MACROECONOMIC

ENVIRONMENT
2. THE DATA OF
MACROECONOMICS

Introduction

Why do we study the national income accounts?

1. National income accounting provides structure for
our macroeconomic theory models.
2. Introduces statistics that characterize the economy.

Output defined in two ways

1. Production side: output produced which also
involves payments to workers in wages, capital in
interest and dividends, and profits.
2. Demand side: output = purchases by different
sectors of the economy.
- As per accounting, output measured via demand and
production equal in equilibrium.

Aggregate Output
National income and product accounts are an
accounting system used to measure aggregate
economic activity.
The measure of aggregate output in the national
income accounts is gross domestic product, or
GDP.
Output typically measured as GDP = value of all
final goods and services produced within a
country over a particular period of time (a year).

The Components Of
The Macroeconomy
The circular flow
diagram shows the
income received and
payments made by
each sector of the
economy.

The Components Of The Macroeconomy

Everyones
expenditure is
someone elses
receipt. Every
transaction must
have two sides.

The Components Of
The Macroeconomy
Transfer payments are payments made
by the government to people who do not
supply goods, services, or labor in
exchange for these payments.

GDP : Meaning
GDP is the value of the final goods and
services produced in the economy during
a given period (of one year).
A final good is a good that is destined for final
consumption.
An intermediate good is a good used in the
production of another good.

Different Approaches For Calculating

GDP (at Market Price)
1. Expenditure Approach
2. Production (or Value Added) Approach
3. Income Approach

The three methods yield the same result

because total expenditures on goods and
services is equal to the value of goods and
services produced which is equal to the total
income paid to the factors that produced the
goods and services.

GDP: Expenditure Approach

There are three ways of computing GDP
1. Expenditure Approach
It measures GDP (at market prices) using final
sales approach
GDPMP = C + Ig + G + NX
C = consumption spending of individuals
Ig = investment spending by business
G = government expenditures
NX= net exports (exports imports)

GDP
GDP == CC ++ Ig
Ig ++ G
G ++ NX
NX
Totaldemand
demand
Total
fordomestic
domestic
for
output(GDP)
(GDP)
output

composed
isiscomposed
of
of

Investment
Investment
spendingby
by
spending
businesses.
businesses.

Consumption
Consumption
spendingby
by
spending
households.
households.

Government
Government
purchasesof
ofgoods
goods
purchases
andservices.
services.
and

Netexports
exports
Net
ornet
netforeign
foreign
or
demand.
demand.

This is the called the national income accounts identity.

1) To compute the total value of different goods and

services, the national income accounts use market prices
(GDP at market prices).
2) Used goods are not included in the calculation of
GDP.
3) Change in inventories is added to GDP. If the goods
are stored, their value is added in GDP. If they spoil,
GDP remains unchanged. When the goods are finally
sold out of inventory, they are considered used goods and
are substracted from GDP (i.e the change in inventories
is added).

4) Intermediate goods are not counted in GDP only

the value of final goods. Reason: the value of
intermediate goods is already included in the market
price.
5) Some goods are not sold in the marketplace and
therefore dont have market prices and are not counted
in GDP. For example, a housewife doing household
chores and not charging anything for it.

2. GDP: Value Added Approach (Production

Approach)
2. GDP is the sum of value added in the economy
during a given period.
Value Added = Value of output Value of Intermediate
consumption.
VA is the extra value created at each stage of the
production process.
Value of Output = Value of the total sales of goods and
services + Value of changes in the inventories.
The sum of Value Added in various economic
activities is known as GDP at factor cost.
GDP at factor cost plus indirect taxes less subsidies
on products is GDP at Market Price.

3. GDP: Income Approach

3. GDP is the sum of the incomes in the economy during
a given period.
This method measures GDP by adding incomes that firms pay
households for factors of production they hire.
More specifically, incomes can be divided into five categories:
Wages, salaries, and supplementary labour income, Corporate profits,
Interest and miscellaneous investment income, Farmers income,
Income from non-farm unincorporated businesses.
These five income components sum to net domestic income (NDP)
at factor cost.
Two adjustments must be made to get GDP (at market price):
1. Indirect taxes minus subsidies are added to get from factor cost
to market prices.
2. Depreciation (or Capital Consumption Allowance) is added to
get from net domestic product to gross domestic product.

Three Ways To Compute GDP

1.
2.
3.
4.

Consider a simple economy in which one good is produced

and sold.
Raj finds a seed and plants it. Sometimes later, an orange tree
appears.
Raj pays Hari Rs.50 in wages to pick and box the oranges.
Next, Raj sells the oranges to Suresh for Rs.80.
Suresh turns the oranges into orange juice and sells the orange
juice to Sarita for Rs.100. Sarita drinks the juice.

GDP (expenditure approach) Sarita is the final buyer in this economy.

GDP = Rs. 100.
GDP (income approach) Haris wages=Rs 50; Rajs profit=Rs30;
Sureshs profit=Rs20. GDP = 50+30+20 = Rs. 100.
GDP (value added approach) Value added by Raj=Rs80; value
added by Suresh=Rs20. GDP = 80+20 = Rs. 100.

GDP, GNP, NNP, NI

GDP includes only that output which is produced within an
economys geographical borders.
GNP consists of the output produced either inside or outside
the country by economic resources owned by residents of
that country.
A nation's GDP is one of the ways of measuring the size of
its local economy whereas the GNP measures the overall
economic strength of a country.
GNP is greater than GDP when residents of that country
employ their resources to produce more output outside that
country than what foreigners produce inside the country.
NNP equals GNP less the allowance made for capital which
has worn out during the year.

GDP, GNP, NNP, NI

GNPMP = GDPMP payments of factor incomes to rest of
the world + receipts of factor income from rest of the world.
GNPMP depreciation = NNPMP
NNPMP indirect taxes + subsidies = NNP FC = NI {Y}
NI direct taxes + transfers = YD (disposable income).
YD = C + S
YD is the amount of money that households have available
for spending and saving after income taxes have been
accounted for.

Income, Expenditure And the Circular Flow

There are 2 main ways
of viewing GDP

Total income of everyone in the economy

Total expenditure on the economys
output of goods and services
Income Rs
Labor

Households

Firms
Goods
Expenditure Rs

For the economy as a whole, income must equal expenditure.

GDP measures the flow of rupees in this economy.

Income, Expenditure And the Circular

Flow
(Two sector model)
i.e Y (i.e NNPFC) = C + I
Compensation for services
of economic resources
(NNPFC)

Business
sector

Household
Sector

Consumption spending
(C)
Household saving = Investment spending
(I)

Income, Expenditure And the Circular

Flow
(Three sector model)
Compensation for services of economic
resources (NNPFC)
Indirect taxes

Household
sector

Direct taxes
on income

Business
sector

Govt
sector
Govt expenditure (G)

Consumer spending(C)
Household saving=investment spending(I)

Y (ie NNPMP) = NNPFC + indirect taxes = C + I + G

GDP, GNP, NNP, NI

NI = payments made to factors of
production owned by residents of that
economy (compensation of employees +
rent + interest + profit). Also called NNP at
factor cost.
In India, depreciation and taxes give
national income as approximately 80%
of GDP.

Components of Demand
Total demand for domestic output is made up
of four components:
1.
2.
3.
4.

Consumption spending by households (C)

Investment spending by firms (I)
Government spending (G)
Foreign demand for our net exports (NX)

- The fundamental national income accounting identity is -

Y C I G NX

Consumption
Consumption = purchases of goods and services by the
household sector.
Includes spending on durable (eg. Cars), non-durable
(eg. Food), and services (eg. Medical services).
Consumption is the primary component of demand.
Consumption as a share of GDP varies by country.
In India, it comprises approximately 60-65% of GDP.
In China, it is 50% of GDP, in USA it is 85% of GDP
approximately.

Government
Includes Government purchases of goods and services
such as national defence expenditures, costs of road
paving by state and local governments, and salaries of
government employees.
Government also makes transfer payments = payments
made to people without their providing a current service
in exchange.
Eg. Social security, unemployment benefits.
Transfer payments are NOT included in GDP since
they are not a part of current production.
i.e total Government expenditure = transfers +
purchases (but transfers are not included in GDP
computation).

Investment
Investment = additions to the physical stock of
capital (i.e. building machinery, construction of
factories, additions to firms inventories).
In the national income accounts, investment is
associated with business sectors adding to the
physical stock of capital, including inventories.
Households building up of inventories is
considered consumption, although new home
constructions are considered part of I, not C.
Gross investment is included in GDP measure,
which is net investment plus depreciation.

Net Exports
Accounts for domestic purchases of foreign goods
(imports) and foreign purchases of domestic goods
(exports) : NX = Exports Imports.
We subtract imports from GDP since we are
accounting for total demand for domestic
production.
NX can be >, <, or = 0
India NX has always been negative trade deficit.
Its CAB/GDP was -0.4% in 2004-05, -2.3% in
2008-09, -2.8% in 2009-10, -2.8% in 2010-11,
-4.2% in 2011-12, -4.6% in 2012-13.

Eco survey, 2012-13 : key indicators

Nominal and Real GDP

Nominal GDP is the sum of the quantities of final goods
produced times their current price.
Nominal GDP increases over time because:
1. The production of most goods increases over time.
2. The prices of most goods also increase over time.
Real GDP is constructed as the sum of the quantities of
final goods times constant (rather than current) prices.

Nominal and Real GDP

Nominal GDP is also called rupee GDP or GDP in
current rupees.
Real GDP is also called GDP in terms of goods, GDP in
constant rupees, GDP adjusted for inflation, or GDP
in 2004-05 rupees.
This conversion from nominal to real units allows us to
eliminate the problems created by having a measuring
stick (rupee value) that essentially changes length over
time, as the price level changes.
Eg: price index of base year (2004-05) = 100
price index of current year (2005-06) = 110
Real GDP(2005-06) = nominal GDP of 2005-06 x 100
110

Calculating Real GDP

Lets see how real GDP is calculated in a simple apple & orange
economy. For example, if we wanted to compare output in 2002
and output in 2003, we would obtain base-year prices, such as
2002 prices.
Real GDP in 2002 would be:
(2002 Price of Apples 2002 Quantity of Apples) +
(2002 Price of Oranges 2002 Quantity of Oranges).
Real GDP in 2003 would be:
(2002 Price of Apples 2003 Quantity of Apples) +
(2002 Price of Oranges 2003 Quantity of Oranges).
Real GDP in 2004 would be:
(2002 Price of Apples 2004 Quantity of Apples) +
(2002 Price of Oranges 2004 Quantity of Oranges).

GDP : Expansions And Recessions

GDP growth equals:
(Yt Yt 1 )
Yt 1

X 100

Periods of positive GDP growth are called

expansions.
Periods of negative GDP growth are called
recessions.

The Other Major

Macroeconomic Variables
GDP is obviously the most important
macroeconomic variable. But two
other variables tell us about other
important aspects of how an economy
is performing:
1. Unemployment
2. Inflation

Unemployment
Unemployment is a state in which a person does not have
a job but is available for work, willing to work, and has made
some effort to find work within the previous four weeks (ILO
definition).
The labor force is the total number of people who are
employed and unemployed.
The unemployment rate is the percentage of the people in
the labor force who are unemployed.
A discouraged worker is a person who is available for
work, willing to work, but who has given up the effort to find
work.
L force participation rate=L force/population of working age

ECO SURVEY, 2011-12

Unemployment rate (India), 2012 = 8.5%

Source : CIA Factbook

Types Of Unemployment
a) Cyclical Unemployment (Okuns law)
b) Structural Unemployment
c) Classical Unemployment
Total Unemployment in a country= a+b+c

The Unemployment Rate

Okuns law is a
relation between the
change in
unemployment and
GDP growth.

Okuns law
Okun found that a 1% cyclical
unemployment rate exists for each 2%
that real GDP falls short of potential GDP.
Potential GDP is the maximum production
that can take place in the domestic
economy without putting upward pressure
on the general level of prices.

The Inflation Rate

Inflation is a sustained rise in the
general level of pricesthe price level.
The inflation rate is the rate at which
the price level increases.
Deflation is a sustained decline in the
price level, or a negative inflation rate.

The GDP Deflator

Pt =

nominal GDP x 100

real GDP

The GDP deflator is what is called an index numberset equal

to 100 in the base year.
The rate of change in the GDP deflator equals the rate of inflation:

( P t P t1 )
P t1

The Consumer Price Index

The GDP deflator measures the average
price of output, while the consumer price
index (CPI) measures the average price
of consumption, or equivalently, the cost
of living.
The CPI and the GDP deflator move
together most of the time.

CPI Versus The GDP Deflator

The GDP deflator measures the prices of all goods
produced, whereas the CPI measures prices of only the
goods and services bought by consumers. Thus, an
increase in the price of goods bought by firms or the
government will show up in the GDP deflator but not in the
CPI.
Also, another difference is that the GDP deflator includes
only those goods and services produced domestically.
Imported goods are not a part of GDP and therefore dont
show up in the GDP deflator.
The final difference is the way the two aggregate the prices
in the economy. The CPI assigns fixed weights to the prices
of different goods every year, whereas the GDP deflator
assigns changing weights.

Inflation Rates, India

Source : Economic Survey, 2012-13

Inflation and Unemployment

The Phillips curve is a
relation between
unemployment and inflation.

PHILLIPS CURVE
When the
unemployment rate is
low (boom), inflation
tends to increase.
When the unemployment rate is high
(recession), inflation
tends to decrease.

PHILLIPS CURVE
The inverse relationship between
unemployment rate and inflation rate as
shown by the Phillips curve is reasonable
since, in the absence of cost-push
inflation, increases in the price level (and
therefore inflation) should occur as output
nears its full employment level (i.e as
unemployment rate drops).

Exchange Rate

Each country has its own currency in which prices are quoted. In the U.S., prices
are quoted in U.S. dollars, in Japan in yen, in most of Europe prices are quoted
in euro, in India in rupees.

Exchange rate = the price of one countrys currency in relation to another

countrys currency. It is needed for international trade, foreign travel etc.
In India 1$ = 64Rs; 1Euro = 85Rs; 1Pound=100.23Rs (Sept 2013).
- The pound is worth U.S. $1.58; 1 Euro = $1.3423.

Floating (or flexible) exchange rate: when two countries agree to let international
market forces of supply and demand determine their ex. rate. It fluctuates
depending on exports and imports of a country.

Most countries today use floating ex. rates within relatively fixed limits.

Fixed exchange rate: when two countries agree to keep their ex. rate fixed
through use of monetary policy.
Chinese currency yuan was fixed till July 2005. Since 2005, China claims to
have adopted the flexible ex. rate system. However, its currency has been
allowed to appreciate slightly since 2005 (1$ = 6.12 CNY, Sept 2013).
Bermuda dollar fixed at 1USD=1.2008 BMD (Sept 2013).

National Accounting System In India

The Central Statistical Organisation is responsible for coordination of

statistical activities in the country, and evolving and maintaining
statistical standards.

Its activities include National Income Accounting; conduct of Annual

Survey of Industries, Economic Censuses and its follow up surveys,
compilation of Index of Industrial Production, as well as Consumer
Price Indices for Urban Non-Manual Employees, Human
Development Statistics, Gender Statistics, imparting training in Official
Statistics, Five Year Plan work relating to Development of Statistics in
the States and Union Territories; dissemination of statistical
information, work relating to trade, energy, construction, and
environment statistics, revision of National Industrial Classification,
etc.

It has a well-equipped Graphical Unit. The CSO is headed by the

Director-General who is assisted by 2 Additional Director-Generals
and 4 Deputy Director-Generals, Directors & Joint Directors and other
supporting staff.

The CSO is located in Delhi. Some portion of Industrial Statistics work

pertaining to Annual Survey of industries is carried out in Calcutta.

National Accounting System In India

National Sample Survey Office (NSSO) {under
Ministry Of Statistics And Programme Implementation}
conducts nationwide sample surveys on various socioeconomic issues in successive rounds, each round
covering subjects of current interest in a specific survey
period. The organisation has four divisions :
(i) Survey Design and Research Division (SDRD)
(ii) Field Operations Division (FOD)
(iii) Data Processing Division (DPD) and
(iv) Co-ordination and Publication Division (CPD)
NSS 66th round (2009-10)
Latest NSS 68th round (2011-12).

Other Sources Of India Data

RBI : money supply, roi, BOP data, exchange rates.
Ministry Of Finance, DEA; CSO; RBI; Planning
commission : GDP data.
Dept Of Industrial Policy and Promotion : WPI.
Dept Of Industrial Policy and Promotion, Labour Bureau :
CPI-IW; CPI-AL
CSO : CPI-UNME
NSSO, Ministry Of Labour & Employment : employment,
unemployment data
Ministry of Finance, Planning commission : budget
documents, economic survey.
DGCIS, Kolkata : exports, imports data (directorate
general of commercial intelligence & statistics).
Office of the Registrar General Of India; Ministry of
Home Affairs : Population data

Macroeconomic Policy Challenges

Five widely agreed policy challenges for
macroeconomists are to:
1.
2.
3.
4.
5.

Boost economic growth

Keep inflation low
Stabilize the business cycle
Reduce unemployment
Reduce government deficits

Macroeconomic Policy Tools

Government in the Macroeconomy
There are three kinds of policy that the
government has used to influence the
macroeconomy:
Fiscal policy
Monetary policy
Growth or supply-side policies

Macroeconomic Policy Tools

Government in the Macroeconomy
Fiscal policy refers to government policies
concerning taxes and spending.
Monetary policy consists of tools used by the
Central Bank to control the quantity of money in
the economy.
Growth policies are government policies that
focus on stimulating aggregate supply instead of
aggregate demand.

Exercise 1
Using the data given below relating to the components of
the consumer price index of a country, determine the
annual rate of inflation for 2006 as measured by the
change in the consumer price index.
------------------------------------------------------------------------------Item

Index weight

Food
Housing
Transport
Other Goods

20
20
15
15

Price index on 31st Dec, 2005

140
126
152
130

Price index on 31st Dec, 2006

145
135
146
125

-------------------------------------------------------------------------------

Exercise 2
Consider an economy that consists only of those who
bake bread and those who produce its ingredients.
Suppose that this economys production is as follows: 1
million loaves of bread (sold at $2 each); 1.2 million
pounds of flour (sold at $1 per pound); and 100,000
pounds each of yeast, sugar, and salt (all sold at $1 per
pound). The flour, yeast, sugar, and salt are sold only to
bakers, who use them exclusively for the purpose of
making bread.
a) What is the value of output in this economy (i.e.
nominal GDP)?
b) How much value is added to the flour, yeast, sugar,
and salt when the bakers turn them into bread?

Exercise 3
Kongkong is a small island nation. Its population
total is 400 and it has 100 wage earners who
earn an average of $50 per year. Each wage
earner spends $40 per year buying local goods
and services and $3 per year buying imports.
The island exports a total of $800 worth of
goods. The govt tax rate is 10% and all govt
money is spent on building infrastructure and
supporting schools. There is only on industry (al
mining) on the island and it employs every wage
earner. The industry spends $600 each year on
new mining equipment.
Calculate GDP of the country.