MACROECONOMICS

HANDOUTS

Importance of National Income

The computation of national income is one of the very important statistics for a country. It has
several important uses and therefore there is a great need for their regular preparation.

The following are some of the important uses of national income statistics:

1) Level of Economic Welfare

The national income estimate reveals the overall performance of the country during a
given financial year. With the help of this statistics the per capita income i.e. the income
earned by every individual is calculated. It is obtained by dividing the total national
income by the total population. With this we come to the level of economic welfare in
terms of its standard of living.
2) Rate of Economic Growth
With the help of national income statistics, we can know whether the economy is
growing or declining. In simple words it helps us to know the conditions of a country
economy. If the national income is growing over a period of year it means that the
economy is growing and if the national income has reduced as compares to the
previous it reveals that the economy is detraining. Similarly, the growing per capita
income shows an increasing standard of living of the people which is a positive sign of a
nations growth and vice versa.
3) Distribution of Wealth
One of the most important objectives that is achieved after calculating national income
is to check its distribution among different categories of income such as wages, profits,
rents and interest. It helps to understand that how well the income is distributed
among the various factors of the economy and their distribution among the people as
well.
4) Ease in Planning
Since the national income estimates also contain the figures of saving, consumption and
investment in the economy so it proves to be a valuable guide to economic policy
relating to planning and active government intervention in the economy. The estimates
are used as a data for future planning also.
5) Formation of Budget
Budget is an effective tool for planning and control. It is prepared in the light of the
information regarding consumption, saving, and investment which are all provided by
the national income estimates. Further we can assess and evaluate the achievements or
otherwise of the development targets laid down in the plans from the changes in
national
income and its various components.
6) Conclusion
 Thus we may conclude that national income statistics chart the movement of a country
from depression to prosperity its rate of economic growth and its standard of living in
comparison with rest of the world.
CONCEPTS OF NATIONAL INCOME
There are different concepts of National Income, namely; GNP, GDP, NNP, Personal Income and
Disposable Income.
1) Gross Domestic Product (GDP): GDP at market price is sum total of all the goods and
services produced in a country during a year within the domestic territory
2) Gross National Product (GNP): GNP at market price is sum total of all the goods and
services produced in a country during a year and net income from abroad. GNP is the sum of
Gross Domestic Product at Market Price and Net Factor Income from abroad
3) GDP at Market Price: If we multiply the total output produced in one year within the
domestic territory, by their ‘Market Prices’, we get GDP at market price.
4) GNP at Market Price: If we multiply the total output produced in one year within the
domestic territory as well as outside the country, by their ‘Market Prices’, we get GNP at market
price.
5) Gross Domestic Product at Factor Cost : The gross domestic product at factor cost is the
difference between gross domestic product at market price and net indirect taxes.
6) Gross National Product at Factor Cost: The gross national product at factor cost is the
difference between gross national product at market prices and net indirect taxes.

Private Income
Central Statistical Organization defines Private Income as “the total of factor income from all
sources and current transfers from the government and rest of the world accruing to private
sector” or in other words the private income refers to the income from socially accepted source
including retained income of corporation.
NI+ Transfer payment + Interest on public debt +Social security + Profit and Surplus of
public enterprises = Private Income

Personal Income
Prof. Peterson defines Personal Income as “the income actually received by persons from all
sources in the form of current transfer payments and factor income. In other words, Private
Income is the Total income received by the citizens of a country from all sources before direct
taxes in a year. PI = Private Income + Undistributed Corporate Profits – Direct Taxes

Disposable Income
Prof. Peterson defined Disposable Income as “the income remaining with individuals after
deduction of all taxes levied against their income and their property by the government.”
Disposable Income refers to the income actually received by the households from all sources.
The individual can dispose this income according to his wish, as it is derived after deducting
direct taxes.
DI = Personal Income - Direct taxes – Miscellaneous receipt of the government.
 Methods of calculating National Income
Value added or production or output approach
1) The output approach focuses on finding the total output of a nation by directly finding the
total value of all goods and services a nation produces.
2.) Problem of Double counting: Because of the complication of the multiple stages in the
production of a good or service, only the final value of a good or service is included in the total
output. This avoids an issue often called 'double counting', wherein the total value of a good is
included several times in national output, by counting it repeatedly in several stages of
production. In the example of meat production, the value of the good from the farm may be
Rs10,
then Rs 30 from the butchers, and Rs 60 from the supermarket. The value that should be
included in final national output should be Rs 60, not the sum of all those numbers, Rs 90. The
values added at each stage of production over the previous stage are respectively Rs 10, Rs 20,
and Rs 30. Their sum gives an alternative way of calculating the value of final output.

Income method
The income approach equates the total output of a nation to the total factor income received by
residents or citizens of the nation. The main types of factor income are:
• Employee compensation/ salaries & wages (cost of fringe benefits, including
unemployment, health, and retirement benefits);
• Interest received net of interest paid;
• Rental income (mainly for the use of real estate) net of expenses of landlords;
• Royalties paid for the use of intellectual property and extractable natural resources.
 Corporate Profits

Expenditure or Consumption method

The expenditure approach is basically an output accounting method. It focuses on finding the
total output of a nation by finding the total amount of money spent. This is acceptable, because
like income,
the total value of all goods is equal to the total amount of money spent
on goods GDP= C+I+G+(X-M) Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services
Note: (X - M) is often written as XN, which stands for "net exports"
 KEYNESIAN THEORY OF EMPLOYMENT
1) Keynes has strongly criticized the classical theory in his book ‘General Theory of
Employment, Interest and Money’. His theory of employment is widely accepted by
modern economists. Keynesian economics is also known as ‘new economics’ and
‘economic revolution’. Keynes has invented new tools and techniques of economic
analysis such as consumption function, multiplier, marginal efficiency of capital,
liquidity preference, effective demand, etc.
2) In the short run, it is assumed by Keynes that capital equipment, population,
technical knowledge, and labor efficiency remain constant. That is why, according to
Keynesian theory, volume of employment depends on the level of national income and
output. Increase in national income would mean increase in employment. The larger
the national income the larger the employment level and vice versa. That is why, the
theory of Keynes is known as ‘theory of employment’ and ‘theory of income’.

Keynes Theory can be explained as:

1) Effective Demand: According to Keynes, the level of employment in the short run
depends on aggregate effective demand for goods in the country. Greater the aggregate
effective demand, the greater will be the volume of employment and vice versa.
According to Keynes, the unemployment is the result of deficiency of effective demand.
Effective demand represents the total money spent on consumption and investment.
The equation is:
Effective demand = National Income (Y) = National Output (O)
The deficiency of effective demand is due to the gap between income and consumption.
The gap can be filled up by increasing investment and hence effective demand, in order
to maintain employment at a high level.
2) According to Keynes, the level of employment in effective demand depends on two
factors: (a) Aggregate supply function, and (b) Aggregate demand function.

(a) Aggregate supply function:

1. According to Dillard, the minimum price or proceeds which will induce
employment on a given scale, is called the ‘aggregate supply price’ of that
amount
of employment.
2. If the output does not fetch sufficient price so as to cover the cost, the
entrepreneurs will employ less number of workers.
3. Therefore, different numbers of workers will be employed at different supply
prices.
4. Thus, the aggregate supply price is a schedule of the minimum amount of
proceeds required to induce varying quantities of employment.
5. We can have a corresponding aggregate supply price curve or aggregate supply
function, which slopes upward to right.

(b) Aggregate demand function:

 1. The essence of aggregate demand function is that the greater the number of
workers employed, the larger the output. That is, the aggregate demand price
increases as the amount of employment increases, and vice versa.
2. The aggregate demand is different from the demand for a product. The aggregate
demand price represents the expected receipts when a given volume of
employment is offered to workers.
3. The aggregate demand curve or aggregate demand function represents a
schedule
of the proceeds of the output produced by different methods of employment.

Significance of Keynesian Theory:

1. Keynes has given a new approach, i.e., Macro-approach to the field of
economics. His theory has several names: theory of income and
employment, demand-side theory, consumption theory, and macro-
economic theory. In fact, he has brought about a revolution in economic
analysis, often known as ‘Keynesian Revolution’.
2. Keynes’ theory has completely demolished the idea of full-employment
and forwards the idea of under-employment equilibrium. He states that
employment level in the economy can only be increased by increasing
investment.
3. The new economic tools and techniques developed by Keynes have
enabled the today’s economists to draw correct conclusions on the
economic situation of a country. Such tools are consumption function,
multiplier, investment function, liquidity preference, etc.
4. Keynes has integrated the theory of money with the theory of value
and output.
5. Keynes has first time introduced a dynamic economic theory, in order to
depict more realistic situation of the economy.
6. He also states the reasons of excess or deficiency of aggregate demand
through inflationary and deflationary gap analysis.
7. Keynes’ theory is a general theory and therefore, can be applied to all
types of economic systems.
8. Keynes influenced on practical policies and criticized the policy of
surplus budget. He advocated deficit financing, if that sited the economic
situation in the country.
9. Keynes has emphasized on suitable fiscal policy as an instrument for
checking inflation and for increasing aggregate demand in a country. He
advocated extensive public work programs as an integral part of
government programs in all countries for expanding employment.
10. He advised several monetary controls for the central bank, which in turn
will act as the instrument of controlling cyclical fluctuations.
11. Keynesian theory has played a vital role in the economic development of
less developed countries.
 12. He rejected the theory of wage-cut as a means of promoting full-
employment.

SAYS LAW OF MARKET

1) Say’s Law is the foundation of classical economics. Assumption of full employment

as a normal condition of a free market economy is justified by classical economists by a
law known as ‘Say’s Law of Markets’. It was the theory on the basis of which classical
economists thought that general over-production and general unemployment are not
possible.
2) Say’s law states that the production of goods creates its own demand

The basic consumptions of says law are :

a Perfectly competitive market and free exchange economy.
b Free flow of money incomes. All the savings must be immediately invested and all
the income must be immediately spent.
c Savings are equal to investment and equality must bring about by flexible interest
rate.
d No intervention of government in market operations, i.e., a laissez faire economy,
and there is no government expenditure, taxation and subsidies.
e Market size is limited by the volume of production and aggregate demand is equal
to aggregate supply.
f It is a closed economy.

The Says law has the following implications:

1. Production creates market (demand) for goods: when the producer obtained the
various inputs to be used in the production process they generate the necessary
income.
2. Barter system is its basis: in its original form the law is applicable to a barter
economy where goods are ultimately sold for goods. Therefore, whatever produced
is
ultimately consumed in the economy.
 3. General over production is impossible: if the production process is continuing
under normal condition, then there will be no deficiency for the producer in the
market. According to say, work being unpleasant no person will work to make a
product unless he wants to exchange it for some other product which he desires
therefore, the very act of supplying goods implies a demand for them. In such a
situation there cannot be general overproduction because the supply of goods will
not exceed demand as a whole.
4. Saving investment Equality: Income occurring to the factors owners in the form of
rent, wages and interest is not spent on consumption but some proportion out of it
is
saved which is automatically invested for further production.
5. Rate of interest as a determinant factor: If there is any gap between saving and
investment, the rate of interest brings about the equality between two
6. Flexibility between interest and wage rate: The theory assumes the part of
income
is saved and available for investment. If at any point of time saving is more than
investment, the rate of interest will fall, which will result in low savings and more
investments. At a lower rate of interest, household will like to save less, where as
producers will like or invest more and economy will be in equilibrium. If there are
unemployed persons in an economy, wage rate will fall. This will induce
entrepreneurs to demand more labor. Ultimately all labor will be absorbed. The
economy will be in full employment equilibrium.
This view suggests that the key to economic growth is not increasing demand, but
increasing production. Say’s views were expanded on by classical economists, such
as James Mill and David Ricardo.
 Value of Money
* If currency and checkable deposits have no intrinsic characteristics giving them value and if they are
not backed by gold or other precious metal, then why are they money?
1. Acceptability
Currency and checkable deposits are money because they are accepted as money.
2. Legal Tender
- Anything that government has decreed must be accepted in payment of a debt.
Currency has been designated as Legal Tender by government. This means paper currency must be
accepted in the payment of a debt or the creditor forfeits both the privilege of charging interest and
the right to sue the debtor for nonpayment.
3. Relative Scarcity
The value of money, like the economic value of anything else, is a supply and demand phenomenon.
Money derives its value from its scarcity relative to its utility. The utility of money lies in its unique
capacity to be exchanged for goods and services, now or in the future.
The economy’s demand for money thus depends on its total dollar volume of transactions in any
period plus the amount of money individuals and businesses want to hold for possible future
transactions. With a reasonable constant demand for money, the supply of money will determine the
value or “purchasing power” of the monetary unit.
Inflation
- Is generally used to mean any sustained or continuing increase in prices.

Undesirability of Inflation

 Economic plans and policies are intended to improve the standards of living of
people. It means, among other things, that the people should be able to buy
more given the incomes that they have. It means that the people should be able
to buy better quality food, live in better houses, send their children to school,
among other things. Inflation, however, negates the economic objective of
improving the quality of life of people.
1. People who have fixed incomes.
 With increased prices, people who belong to this group would lose out because the
income they receive now would be able to buy less than before. Thus, their economic
welfare is diminished.
2. Creditors lose out during Inflation
 The reason they lose out is because the fixed amount of principal and interest they lent
out would now be valued less. If interest rate charged by the creditors is 12 percent but
the inflation rate is 20 percent, the net loss of the creditor would be 8 percent.

Inflation Gainers
1. People who have flexible incomes
 For example, businessmen would gain more if prices of commodities they produce and
sell go up.
So long as there is a demand for their product, their products would be sold. At higher
prices, their income would obviously register a bigger gain.
2. Speculators
 These are the perceptive and lucky individuals who are able to buy goods at cheaper
prices and then sell them later at higher prices because of inflation. Among the goods
that are traded in this category would be groceries, appliances, land, jewelry, etc.
3. Debtors
 Usually gain because the value of the money they borrowed before would now have
more value. For example, a man borrows ₱10,000 to buy an appliance. If inflation occurs
after that, the cost of that appliance would now be more than ₱10,000. Other gainers
would be the people who built their houses in the 70’s through housing loans with the
 SSS or the GSIS. Obviously, the worth of their houses and lots are much more now than
before.

Types of Inflation

1. Demand-Pull Inflation
 One type of inflation is called demand-pull inflation. Inflation is said to be demand-pull if
those who buy goods and services desire to purchase goods and services greater than
what the economy can produce. In other words, excess demand for commodities would
tend to push prices up.
 When there is an increased in demand, prices will tend to go up and output of goods and
services would also tend to increase. However, if the economy is already at full
employment, the effect of the increase in demand would only be translated through
increase in prices.
 demand-pull inflation occurs under many different circumstances.
The first of these has to do primarily with Money.
Without an increase in supply of money, no major inflation can last very long.
Excessive supply of money in the circular flow would invariably lead to upward movement
of prices.

2. Cost-Push Inflation
 is the type of inflation where increases in the costs of production push
prices up.
 Second factor for Cost-Push Inflation could be the demand for higher
wages by labor unions. We would expect that if labor unions had the
power to drive up money wages., they would have done so, stopping only
at the point where higher wages would produce an unacceptable level of
unemployment. If firms accede to the demand for higher wages, they have
no recourse but pass on the costs to the consumers through higher prices.
 Third could be the monopolies in society. We would expect monopolies to
increase their markup as much as would be acceptable and profitable.
Powerful monopolistic firms can raise their prices disproportionately when
wages are raised or when other cost of inputs increase.
 Fourth factor can be provided by the devaluations we have had.
Devaluation of the peso makes the peso worth less in relation to, say, the
dollar. When this happens, it would be more expensive to import goods.
Since our economy is a highly import-dependent economy, higher cost of
imports means higher prices.

Measurement of Price Increases

1. Consumer Price Index (CPI)
 Is the most popular and the most used measure as it reflects what happens to the
living standards of most of us, the consumers.
 Is intended to provide a general measure of average monthly and annual changes in
the retail prices of commodities commonly bought by consumers in the Philippines,
covering all income households.
2. Retail Price Index
 Is designed to measure monthly changes of the prices at which retailers dispose of their
goods to consumers and end-users.
The term “Retail Price” refers to the price at which sellers accept orders for spot or earliest
delivery usually in small quantities.
3. Wholesale Price Index
 Measures monthly changes in the general price level of commodities that flow into
wholesale trade intermediaries in Metro Manila; hence, it measures price changes
during trade turnover.
4. Stock Price Index
 Serves as a measure of the changes in, and to trace the movement of the average prices
of company shares of stocks traded in the Makati and Manila Stock Exchanges.