[C G ] + Pvt. / Business Consumption Ezpenditure [C B] + Govt. Capital / Investment Ezpenditure [I G] + Pvt. /

Business Capital / Investment Ezpenditure [I B] + Replacement Expenditure [E R] + Net Foreign Investment[NFI]

NNE or Net National Expenditure = GNE or Gross National Expenditure - Replacement Expenditure [E R]

NDE or Net Domestic Expenditure = NNE or Net National Expenditure - Net Foreign Investment [NFI]

NFI or Net Foreign Investment is the difference between Expenditure done by the residents on acquiring foreign

assets & Expenditure done by the non residents on acquiring domestic assets

The Output Approach / Product method / Value addition method

In this approach we measure the value of output produced by

firms and other organization in a particular time period. i.e. the National

Income = income from agriculture + fishery + forestry + construction +

transportation + manufacturing + tourism + water + energy ...

Gdp At Market Price + Subsidies –Taxes

Gnp At Factor Cost + Net Income From Abroad

Factors Determining National Income:

1. Quantity of goods and services produced by the country. Higher

the quantity of production, higher shall be the national income.

2. Quality of products and services produced in the country will also

determine the national income of a country.

3. Innovation of more technical skills will improve the productivity

which will reflect on national income of the country.

4. Political stability strengthens the national income of an economy.

Difficulties In The Calculation Of National Income

1. Any income earned abroad have to be included.

2. To avoid double counting, value added method should be considered.

3. Services rendered free of charges are not to be included.

4. Capital gains, transfer payments are not to be included.

5. Changes in price level will also affect the calculation.

6. Value of military services will not be taken into consideration.

Problems In Measuring National Income In India

1. Non monetized sector: there are number of sectors in which the

wages and salaries are provided in kind, not in monetary measures.

2. Illiteracy: due to higher illiteracy rate the results may be biased.

3. Lack of occupational specification: we have difficulty in classifying the

nature of the job existing in India.

4. Unorganized productive activities: people involved in unorganized

productive activities are not fully covered in the calculation of national income.

5. Lack of adequate statistical data: Inadequate data leads to

approximation of the calculation.

6. Self consumption: Farm products kept for self consumption are not

considered for the national income calculation.

7. Unpaid Services: services of house wives are not reckoned as national

income.

Uses Of National Income Estimates

1. National income is a measure of economic growth

2. National income is an indicator of success or failure of planning

3. Useful in estimating per capita income

4. Useful in assessing the performance of different production sectors

5. Useful in measuring inequalities in the distribution of income

6. Useful in measuring standard of living

7. Useful in revealing the consumption behaviour of the society

8. Useful in measuring the level and pattern of investment

9. Makes international comparisons possible

Difficulties Of Comparing National Income

It is difficult to compare the national income of a country with others due to the

difference in population size, working hours of labour force, currency values in

the market, consumption pattern of general public, cultural difference and

inflationary pressure of the country. Even with all the above mentioned

difficulties the GDP is the major economic indicator of an economy.

National Income And Managers

The managers of various organizations in different sectors follow the national

income statistics to take managerial decisions at the firm level. Particularly

national income data is useful for the marketing managers, financial managers,

production managers, and advertising agents of any firm. The macro level policy

makers will also use the data for their decision making.

Business Cycle

A study of fluctuations in business activity is called business cycle. Business cycle

can be defined as a periodically recurring wave like movements in aggregate

economic activity (like national income, employment, investment, profits, prices)

reflected in simultaneous, fluctuations in major macro economic variables.

R A Gordon defined business cycle as consisting of “recurring alteration of

expansion and contraction in aggregate economic activity, the alternating

movements in each direction being self-reinforcing and prevailing virtually all

parts of the economy”

Characteristic Features Of Business Cycle

1. It occurs periodically: the fluctuations in economic activities occur

periodically but not at a fixed period of interval.

2. It is international in character: the changes in any economic activity of a

country have impact on economies of the world (for example financial crisis in

US had impact on various other countries economic activities).

3. It is wave like: the fluctuations indicate ups and downs in various

economic indicators of a country.

4. The process is cumulative: the process is cumulative in nature, that means

change in income level, savings or any other activity will be in aggregates.

5. The cycles will be similar but not identical: the cycle has ups and downs

but not identical spacing that means the time period of occurrence will differ.

Phases Of A Business Cycle

The business cycle has four phases, Boom, Recession, Slump and Recovery. In

economics it has been observed that income and employment tend to fluctuate

regularly overtime. These fluctuations are known as business cycle or trade cycle.

Peak / Boom: when the economy is booming national income of the country

is high and there is full employment, the consumption and investment is

high. Tax revenue is high. Wages and profits will also increase. There will

be inflationary pressure in the economy.

Recession: when the economy moves into recession, output and income fall

leading to a reduction in consumption and investment. Tax revenue begins to fall

and government expenditure begins to benefit the society. Wage demands

moderate as unemployment rises, import and inflationary pressure declines.

Trough: economic activities of the country are low, mass unemployment exists, so

consumption investment and imports will be low. Pricing may be falling (there

will be deflation).

Recovery: as the economy moves into recovery, national income and output begin

to increase. Unemployment falls, consumption, investment and import begins t

rise. Workers demand more wages and inflationary pressure begins to mount.

PEAK
EXPANSION
BOOM RECESSION

RECOVERY
DEPRESSION
TROUGH

The fluctuation in the activities is measured with respect to a horizontal line

indicating a given steady level of economic activity. However, if the time series

reveals a significant long term trend, the vertical deviations of the reported or

actual points from the estimated trend line are measured and plotted separately

to obtain a clear picture of the underlying business cycle. Most economic variables

go through ups and downs over time and the economy as a whole experience

periods of prosperity and periods of recession. The measure of prosperity is the

amount of goods/services produced (GDP) during a year. Actual business cycle are

measured by changes in real GDP, that is the market value of all the goods and

services produced within a nation’s borders, with market values measured in

constant prices (prices of a specific base year).

Expansion or boom: is the period in the business cycle from a trough up to a

peak, during which output and employment rise.

Contractions, recession, or slump: is the period in the business cycle from a

peak down to a trough, during which output and employment fall.

Recession: a decline in total output (real GDP) for 2 or more consecutive

quarters. Reduction in investment, employment and production, reduction in

income, expenditure, prices and profits reduction in bank loans. The business

expansion stops that leads to depression.

Depression: the level of economic activity is extremely low. The income,

production, employment, prices, profits of the country is very low. Organizations

fix low price which leads to low profit, low wages, people suffer, closing down of

business.

Recovery: slow increase in output, employment, income and price. Increase in

demand, investment, bank loan, advances. This leads to recovery, revival of

prosperity.

Theories On Business Cycle

Sunspot theory / climate theory: depending on climatic changes agricultural

products are produced. Based on the production other ancillary units will function

therefore the base for any change in economic activity of the country is climate.

Psychological theory: during depression or crisis of any business organization it

is completely based on the psychology of the entrepreneur as to whether the

organization can be revived or shut down.

Monetary theory: means the demand and supply of money is the primary reason

for economic fluctuations of a country.

Over investment theory: if the organizations and individuals save more and

invest a huge amount then their expectations on increase in their returns.

Over savings/ under consumption theory: As per this theory the increase in

savings and investment will bring down the consumption which will reduce the

demand for goods in the market.

Innovation theory: According to this theory more innovations lead to new

technology and new business that leads to prosperity in the economy.

There are two types of business cycle models, they are (i) Exogenous model; due

to economic shocks like war. (ii) Endogenous model; trade cycle because of factors

which lie within the economic system.

A monetarist explanation: business cycles are essentially monetary phenomena

caused by changes in the money supply. Change in money supply leads to change

in employment and national income which increases the price. The path to an

increased price level is cyclical. The link between changes in money supply and

changes in income is known as the transmission mechanism.

Inflation

Inflation is an economic condition in which the aggregate prices are always

increasing in a country. The value of money is falling. Inflation is nothing but

too much of money chasing too few goods. For example in Zimbabwe the

inflationary rate is too high as more than 1000 % and in turn they require bag

full of money for a meal. And the value of their currency is very low in the

market. Inflation means not only sustainable rise in the price of the goods and

services, but the value of the currency falls in the market and the supply of

money in circulation is more.

Deflation is the opposite of inflation. It is a state of disequilibrium in which a

contraction of purchasing power tends to cause or is the effect of a decline of the

price level.
 Types Of Inflation On The Basis Of Speed

1. Creeping inflation: the inflationary rate is less than 2% that

means prices are increasing gradually.

2. Walking inflation: the inflationary rate of a country is around 5%

little more than creeping.

3. Running inflation: the rate of growth in prices are more i.e. the

inflation is growing at the rate of 10%.

4. Galloping inflation: higher growth rate compared to the earlier

stages i.e. the change is around 25%.

The major four types of inflation is depicted graphically in the following graph.
‘X’ axis denotes the year and ‘Y’ axis for rise in price level. Based on the

elasticity and slope we can understand over a period of time sustainable

inflationary situation leads to higher level of inflation in the economy.

GALLOPING
RUNNING

WALKING

CREEPING

On The Basis Of Inducement:

1. Deficit induced: the deficit in the balance of payments of the country or

fiscal deficit is the reasons for inflation. The value of the currency is falling due

to the above mentioned reasons.

2. Wage induced: due to higher wages and salaries the money supply in the

country increases leading to inflation.

3. Profit induced: higher the profit the organizations earn, they tend to

share with their stakeholders which induces the money supply and reduces the

value of money.
4. Scarcity induced: the raw material and other input factor scarcity (for

example petrol) may induce the price hike in the market.

5. Currency induced: the value of currency fluctuates due to various

internal and external forces.

6. Sectoral inflation: a particular sector of a country may be the reason for

economic growth or money supply. (for example in India the growth in service

sector particularly IT).

7. Foreign trade induced: if the country has unfavorable balance of

payments, that means the country’s exports are less than the imports, then we

need more of foreign currency to make payments to the exporters ultimately this

increases the demand for other currencies in the market.

8. War time, Post war, Peace time: During war period the government

expenditure on various amenities will induce the inflation and the production,

availability of the commodities will be low which leads to price hike. To settle

down the economy after war or natural calamities the government spending will

be more.

Effects Of Inflation On Various Economic Activities Of The

Country

1. On Producers: Producers will earn more profit due to higher prices.

2. On debtors and creditors: Creditors will be happy to receive more returns

on their lending.

3. On wage and salary earners: Wage holders will struggle to purchase the

goods and services.

4. On fixed income group: Income is fixed but the value of the currency

is falling and prices are increasing therefore it is difficult to manage the

normal life. i.e. they are affected.

5. On investors: Investors will receive more returns on their investments.

6. On farmers: Farmers will suffer.

7. On social, moral and political effects: Due to money supply and higher
the cash in hand the social, moral values are declining in the society with

political disturbances.

Monetary Phenomena

If the money supply increases in line with real output then there will be no

inflation. M.Friedman stated “Inflation is always and everywhere a monetary

phenomenon in the sense that it is and can be produced only by a more rapid

increase in the quantity of money than in output.

Explanation of why money supply leads to inflation

1. Quantum of money supply rises but aggregate production is constant or

declining.

2. Quantum of money supply is static but aggregate production is declining.

3. Quantum of money supply rises at a higher rate but aggregate production

is rising slowly.

4. Quantum of money supply falls slowly but aggregate production is declining

fast.

5. Quantum of money supply rises but aggregate production is declining.

Post Full Employment Phenomenon [ Keynesian view]

As per this the real inflation occurs post full employment.

 Demand Pull Inflation

Inflation will result if there is too much spending when compared to output.
Aggregate demand is greater than aggregate supply which leads to price hike and

inflation. An increase in aggregate demand when the economy is at less than full

employment level will result in an increase in both price and output. If the

economy is at full employment then the demand will increase which leads to

inflation.

Cost Push Inflation:

Inflation is caused by change in the supply side of the economy, it increases cost

of production, prices and inflation. Initially increase in costs leads to a chain of

wage increases which leads to increase in demand and cost.

 Methods Of Controlling Inflation

Control Of Inflation

It is clear that the inflationary situation in the long run is not going
to help the economy to grow. Therefore the Government has to take many

steps to overcome this problem.

Monetary measures : to control inflation are:

1. Bank rate

2. Open market operations

3. Higher reserve ratio

4. Consumer credit control

5. Higher margin requirements

Fiscal measures:

1. Regulating to Government expenditure

2. Taxation

3. Public borrowing

4. Debt management

5. Over valuation of home currency

Others:

1. Wage policy

2. Price control measures and rationing the essential supplies

3. Moral suasion

4. Anti Inflationary Measures:

 ASSIGNMENT 5

DATE OF SUBMISSION 15/11/2019

1. Define macro economics. What do you mean by aggregate demand and

aggregate supply? What are the major objectives of macroeconomic policies

of our country?

2. Discuss the major National Income concepts. Explain the three national

income calculation methods. List out the major difficulties and problems in

the national income calculation of our country.

3. Mention the uses of national income calculation in the manager’s point of

view.
4. Define Business cycle, list out its characteristic features. Explain various

phases of a business cycle.

5. Discuss the theories on business cycle. Explain the managerial uses of

business cycle.

6. Are cyclical fluctuations necessary for economic growth?

7. What is inflation? What are the types of inflation?

8. Write short note on demand pull inflation and cost push inflation.

9. List out the major factors influencing inflation in India.

10. Explain the effects of inflation on various groups of people in the

society.

11. Discuss the causes and control measures of the inflation.