Macroeconomics Ganesh Kumar N.

Recent news paper reports

Loans to get costlier, RBI hikes key lending rates, PTI, Mumbai, September 16, 2011 Concerned over high inflation, the Reserve Bank on Friday raised key interest rates by 25 basis points, its 12th such hike since March, 2010. Bankers want RBI to halt policy rate hike, 4 Oct, 2011, IST, PTI Fearing a deterioration in asset quality and to fire up credit demand, some of the top bankers today urged the Reserve Bank to pause on its interest rate hike cycle.

Recent news paper reports

Manufacturing growth lowest in 30 months BS Reporter / New Delhi October 4, 2011. Fears of sub-8% economic growth for the third quarter in a row Current account deficit at 3.1% of GDP in Q1, BS Reporter / Mumbai October 1, 2011 Indias current account deficit hit 3.1 per cent of gross domestic product (GDP) at Juneend, conclusion of the first quarter. US Federal Reserve ramps up aid to economy with $400 billion stimulus Sept. 22, 2011, Reuters

Agenda
Course administration Overview of recent macroeconomic data/events Scope of macroeconomics Observed facts of economies Long run, short run, medium run models Business cycles

Course Evaluation
Component %age

Quizzes Mid Term

End Term Class Participation

20 35
35 10

US Recession & Recovery

20 07
10 12 0 2 4 6 8

-2

Ja n Ap r Ju l

O ct 20 08 Ja n Ap r Ju l O ct 20 09 Ja n Ap r Ju l O ct 20 10 Ja n Ap r Ju l

Overall Inflation - WPI

Scope of Macroeconomics

Macroeconomics is concerned with economy as a whole

Booms and recessions Consumption and investment Rate of inflation, wages Interest rates Unemployment Exports, Imports, Balance of payments Budget deficits Monetary policy and Fiscal policy

Observed facts about economies

Over long periods of time economy grows at steady rates Long run behaviour of the economy In some periods inflation rates are much higher 1970s; Medium run behaviour of the economy. In bad year unemployment rate rises short run behaviour year to year fluctuations Macroeconomcs help us undertsand the reasons for these observed facts

Long run: Growth theory

Actual Vs. Potential GDP
In growth theory, we focus on long term growth ignoring short term fluctuations booms and recessions.

GDP 80-81 prices

1950

1960

1970

1980

1990

Long run

Aggregate supply: amount of output an economy can produce given resources and technology Aggregate demand: Total demand for goods & services Economy with fixed productive capacity Output is determined by productive capacity, price level is determined by demand relative to the output

Economy with fixed productive capacity

P

AS

Level of output is determined by productive capacity Inflation (price rise) is generally due outcome due to changes in AD
Output, Y

AD

Y0

AS in the long run

P AS

Time

Output, Y

Short run

Fluctuations in output around the potential output Flat AS: Any level of output can be produced at a given price Underlying assumption is output does not affect prices in the short run Fluctuations in output are due to fluctuations in AD

Short run
P

AS

AD

Y0

Output, Y

Medium run
P

Positively sloping AS: When AD demand pushes output beyond sustainable level as per the long run model, firms start raising prices
Output, Y

AS

AD

Y0

Inflation unemployment trade off The Phillips curve

US Economy

Business cycles
Inflation, growth and output are related through business cycles It is a regular pattern of expansion (recovery) and contraction (recession) in economic activity around the path of trend growth

Business Cycles

GDP (80-81 prices)

Peak

Recession Recovery

Trough
1975 1976 1977 1978 1979 1980 1981 1982

A recession is a decline in output that persists for more than two consecutive quarters in a year.

Inflation and business cycle

Output gap =actual output potential output Inflation rates are positively related to output gap During recession inflation comes down During boom inflation rate picks up

National Income Accounts: Agenda

National income accounts

Circular flow of income, GDP, components of aggregate demand

Inflation & its measurement WPI, CPI, GDP deflator Nominal & real variables Data sources

GDP growth at current prices

Growth rate %
2006-07 07-08 ------------------16.3 16.1 2010-11 ---------20.3

In which year India has done better?

CIRCULAR FLOW OF INCOME

Consumption Exp.
Goods and Services Household Sector

FIRMS

Factor Services Payment of Factor Income (Wages, Profit, Interest, Rent)

Govt. Expenditure Investment

Govt
Capital Mkt Saving

Tax

Consumption Exp.
Goods and Services Household Sector

FIRMS

Factor Services Payment of Factor Income CIRCULAR FLOW OF INCOME

Gross Domestic Product (GDP)

GDP is the market value of all final goods and services produced within a country in a given period of time Measuring GDP

1. Product approach
2. Income approach 3. Expenditure approach

Nominal GDP (GDP at current Prices) Product approach

Items

2000 Price (Rs.) 20 30

Quantity

Market Value

Oranges Apples Total

10,000 5,000

2,00,000 1,50,000 3,50,000

2010

Items
Oranges Apples Total

Price (Rs.)
30 45

Quantity
20,000 10,000

Market Value

6,00,000 4,50,000 10,50,000

Real GDP (GDP at const. prices)

2010 Items Price (Rs.) 2000 Quantity 2010 Value at 2000 prices

Oranges
Apples Total

20
30

20,000
10,000

4,00,000
3,00,000 7,00,000

GDP and related indicators (Source: Economic Survey 2011)

GDP Rs. crore (current prices) GDP at Constant prices (2004-5) 2008-9 5582623 2009-10 6550271 2010-11 7877947

4162509

4493743

4879232

Growth rate % (current prices) Growth of GDP 9.6 (constant prices) %

06-07 07-08 08-09 09-10 10-11 ---------------------------------------------------16.3 16.1 12.0 17.3 20.3 9.3 6.8 8.0 8.6

Components of Aggregate demand

We look at different purposes for which domestically produced goods and services is demanded. Aggregate demand is the total demand for goods and services in the economy. AD= Consumption (C), Investment (I), Govt. expenditure (G), and net exports (NX). AD= C+I+G+NX Consumption Consumption is spending by household on food, clothing, education etc.

Components of Aggregate demand

Investment Investment (I) means addition to physical stock of capital. It also includes inventories with firms. Govt. expenditure (G) It refers to govt. purchases of goods and services. It includes such items as national defence expenditure, costs of roads, salaries of govt. employees etc.

Components of Aggregate demand

Net exports (NX) Spending by foreigners on domestic goods [ export, X] minus spending by domestic residents on foreign goods (import, Q) NX = X-Q

GDP deflator
GDP deflator: Measure of price index (Nominal GDP/Real GDP)*100 Our example: (10,50,000/7,00,000)*100 = 150 This means that prices have risen by 50% on an average over 2000-10.

GDP and related indicators (Source: Economic Survey 2011)

GDP Rs. crore (current prices) GDP at Constant prices (2004-5) Questions: 1. What is the GDP deflator for 2009-10 and 2010-11? 2. What is the inflation rate for 2010-11? 2008-9 5582623 2009-10 6550271 2010-11 7877947

4162509

4493743

4879232

Problems of GDP Measurement

Productive Vs. Non-productive activity: In general activities resulting in marketable goods and services should be included in national income. Non-market transactions- Example: Produce consumed by farmers also included in GDP

Problems of GDP Measurement

Excluded form GDP Underground economy Change in the quality of goods Environmental pollution/ degradation Healthcare, schooling, distribution of income, happiness

WHOLESALE PRICE INDEX

Base 2004-5 Primary atricles Food Non-food Minerals Fuel Coal Mining Mineral oil Manufacturing Food Non-food Weights 20.1 14.3 4.3 1.5 14.9 2.1 9.4 64.9 9.9 55

New WPI (Introduced in Aug.2010) tracks 676 commodities

Consumer Price Index (CPI)

Basket:
Food, Beverages and Tobacco: Fuel and light: 47.13% 5.48%

Housing:
Clothing and foot wear: Misc. (Education, healthcare etc.):

16.41%
7.03% 23.95%

Inflation rate is the % change in price index.

Some important identities

Y=C+I+G+NX (income/output = expenditure) YD=Y+TR-TA (disposable income) YD=C+S C+S=(C+I+G+NX)+TR-TA S-I=(G+TR-TA)+NX S-I= (TR+G-TA)+(X-Q) . Twin deficits

Y=C+I+G+NX

Y here is GDP at MP, C, Y, G, NX are all at market prices All taxes direct, indirect, corporate taxes etc. will reduce the income at the hands of the consumer and hence will reduce his consumption. But taxes collected will be spent by govt. which creates demand. Disposable income = GDP MP IDT-Corporate taxes Personal income tax (see last two slides, by repeated substitution we can get this. TA can be interpretted as all taxes.

1992 269 30 U.S TRADE AND BUDGET DEFICITS 1993 223 65 Budget Deficit 300
Billions of Dollars

Trade Deficit

250 200 150 100 50 0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Year

Other NI concepts
Gross National Product (GNP) (Market Prices)

GNP(MP) = GDP (MP) + Net Factor Earnings from abroad

Net National Product (NNP)

NNP(MP) = GNP(MP) depreciation

NNP(Factor Cost)

NNP(FC) = NNP (MP) Indirect taxes (IDT) + subsidies

(Market price = factor cost + IDT subsidies)

Sources of Data
Government of India, Ministry of Statistics and programme Implementation Web site: http://mospi.gov.in/ CSO:The Central Statistical Organisation is responsible for coordination of statistical activities in the country, and evolving and maintaining statistical standards. Data: National accounts, CPI, WPI etc.f NSSO The National Sample Survey (NSS), initiated in the year 1950, is a nation-wide, large-scale, continuous survey operation conducted in the form of successive rounds. Surveys on consumption, employment.