Key Macroeconomic

Phenomena
Concept of National Income
National Income refers to the total value of all goods and services
produced by a country's residents, whether within its borders or abroad,
during a specific period (typically one year).

There are two main definitions of National Income:

1.Traditional Definition of National Income: National Income is the

total value of goods and services produced through the labour and
capital of a country, utilizing its natural resources.
2.Modern Definition: Modern economists break National Income into
two main components:
 Gross Domestic Product (GDP)
 Gross National Product (GNP)
Gross Domestic Product(GDP)
Gross Domestic Product is defined as the total market value of all final
goods and services produced in a year in the domestic territory of a
country.

Two things must be noted in regard to gross national product.

I. It measures the market value of annual output. In other words, GDP

is a monetary measure.
II. For calculating gross domestic product accurately, all goods and
services produced in any given year must be counted once, and not
more than once.
Gross Domestic Product(GDP)

In mathematical term GDP can be expressed as,

Where,
C = Consumption
I = Investment
G = Government Expenditure
(X-M) = Export minus Import or net export.
Components of GDP
1. Value of final consumer goods and services produced in a year and
consumed by the households which is denoted by consumption (C) by
households.
2. Value of new capital goods produced and addition to the inventories
of goods such as raw materials, unfinished goods and consumer
goods produced but not sold during a year. This is called Gross Private
Investment (I).
3. Value of output of General Government which is taken to be equal to
the value of purchases of goods and services by the Government
which we denote by (G).
4. Net Exports (NX) which is equal to value of goods exported minus the
value of goods imported (M).
Gross National Product(GNP)
Gross national product is the money value of all final goods and services
produced by normal residents as well as non-residents in the domestic
territory of a country and also not includes net factor income earned from
abroad.

In mathematical term GNP can be expressed as,

Net Factor Payment From Abroad
The net factor income from abroad is the difference between factor
income received from abroad by normal residents of Bangladesh for
rendering factor services in other countries on the one hand and the
factor incomes paid to the foreign residents for factor services rendered
by them in the domestic territory of India on the other.

Net factor incomes earned from abroad have therefore the following
three components:
1. Net compensation to employees.
2. Net income from property i.e., rent, interest and income from
entrepreneurship (that is, profits and dividends)
3. Net retained earnings of the resident companies working in foreign
countries.
Personal Income and Disposable Income
PI : Personal Income is the sum of all incomes actually received by all
individuals or households during a given year.

Personal Income = National Income – Social Security Contributions –

Corporate Income Taxes – Undistributed Corporate Profits + Transfer
Payments.

DI : After a part of personal income is paid to government in the form of

personal taxes like income tax, personal property taxes, etc., what
remains of personal income is called personal disposable income.

Disposable Income = Personal Income – Taxes + Transfer Payments.

Measurement of National Income

1. Value added method

2. Income method

3. Expenditure method
Measurement of National Income
1. Value added method :

This is also called output method or production method. In this

method the contribution of each enterprise to the generation of flow
of goods and services is measured. Under this method, the economy is
divided into different industrial sectors such as agriculture, fishing,
mining, construction, manufacturing, trade and commerce, transport,
communication and other services. Then, the net value added at
factor cost (NVAFC) by each productive enterprise as well as by each
industry or sector is estimated. Measuring net value added at factor
cost (NVAFC) by each industry requires first to find out the value of
output.
Measurement of National Income
The income method calculates national income by summing all incomes earned
by individuals within a country. It reflects income distribution among factors of
production. The process involves:

1.Classifying productive enterprises: Categorizing businesses into sectors like

agriculture, manufacturing, etc.

2.Classifying factor payments: Grouping incomes into:

•Compensation of employees (wages, salaries, social security contributions).

•Rent and royalties.

•Interest.
•Profits (dividends, undistributed profits, corporate income tax).
•Mixed income of self-employed (unincorporated businesses where labor
and capital returns are indistinguishable).
Measurement of National Income
3.Measuring factor payments: Determining income paid to each factor
(labor, land, capital, entrepreneurship) by multiplying the quantity of the
factor used by its respective price.

4.Summing sectoral incomes: Adding factor payments across all

enterprises within each sector.

5.Calculating domestic factor income (NDPFC): Summing incomes across

all sectors.

6.Calculating national income (NNPFC): Adding net factor income from

abroad to NDPFC.
Nominal vs Real GDP
Nominal Gross Domestic Product (GDP) and Real GDP both quantify the
total value of all goods produced in a country in a year. However,
real GDP is adjusted for inflation, while nominal GDP isn’t. Thus, real
GDP is almost always slightly lower than its equivalent nominal figure. In
most circumstances, the real GDP (and real GDP per capita) shows a
more accurate picture of a country’s economic performance since it can
be more easily compared to past figures. Thus, we can deduce whether a
country really is better or worse off year over year.

Nominal GDP is calculated using the following equation:

Nominal vs Real GDP
To calculate real GDP, we must discount the nominal GDP by a GDP
deflator. The GDP deflator is a measure of the price levels of new goods
that are available in a country’s domestic market. It includes prices for
businesses, the government, and private consumers. The GDP deflator
essentially removes inflation from the equation and enables us to compare
the GDP of a recent year to the GDP of a target (or “base”) year.
Inflation and Its types
Concept of Inflation

Inflation is defined a sustained increase in the general price level of

goods and services in an economy over a period of time.

It is measured as an annual percentage increase. When the general

price level rises, each unit of currency buys fewer goods and services.
This implies that inflation reflects a reduction in the purchasing power
per unit of money. In other words, inflation indicates a loss of real value
in the medium of exchange and unit of account in the economy.
Types of Inflation
1. Creeping Inflation: Creeping Inflation also known as a Mild Inflation
or Low Inflation refers to that type of inflation when the rise in prices
is very slow like that of snail or creeper. It is the mildest form of
inflation with less than 3% per annum.
2. Chronic Inflation: If creeping inflation persist for a longer period of
time then it is often called as Chronic or Secular Inflation. It is called
chronic because if an inflation rate continues to grow for a longer
period without any downturn which may possibly lead to
Hyperinflation.
3. Walking or Trotting Inflation: When prices rise moderately with a
single digit of less more than 3% but less than 10% per annum it is
called as Walking Inflation.
4. Running Inflation: A rapid acceleration in the rate of rising prices is
referred as Running Inflation. This type of inflation occurs when
prices rise by more than 10% per annum.
Types of Inflation
6. Galloping Inflation: Galloping inflation also known as Jumping
inflation occurs when prices rise by double or triple digit inflation
rates of more than 20% but less than 1000% per annum. 6.
Hyperinflation: when prices rise at an alarming high rate with
quadruple or four digit inflation rate of above 1000% per annum
then is termed as Hyperinflation. It is a situation where the prices
rise so fast that it becomes very difficult to measure its magnitude.
During a worst case scenario of hyperinflation, value of national
currency of an affected country reduces almost to zero. Paper
money becomes worthless and people start trading either in gold
and silver or sometimes even use the old barter system of
commerce. Two worst examples of hyperinflation recorded in world
history are of those experienced by Hungary in year 1946 and
Zimbabwe during 2004-2009 under Robert Mugabe's regime.
Causes of Inflation
1. Demand-Pull Inflation: Demand-Pull Inflation also known as Excess
Demand Inflation takes place when aggregate demand for a good
or service outstrips aggregate supply. In other words, when
aggregate demand for all purposes- consumption, investment and
government expenditure-exceeds the supply of goods at current
prices then it is called Demand-Pull Inflation. Demand-Pull inflation
gives rise to a situation often economists describe as “Too much
money chasing too few goods”.
2. Cost-Push Inflation: When prices rise due to growing cost of
production of goods and services then it is known as Cost-Push
Inflation. Cost-push inflation also came to known as “New Inflation”
is determined by supply-side factors mainly caused by higher wage-
push, Profit-Push and higher costs of raw materials.
Causes of Inflation
3. Scarcity Inflation: Scarcity inflation occurs due to hoarding by
unscrupulous traders and black marketers so as to create an
artificial shortage of essential goods like food grains, kerosene,etc.
with an intension to sell them only at higher prices to make huge
profits.
4. Structural Inflation: Structural inflation is that type of inflation
often experienced in developing countries which is caused by
structural rigidities such as agricultural bottlenecks, resource
constraints bottlenecks, foreign exchange bottlenecks, physical
infrastructural bottlenecks etc.
Multiplier
 Aggregate demand is the total amount of goods demanded in
the economy.
𝑨𝑫 = 𝑪 + 𝑰 + 𝑮 + 𝑵𝑿
 Output is at its equilibrium level when the quantity of output
produced is equal to the quantity demanded.

𝒀 = 𝑨𝑫 =𝑪+ 𝑰+ 𝑮+ 𝑵𝑿
𝑰𝑼 =𝒀 – 𝑨𝑫
 where IU is unplanned additions to inventory.
• The equilibrium value of
income
E E =Y

planned E =C +I +G+
E<Y NX
expenditure
E>Y

Y0 Ye Yincome,
1
output, Y
E>Y: depleting inventories: must produce more.
E<Y: accumulating inventories: must produce less.
slide 23
An increase in government
purchases
E

Y
=
At Y1, E =C +I +G2+NX

E
there is now an
unplanned drop E =C +I +G1+
in inventory… NX


G Looks like
…so firms Y>G
increase output,
and income Y
rises toward a
new equilibrium E1 = Y1 Y E2 = Y2
 An increase in any exogenous variable, for example
govt. expenditure
E

Y
=
At Y1, E =C +I

E
there is now an +G2
unplanned drop E =C +I
in inventory… +G1


G Looks like
…so firms Y>G
increase output,
and income Y
rises toward a
𝟏
new equilibrium ∆𝒀= ∆𝑮
𝟏−𝒄

slide 25
Inflationary Gap
An inflationary gap is a macroeconomic concept that describes the difference
between the current level of real gross domestic product (GDP) and the GDP
that would exist if an economy was operating at full employment.

Key points to remember about inflationary gaps:

 It occurs when actual GDP exceeds potential GDP. This means the
economy is overheating and producing beyond its sustainable capacity.
 It leads to inflation. The increased demand and limited supply cause prices
to rise.
 It's a sign of an expanding economy. While some growth is good, an
inflationary gap indicates unsustainable growth that can lead to economic
instability.
Inflationary Gap
Y

Y
=
E =C +I +G2

E
Inflationary Gap H
T E =C +I +G1

YF Y2 X
Inflationary Gap
Deflationary Gap
In simpler terms, it's when the economy is producing less than it potentially
can with all its resources fully utilized. This leads to decreased demand for
goods and services, which can cause prices to fall and deflation to occur.

Key points to remember about deflationary gaps:

•It occurs when actual GDP is below potential GDP. This means the
economy is underperforming and not using its resources efficiently.
•It can lead to deflation. The decreased demand can cause prices to fall,
leading to deflation.
•It's a sign of a struggling economy. A deflationary gap indicates economic
weakness and can lead to job losses and reduced investment.
Deflationary Gap
Y

Y
=
E =C +I +G2

E
Deflationary Gap
H
T E =C +I +G1

Y1 YF X
Unemployment
Labour Force

The labor force is defined as all the civilian workers along with the
unemployed individuals who are actively looking for work.

Conditions to be in labour force :

1. Individuals must be above 16 years.
2. Physically and mentally fit for work.
3. Ready to work in existing wage rate.
4. Actively searching for job.

Despite fulfilling this conditions, if a person doesn’t have any job for
more than four weeks he will consider as unemployed.
Types of Unemployment

Demand deficient unemployment

Demand deficit unemployment is the biggest cause of unemployment that
typically happens during a recession. When companies experience a reduction
in the demand for their products or services, they respond by cutting back on
their production, making it necessary to reduce their workforce within the
organization. In effect, workers are laid off.

Frictional unemployment
Frictional unemployment refers to those workers who are in between jobs. An
example is a worker who recently quit or was fired and is looking for a job in an
economy that is not experiencing a recession. It is not an unhealthy thing
because it is usually caused by workers trying to find a job that is most suitable
for their skills.
Types of Unemployment

Structural unemployment
Structural unemployment happens when the skills set of a worker does not
match the skills demanded by the jobs available, or alternatively when workers
are available but are unable to reach the geographical location of the jobs.
An example is a teaching job that requires relocation to China, but the worker
cannot secure a work visa due to certain visa restrictions. It can also happen
when there is a technological change in the organization, such as workflow
automation that displaces the need for human labor.

Voluntary unemployment
Voluntary unemployment happens when a worker decides to leave a job
because it is no longer financially compelling. An example is a worker whose
take-home pay is less than his or her cost of living.
Stagflation
Introduction
Stagflation is an economic cycle characterized by slow growth and a
high unemployment rate accompanied by inflation.

Causes of Inflation
There is no consensus among economists on the causes of stagflation.
Each economics school offers its own view on its origins. However, two
main theories may be derived:

 Adverse Supply shock and

 Poor economic policies.
Causes of Inflation

 The supply shock theory suggests that stagflation occurs when an economy
faces a sudden increase or decrease in the supply of a commodity or service
(supply shock), such as a rapid increase in the price of oil. In such a situation,
prices surge, making production costlier and less profitable, thus slowing
economic growth.

 A second theory states that stagflation can be a result of a poorly made

economic policy. For example, the government can create a policy that
harms industries while growing the money supply too quickly. The
simultaneous occurrence of these policies can lead to slower economic
growth and higher inflation.
AD-AS Model
Introduction

Aggregate demand is the total demand for goods and services in an economy,
while aggregate supply is the total supply of goods and services in an
economy. These terms are used to describe the supply and demand for an entire
country.

 The total amount of money spent on domestic goods and services in an

economy.
 The total quantity of goods and services consumed in an economy at all
possible price levels.
Introduction
Aggregate demand is the total demand for goods and services in an
economy.

 The total amount of money spent on domestic goods and services in an

economy.
 The total quantity of goods and services consumed in an economy at all
possible price levels.

Aggregate supply is the total supply of goods and services in an economy.

 The total quantity of goods and services produced in an economy at all

possible price levels
 The total amount of goods and services that producers are willing to sell to
consumers
Aggregate demand Curve

AD curve shows the negative P

relationship between AD and
price level.

AD
Y
Determinants of Aggregate Demand (AD)

1.Consumption (C): Influenced by income, consumer confidence, interest

rates, and wealth.
2.Investment (I): Affected by business confidence, interest rates, taxes,
and credit availability.
3.Government Spending (G): Driven by fiscal policies, public investment,
and welfare programs.
4.Net Exports (X - M): Influenced by exchange rates, global demand, and
trade policies.
5.Monetary & Fiscal Policies: Lower interest rates and tax cuts boost AD.
Shifts in Aggregate demand Curve

P An increase in
If central bank increases or the money
decreases money supply of its supply shifts the
economy it will change the AD curve to the
purchasing power of the right.
individual so do the aggregate
demand.
As a result the AD will inward
or outward. AD
AD 2

1
Y
Aggregate Supply Curve

AS curve shows the positive P

relationship between AS and AS
price level.

Y
Determinants of Aggregate Supply (AS)

•Input Costs: Labor wages, raw materials, and energy prices.

•Technology: Productivity improvements and innovation.
•Labor Market: Workforce size, skills, and regulations.
•Government Policies: Taxes, subsidies, and business regulations.
•Natural Factors: Climate, natural disasters, and resource availability.
Shifts in Aggregate Supply Curve

AS AS
Due to any shock in the P
economy like decrease in
production cost or good
harvesting of raw materials AS
can shifts to the right.

Y
IS-LM Model
Introduction to IS
IS curve shows the different combinations of interest rate (r) and output (Y)
that result in goods market equilibrium.

The equation for the IS curve is:

𝒀 =𝑪+ 𝑰 ( 𝒓 )+ 𝑮
Deriving the IS curve
E E =Y
E =C +I (r2 )+G

r  I E =C +I (r1 )+G

 E I

 Y Y1 Y2 Y
r
r1

r2
IS
Y1 Y2 Y
Understanding the IS curve’s slope

• The IS curve is negatively sloped.

A fall in the interest rate motivates firms to increase investment spending,

which drives up total planned spending (E ).

To restore equilibrium in the goods market, output (a.k.a. actual

expenditure)must increase.
Fiscal Policy and the IS curve
• We can use the IS-LM model to see how fiscal policy (G
and T ) can affect aggregate demand and output.
• Let’s start by using the Keynesian Cross to see how fiscal
policy shifts the IS curve…
Shifting the IS curve: G
E E =Y E =C +I (r )+G
At any value of r, G 1 2

 E  Y E =C +I (r1 )
+G1
…so the IS curve
shifts to the
right. Y1 Y2 Y
The horizontal r
distance of the r
1

IS shift 1
equals Y
Y  G IS2
1 MPC IS1
Y1 Y2 Y

slide 52
Introduction to LM
LM curve shows the different combinations of interest rate (r) and output (Y)
that result in money market equilibrium.
Now let’s put Y back into the money demand function:

M P
d
 L(r ,Y )
The LM curve is a graph of all combinations of r and
Y that equate the supply and demand for real money
balances.
The equation for the LM curve is:
M P L(r ,Y )
Deriving the LM curve

(a) The market for

(b) The LM curve
real money
r balances r
LM

r2 r2

L (r ,
r1 Y2 ) r1
L (r ,
Y1 )
M1 M/P Y1 Y2 Y
P
Understanding the LM curve’s slope
• The LM curve is positively sloped.
• Intuition:
An increase in income raises money demand.
Since the supply of real balances is fixed, there is now excess
demand in the money market at the initial interest rate.
The interest rate must rise to restore equilibrium in the money
market.

slide 55
How M shifts the LM curve
(a) The market for
(b) The LM curve
real money
r balances r
LM
2
LM1
r2 r2

r1 r1
L (r , Y1 )

M2 M1 M/P Y1 Y
P P

slide 56
The IS-LM equilibrium
The short-run equilibrium is the r
combination of r and Y that LM
simultaneously satisfies the
equilibrium conditions in the
goods & money markets:

Y C (Y  T )  I (r )  G IS
M P L(r ,Y ) Y
Equilibrium
interest Equilibrium
rate level of
income
An increase in government purchases
1. IS curve shifts right r
1 LM
by G
1 MPC
causing output & r2
income to rise. 2.
r1
2. This raises money
1. IS2
demand, causing
the interest rate to IS1
rise… Y
3. …which reduces Y1 Y2
investment, so the final 3.
increase in Y 1
is smaller than G
1 MPC
Monetary Policy: an increase in M
1. M > 0 shifts r
LM1
the LM curve down
(or to the right) LM2

2. …causing the r1
interest rate to r2
fall
3. …which IS
increases Y
Y1 Y2
investment,
causing output &
income to rise.
The End