Macro economics

Economic Variables

Thursday, October 29, 2020 6:35 PM

Basic concept of macroeconomics

Macroeconomics it’s the study of the economy as whole or totality .Subject matter
of macroeconomics are : national income aggregate demand aggerate supply money
banking . It concerns with issues like governments economic policy fiscal policy
national income trade cycle aggerate investment BOP theories of income and
investment

Closed economy: closed economy is an economy which does not keep any economic
relationship with other countries such economy does not interact with other
economies .Closed economy produces all the required things to become self-reliant .
it is also known as protectionist economy. Closed economic system bring into action
on basic of nationalism and patriotism.

Features of the close economy
→ Closed economy has no relation with the rest of the world
→ Closed economy neither borrows or takes foreign aid nor lends or gives aid to

other countries
→ The citizens of closed economy are not allowed to go to and work to the other

countries
→ The GDP and GNP of closed economy are equal as NFIA is zero
→ A closed economy calculates in GDP as GDP=C+I+G

Open economy
Open economy is an economy in which there is freedom of interaction with
other countries. Such economy develops business relationship with other
countries on the basis of comparative cost . Economy of household , business
firm , government and foreign sectors are the sectors of open economy .

Features of open economy

 An open economy has internal relation with the rest of the world in
economic and other aspects

 It imports and exports goods and services from the words markets
 Open economy borrows or take foreign aid and grants or provides aid to other

countries

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countries

 The citizens of open economy move to other countries and foreigners are
allowed to work in the nation

 The values of GDP and GNP are different in open economy due to the presence of

NFIA

 An open economy calculates its GDP as

difference between open and close economy book page 137

macroeconomic variables

macroeconomic variables means the variables which show the economic
condition of countries in totality .Macroeconomic variables helps to
compare different economy .It sketches roadmap for development and
diagnose the problem to improve the health of economy .There are two
type of microeconomic variables

1) Real sector variables
2) Monitory sector variable

Real sector variables
1) Total output and productivity : total output is the market value of goods an service

produce in a year by a country . Productivity refers the capacity of production of
goods and services .Total out put productivity shows the condition of nation income
and its capacity .
2) Total consumption saving & investment: consumption of goods and services show
the status of material well fare and living standards of people. Saving and
investment shows the status of development because investment is possible due to
saving . Development is he out come of investment.
3) Aggregate demand and supply: aggregate demand and supply determine the
employment .It determines productivity of factors of production and income.
4) Employment and unemployment:- Employment refers to the opportunity to work
for labors ,labors skill knowledge and role of production .Employment shows the
living standard .So, employment and unemployment is the important
microeconomic variable.
5) Poverty:- in generals sense , poverty refers to the inability of people to fulfil their
basic needs. Poverty also refers lack of access to decision making and public poverty.
6) Government’s income expenditure and public borrowing : It shows economic
operation and development of the country because government income
expenditure and pubic borrowing reflect the strength priorities , responsibility to
wards public status of government .

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wards public status of government .
7) Business cycle: - ups and down of economic activities of market is called business

cycle. It includes prosperity recession, depression an recovery . Study of business
cycle inform the condition of economy and required policy to operate. So business
cycle is one of the important macroeconomic variable.

Monitory sectors variable
I) Money supply: total amount of money circulation and total money saving and

deposited in bank is called money supply .If money supply is increase and decrease ,
in interest rate then it increase investment. This situation increase opportunity of
employment which leads the county to posterity. Otherwise increase in money
supply creates inflation which is great burden to poor. So money supply is necessary
to manage as major variable.
II) Inflation an deflation : Inflation is the continuous rise in general price level . Inflation
causes fall in the purchasing power of money and living standard .Deflation is the
continuous fall in price level which cause scarcity of money aggregate demand.
III) Interest rate : interest is the price paid for use of capital . Rate of interest and
investment have inverse relation .Rate interest and investment have positive
relation .So, interest rate is the macroeconomic variable .
IV) Balance of payment : balance of payment means the overall transaction of country
with rest of all foreign country . It shoes the import and export of goods an services
of country .Hence evaluation of BOP shows the condition of country .So BOP is a
macroeconomic variable.
V) Foreign exchange and its reversed : the exchange rate directly affect the quantity of
import and export .If the quantity of reserve of foreign exchange is less than
required amount it badly affect the economy .So foreign exchange is one of the
major macroeconomic variable.

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Unit 8 8:49 PM

Tuesday, January 19, 2021

Unit 8 ( national income accounting )
National income accounting refers to the science of measuring the aggregate output. National
income gives the idea about output income and expenditure of a country. So, it provides basis
of formulating planning, analyzing economic structure, comparing performance of different
countries .Hence national income is one of the macroeconomic variable. National income can
be measured by
1. production method
2. income method expenditure method
3. expenditure method

Mentions different concepts of national income

1. Gross domestic product(GDP): GDP is monetary or value of market value of all final goods
and services produced within the domestic territory of a county during year

so GDP=

or GDP=

2. Gross National Product(GNP):-Gross national product (GNP) is the market value of all
final goods and services produced during a year by domestically owned resource or
factor
GNP= GDP+ NFIA
where
NFIA=net factor income from the abroad

3) Net national product (NNP): NNP is equal to gross national product t minus
depreciation . Depreciation is the consumption of fixed capital assets or fall in the value
of fixed capital

4) National Income: The sum of income received by all factors of product in the form of
rent ,wages , interest and profit of a nation is called national income

NI= NNP- indirect taxes +subsides

5) Personal income(PI) : personal income is the total money income received by
individual and household of a country from all possible sources before direct taxes.

6) disposable income: the income left after the payment of direct taxes from personal
income is called disposable income
DI=PI- direct taxes ie consumption + saving

7) Per capita income: the average income of the individual of a country is called per capita

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7) Per capita income: the average income of the individual of a country is called per capita
income

per-capita income of 2021=

Difference between the GDP and GNP (book page 147)

Features of GDP
1) GDP is the money value of all final goods and services
2) GDP is the value of only final goods and services
3) The value of final goods and services is calculated at the current market prices
4) GDP is a flow and not a stock variable
5) GDP includes only those goods which have market value and brought in the market for

sale

6) Transfer payment like pension are not include in GDP
7) GDP does not include capital gain

Distinguish between GDP and GNP
book page 151

Distinguish between Nominal and Real GDP
(book page 154)

GDP deflator: The GDP deflator is a price index which measure the change in the overal
price of all newly produced final goods and services

It is calculated by

GDP deflator= .

Nominal GDP reflect both the price and quantities of goods and services that only the
quantities of goods produced .
So, rate of inflation=

What is national income? How is national income calculated under
expenditure method? Give an example

Meaning of national income(NI): The sum of income earned by all individuals of a country
with in one years is called national income .Alternately , national income is the also
defined as the sum of the income of the received by all the factors of production in the
form of rent wages interest and wage profit
Symbolically ,
National income = rent+ wage+ interest +profit
Expenditure method: Expenditure method is one of the method which is used to calculated
national income and produce of a country . This method measures the GDP and national

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national income and produce of a country . This method measures the GDP and national
income by adding all the expenditures made by different sectors of an economy on the
purchase of final goods and services in a year .In an open economy , total demand for
domestic output is made up of four components:
a) Consumption expenditure made by household sectors:
b) Investment expenditure on goods and services
c) Government expenditure on goods and services
d) Net foreign exports (X-M)
We use the following formula to calculate GDP and NI under this method

NI=NNP-indirect tax+subsidy
The component of NI under expenditure approach are briefly described here

a) consumption expenditure: consumption is the key activity of household sector. They
purchase different types of goods and services like basic goods (clothes foods etc.)
luxurious goods ( diamond vehicles ) durable and non-durable goods and various services.

b) Private investment expenditure (I)- private business sector invest a lot to purchase fixed and
variable factors of production like building machinery raw material labor vehicles etc. to
produce goods and services

c) Government expenditure _ Government makes expenditures on national defense law and
order social sector , development etc.

d) Net export ( X-M)- net export means the difference between export earnings and import
expenses

e) net factor income from abroad from abroad ( NFIA) _ NFIA is added to GDP to get GNP

f) Depreciation- the wear and tear value of machinery items is deducted from GNP to get NNP

g) Net indirect tax - the difference between indirect tax and subsidy

h) Numerical example: the calculation of national income by expenditure method has been
summarized with the help of following numerical example:

Heading of expenditure
Consumption expenditure
investment expenditure

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investment expenditure
government expenditure
Net exports
GDP
NFIA
GNP
depreciation
Net national expenditure
- Indirect tax
National income

Conclusion : A nation can use any one method i.e. income method or expenditure method or
product method to calculate the national income. The selection of appropriate method
depends upon the easy availability of data

How is national income calculated under income method? Give an example

Meaning of national income(NI): The sum of income earned by all individuals of a country with
in one years is called national income . Alternately the sum of the income received by all
factors of production of a nation is called national income . National income is the
macroeconomic variable which represent economy as a whole
In income method of measuring the national income , national income is calculated from
distribution side . The goods and services are produced by joint efforts of various factors of
production i.e. land, labor, capital and origination.

Gross Domestic Income= Rent+ wages+ interest + profit+net indirect taxes+
depreciation
Gross National income=GDI+NFIA
NNI=GNI-depreciation
NI=NNI- Net indirect taxes
The components of national income in the income approach
a) Wages and salaries: it includes the wages and salary received by the employees during

the year .It also include bonus tips overtime provident fund and other labor income.
b) Rent: It includes the rent of land factories houses machinery , apartment , vehicles etc.
c) Interest:- it includes the net interest income received by the people of the country
d) Profit:- it is the profit before tax which consists of dividends and undistributed profits
e) Net indirect taxes: Net indirect tax consist VAT sales tax excise duty custom duty
f) Net exports earnings : it is the difference export earnings and impot expense of goods

and services .

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Heading of expenditure Amount of income

Wages and salaries
Rent
Interest
Profit
Mixed income
Net indirect tax
depreciation

GDP
NFIA

GNP
depreciation

Net national income

- Indirect tax
+ subsidies

National income
it does not include transfer payment illegal income wind fall gain gift income from sales
of second hand goods

How is national income calculated under production method method? Give an example
Production method measures national income at the phase of production .This method
measures national income from the total sum of market values of all final goods and
services produced in economy. In this method economy is divided into three sectors They
are
1) Primary sectors : It includes agriproducts fishery forestry mining and others
2) Secondary : it includes activities of manufacturing and construction such as food
processing textiles iron and steel production , vehicles manufacturing etc
3) Tertiary sectors : it is the services sectors it includes banking heal education defense ,
administration , insurance transportation , communication information technology
so, GDP= total product of ( primary sectors + secondary sector+ tertiary sector)

or

GNP= GDP +NFIA
NNP= GNP-depreciation
NI = NNP+ net indirect tax
In production method national income can be calculated by two method
a) final product method : In this method , national income is estimated by finding
market value of all final goods and services in economy in a year

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market value of all final goods and services in economy in a year

b) value added method : in this method , the value added or value created at different
stages of production is counted for estimating national income . So according to this
method national income is the sum of total value added by different producing units of
a country in their production process value added is calculated by gross value added
Gross Value added = Value of output - cost of intermediate goods for example

Producer stage of production value of output Cost of gross value added

intermediaries

farmer wheat 100 - 100

miller flour 150 100 50

baker bread 250 150 100

Total Value added=250

Value added method may avoid the problem of double counting . The example of
national income from production method is given below

Heading of expenditure
primary sector
secondary sector
tertiary sector

GDP
NFIA
GNP
depreciation
Net national production
- Indirect tax
National income

Difficulties while measuring national income

Introduction : National income refers to the sum of income earned by all individual of a

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Introduction : National income refers to the sum of income earned by all individual of a
country from various possible sources generally within a year . There are many
difficulties in measuring the measuring the national income correctly . They are
1) 1) Non-monetary transaction : none of the major problems in national income
accounting is related with nonmonetary transaction for eg the service of housewife to
family members teaching own children self-consumption agricultural product etc.
Such activities are not included in national income which underestimates the GDP/NI
2) 2) Problem of double counting : National income accounting keeps the record of only
final goods and services . Bur It is very difficult to distinguish between final products
and intermediate goods . For eg- wheat is the final product for farmer but
intermediate goods for the mill. So there is possibility of double counting .
3) 3)Underground economy: different types of unrecorded and illegal activities takes
place in countries like Nepal for eg -smuggling prostitution , gambling etc since there
income are not included in the national income it underestimates the national income .
4) 4)Inadequate data: sufficient and reliable data are needed from various sectors to
calculate national income . But we do not have proper record keeping system . So it is
also a problem
5) 5)Petty production: there are large numbers of petty production such production do
not maintain any account .So , it is very difficult to include their production in national
income
besides these points illiteracy ignorance , transfer payment are other problems

circular flow note
Explain circular flow of income
in an income , Goods and services are produce by joint effort of land labor and capital
and origination. Goods and services are produced to consume .Firs produce the
goods .Household supply goods and services to household .Household consume these
goods and services to firm and firm convert into goods and services so there is
movement of production, income and resources between production and consume. this
movement is called circular flow of income .Circular flow I two sectored economy is
shown below

Fig : circular flow in two sector economy
The figure shows that Household sector supply factors of production ie land labor
capital and organization to business sector and receive rent wage interest
profit .Household sector spend their receipts for goods and services

in Modern age economy consist four sectors business sectors government sectors

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in Modern age economy consist four sectors business sectors government sectors
and foreign sectors .The circular flow income end expenditure in four sector economy
is shown in following figure
Ready for next chapter

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Unit 3.3 12:37 PM

Friday, February 26, 2021

money

Barter system:
An exchange system in which goods are exchange with other goods without using money is called
barter system for example exchanging rice and wheat
difficulty of barter system
1) Lack of double coincidence of wants
2) lack of common measure of value
3) problem of divisibility of goods
4) lack of store value
5) Difficulty in making deferred payment
6) Lack of transfer of value
7) accounting problem
8) limitation of trade and economic development

Meaning of money
Generally money refers to the currency consisting note and coins . However , in economic
money had taken in broad sense .Money is any things that is generally acceptable as a medium
of exchange , common measure and store value .
function of money
functions of money are broadly classified into three categories which are are explained below
1) Primary function
a) Medium of exchange: fist and fore most function of money is medium of exchange it is used in
buying and selling of goods and services .It facilities the transaction. Monet solve the problems
of batter systems, benefits geographical and human specializations
b) Measures of value: money also works as measure value. The value of every goods and services
can be express in form of monetary unit
2) secondary functions
a) Store of value : money serves as a store value .Money is the most liquid and convenient form
of assets. Individual can store wealth in the form of money, Money store value of goods and
services easily for the long period of time without cost and reducing value
b) standard of deferred payment: goods and services can be sold and purchase on credit because
money serve as a standard unit of future payment value of money is stable and durable
compare to goods and services . Saving investment, borrowing, interest are possible because of
this function of money
c) transfer of value: money is used to transfer value of goods and services from person to person,
time to time place to place without time cost and difficult . It help in mobility of resource
3) Contingent function:
a) Calculation of national income : national income /product is the measure of money value of
goods and services produce in an economy in a given period national income is impossible
because we cannot add the physical volume goods and services

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because we cannot add the physical volume goods and services
b) distribution of income: money facilities for the distribution of total income into various factors

of production such as wage for labor interest for capital ren t for land and profit for
entrepreneurs
c) liquidity of wealth : money works for the liquidity for any type of wealth like house apartment
land vehicle share etc.
d) basis of credit :on the basis of cash reverses, bank create credit to finance in trade and
industry . People trust on money and its future payment. So money is the basis of credit
features of money
1) General acceptability: money should be acceptable without any hesitation in exchange for
goods and services if all people cannot accept it as money transaction is not possible
2) Stability : unstable value makes trade difficult so it cannot be accept as standers of exchange . It
cannot win the faith of people
3) portability : money should be easier to carry otherwise it cannot be bring into payment
4) durability : money should be durable otherwise it lose its value an people can't store value for
long time
5) divisibility : money should be divisibility into smaller units without losing g its value l it makes
easy to pursue smaller units of commodity
6) Utility: money should have utility for its user . It should be use to satisfy want at any time at any
place
7) homogeneity : units of money must be homogeneous or units in terms of weight shape size
color otherwise it cannot be generally acceptable

Role of money

1) In production :saving investment , profit are possible due to money which plays vital role in
production.

2) Distribution: wage rent interest and profit are determined in term of money. Money have
features of divisibility and acceptability so money plays important role in the distribution of
national income

3) in consumption : people use money to buy goods and services . Consumer measure utility
derived from consumption of goods in terms of money . So consumers maximize the utility and
save the remaining income

4) Exchange : money possess the purchasing power so it facilities exchange and develop the trade
5) public fiancé: government collects revenue such as tax fee fines in form of money . Government

disburse the expenditure in form of money
6) Positive role money stimulate promote motivates facilities all economic activities related to

production distribution exchange and consumption . Modern world cannot move without
money . Money improve in living standard money help in economic development money
promote in national unity
7) Evil of money trade cycle, over production, crime ,social unrest, income inequality, illegal trade
are the negative role of money

forms ( types or kinds of money )

1) Commodity money :at first various commodity were used as the medium of exchange like
leather bones stone fish hook food grain which is calls commodity money

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leather bones stone fish hook food grain which is calls commodity money
2) Metallic money: The money which is made from metal is called metallic money .they are two

types
a) Standard or full bodies coins: money whose value is not reduce if it is melt i.e. face value is

equal to intrinsic value
b) token or subsidiary coin: money which are made from inferior metal like copper aluminum an

face value is more that intrinsic value
3) Paper money : paper money is made from paper . Government or central bank issues paper

money . Face value is more intrinsic value . It has unlimited legal tender .the types of paper
money are
a) Representative paper money: paper money which is issued by 100% reserved of gold or silver
can convert into gold or solver
b) convertible paper money : it can be convert into gold or silver at any time at the option of the
hold .But there may not be 100% backing of gold or silver
c) fiat money : fiat money is issued without any backing of gold or silver or other securities. Such
type of paper notes issues in some critical economic situation
4) bank money :The cheque drawn on current deposit is called bank money . Bank draft traveler's
cheque, credit card are also bank money .It is optional money because no none force to accept
this type of money

inflation

Inflation is defined as sustained or continuous rise in the genera price level of goods and
services in the economy . Inflation is fall in purchasing power of money .Inflation occur when
most price are rising by some degree across the entire economy
features of inflation
1) it involves rising trend in price level .
2) it is state of disequilibrium .
3) it is scarcity oriented .
4) it is dynamic in nature .
5) it is purely monetary phenomena .
6) inflationary price persistent and irreversible .
Consequence page 185

on the basis of factors causing inflation are two types of inflation
a) demand full inflation: due to excess demand for goods and services over limited supply then it

is called demand pull inflation it explain by following figure

Page 181
fig

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in figure, YF shows full employment level of real output as the demand for real output increase
from AD1 to AD2 and AD3 to AD4 then price level also rises from p1 to p2 and p3 to p4
respectively. It shows when AD increase price level also increase which is called demand pull
inflation.
Causes of demand pull inflation are
1) increase in money supply
2) Increase in total expenditure
3) increase in government expenditure
4) reduction in taxation
5) increase in export and decrees in import
6) Shortage of goods and services
7) increase in population

a) Cost push inflation : if inflation arises due to the increase in cost of production the it is called
cost push inflation it is explained by following figure

Book page 182

in figure DD is the aggregate demand curve which is unchanged. If cost of factors of production
like cost of raw material , interest ,wage of labor, increase then it increase cost of production
and supply curve as the cos to production increase the supply curve sift to AS to A2 and AS2 to
As 3 which increase the price from P1 to P2 and P2 to P3
Causes f cost pus inflation
1) increase in wage and salary
2) increase in profit margin by the producer
3) increase in factors cost by government
4) shortage of basic raw material
5) increase in rate of indirect tax
6) devaluation of currency
7) Some international causes

Deflation : deflation is the sustained continues fall in the genera price level of good and service
in the economy

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in the economy
causes of deflation
1) Rapid increase in industrial and agriculture product
2) decrease in wage and s salary
3) control of credit by centra bank
4) decrease in money supply by central bank

Critically explained fisher quantity theory of money
Introduction : An American economist Iviring fisher has developed a theory of money in 1911
AD , in his book " ;The purchasing power of money" .This theory is well known as fisher's
quantity theory of money . This theory explains that there is direct and proportional
relationship between money supply and value of money

Statement: According to fisher . " other things remaining the same , any given
percentage increase or decrease in money supply leads to same percentage increase
or decrease in price level but the value of money changes inversely with money
supply."

Assumptions
→ price level (P) is a passive variable.
→ The variable M,V,P,T are supposed to be independent
→ The volume of transaction (T) and velocity of circulation (V) are constant
→ There is full employment of resources in long run
→ Based on the concept of long -run

Explanation
Money is demanded for transaction.

Demand of money =PT

Money is exogenously carried out by the central bank

Supply of money = MV
for equilibrium,

Demand of money = supply of money

Where M= money supply , V= velocity of circulation ,
P= price level and T= volume of transaction
Later on fisher revised the equation including credit or bank money

where M1= volume of bank demand
V1 = velocity of bank deposits
As V and T are supposed to be constant , there is direct and proportional relation between M
and P .when money supply increase by 20% price level also increase by 20 % and vice versa
It is explain with the help of the following figure

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Book page 179

Fig

In the given figure money supply is shown on X-axis .Price level and value of money are
measured on the Y-axis . Figure "a" shows that when money supply increase price level also
increase and vice versa .But figure "b' shows that when money supply increase value of money
decrease and vice -versa
Criticism
a) Price level does not depend only upon money supply: Fisher's quantity theory assumes that
price level .but critics said that the price level depend upon various economic situation like
inflation deflation over and under production .Price level will be high in inflations and low in
deflation
b) Velocity of Money and transaction are not constant: this theory assumes that V and T are
constant but in reality volume of transaction changes when the number of buying and selling
increase the velocity of circulation also change . So V and T are not constant
C) This theory has ignored the demand for money : quantity theory says that price level is determined by

money supply .It has completely ignored the role of demand for money which is equally important to
determine the price level and other economic activities

D) Unrealistic assumption of the full employment and long run: this theory is only applicable in long
run .but most of the economic activities are short run in nature .It assumes full employment of
resources which is unrealistic and not possible

E) the variables like MVP and T are not independent: this theory assumes that three variables are

independent But in reality velocity is related with transaction volume price level depends upon transaction
etc.

What is inflation ? Explain its consequences.

Inflation is defined as sustained or continuous rise in the genera price level of goods and
services in the economy . Inflation is fall in purchasing power of money .Inflation occur when
most price are rising by some degree across the entire economy
consequences of inflation depends on the rate of inflations and absorption capacity of economy
the sequence of inflation are as follows
1) Decrees in value of money: inflation increase price level so it decrease in value of money it
results into higher expenditure and reduce saving
2) encourage hoarding of goods inflation decrease the value of money and too many money
chase too few goods so it increase hoarding of goods it create scarcity of goods in market
3) decrees the faith on domestic currency: inflation decrease the value of money and increase
price level .Due to this people lose faith on domestic currency

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price level .Due to this people lose faith on domestic currency
4) effects on economic growth: low rate of inflation stimulate output employment but high level

of inflation decrease saining investment and economic growth
5) harmful to fixed income group : due to inflation value of money decrease but income of fixed

income group does not increase so it harmful to them
6) other effects
a) change in stricture of production
b) decrease inflow of foreign capital
c) create uncertainties in economy people do not trust the government
d) export become expensive an import become cheaper
e) encourage hoarding ,speculation, corruption, black marketing

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