This document discusses key concepts in macroeconomics including the circular flow of income, national income, business cycles, and macroeconomic policy tools. It defines circular flow as the continuous movement of money between households and firms as goods and services are produced and exchanged. It outlines the measurement of national income using the product, income, and expenditure approaches. It also describes the phases of business cycles including expansion, peak, contraction, and trough, and how factors like investment, interest rates, expectations, and external shocks can influence the business cycle. Key macroeconomic policy tools are also briefly introduced including fiscal and monetary policy.

1. Managerial Economics
Module 5

2. Topics
• Instruments of Macro Economic Policy: Circular Flow of
Income – National Income – Concepts of National
Income – Methods of measuring National Income
• Product Approach, Income Approach and Expenditure
Approach
• Business Cycle – Inflation and Deflation
• Fiscal Policy – Budget Deficit and Debt – Government
Budgetary Policy
• Monetary Policy – Instruments of Monetary Policy
• Balance of Payment.

3. Emergence of Macro Economics
•Economic theory is divided under two heads
namely:
–Micro Economic Theory and Macro Economic
Theory.
•These terms were coined by Prof.Ragnar Frish
•The terms micro and macro have been derived
from the Greek words ‘Mikros’ meaning small
and ‘Makros’ meaning large.

4. Micro Economics
• Studies the behavior of production units, factors
of production, consumers etc.
• It studies about small units of the economy
• Price determination is the main concern in micro
economics
• It is also known as Price Theory.
• Demand theory, supply theory, theory of
production and cost, theory of factor pricing
etc.are the subject matter of micro economics.

5. Macro Economics
• Economic Agent include Macro economic
agents like Government,central Bank etc.
• Public wealfare is the main aim of them rather
than selfish interests.
• Micro Economics studies with the behaviour
of thoese macro economic agents.ie,macro
econmics studies the economy as a whole.
• It is also known as aggregate economics

6. Subject Matter of Macro Economics
• National Income and related ideas
• General Price Level, inflation and deflation
• Trade Cycle
• Monetary policy and fiscal policy
• International Trade
• Economic growth
• Money supply and banking

7. Meaning of Circular Flow of Income
• Production is a continuous process.
• Four factors of productions are combined together for the
Production of goods and services.
• Supply of factors of production comes from household sector.
• Household sector offers factors of productions to firms who in
return produce goods and services.
• Firms make payments to household sector in the form of
rent,wages,interest and profit and household sector spends this
money on goods and services produced by the firms.
• So the income flows in a circular flow.
• The economic activity remains in action with the help of circular
flow of money and goods in 4 sectors: Household sector, Producing
sector, Government sector and foreign sector.

8. Circular flow of Income -Figure

9. The Circular-Flow Diagram

10. Types of Circular Flow
1.Real Circular Flow
2.Money Circular Flow.
Let us assume an economy with only two
sectors:
1.House Hold Sector
2.Producing sector or Firms

11. Continuation……
A two sector economy functions on the basis of the following
assumptions.
1) There are only two sectors in the economy – firms and
households(Here no government and external sectors)
2) Money is used as a medium of exchange.
3) Neither household sector nor firms save at all
4)Firms hire factors services from household sectors
5)Household spend their entire incomes on consumption.
6)Firms sell their entire products to the households
7)No Taxes
8)There is no trade relations(Exports and imports)with the rest of the
world
Such an economy consists (1) The factor market and (2) The product
market

12. Types of Circular Flow
• 1.Real Circular Flow
• Money Circular Flow
When goods and services flow from one sector to another known as
real circular flow.
Eg:The household sector provide factor services(Land , Labour , Capital
and enterprise)to the firm. By using these factors ,the firm produce
goods and servises.These goods and services from producing sector
to the household sector as rewards for their factor services
When goods and services are produced in the economy and are
exchanged for money, it is called Money flow.
Eg:The household sector provides factor services to the firms and
receives payments in terms of money. It spends its money income
on the purchase of goods and services produced by the firms.

13. Circular flow in a closed economy
The closed economy is that economy in which
we do not have imports and exports.
In a closed economy the circular flow of income
can be explained in three ways:
1.Circular flow in a single sector economy.
2.Circular flow in a two sector economy.
3.Circular flow in a three sector economy.

14. Circular flow in single sector economy
In single sector economy we have only either
household sector or Business sector.

15. CFI in two sector economy

16. Three Sector Model
• Circular Flow of Money- Three Sector Model
Business Sector Household Sector
Factors
Market
Government
Sector
Taxes
Capital
Market Savings
Investment
Government
Purchases
T
a
x
e
s
Transfer
Payments
Consumption
Expenditure
Product
Market
Factor
Payments

17. Four Sector Model
Four Sector-Circular Flow of Income
Business Sector Household Sector
Factors
Market
Government
Sector Taxes
Capital
Market Savings
Investment
Government
Purchases
T
a
x
e
s
Transfer
Payments
Consumption
Expenditure
Product
Market
Factors
Payments
Foreign
Sector
Imports
Transfer Payments
Exports
Imports

18. National Income
• It means the total value of goods and
services produced annually in a country.
• It includes payments made to all resources
in the form of wages, interest, rent and
profits.

19. Concepts of National Income
• Gross National Product: It is the total measure of the flow of goods
and services at market value resulting from current production during
a year in a country, including net income from abroad.
• GNP at Market Prices: When the total output produced in one year is
multiplied by their market prices prevalent during that year in a
country, plus net income from abroad, it is called GNP at Market
Prices.
• GNP at Factor Cost: It is the sum of the money value of the income
accruing to the various factors of production in one year in a country.
GNP at Factor Cost = GNP at market prices – Indirect Taxes + Subsidies.

20. Concepts of National Income
• Net National Product (NNP): NNP is GNP net of depreciation.
NNP = GNP – Depreciation.
• NNP at Market Prices: Net value of final goods and services
evaluated at market prices: NNP at Market Prices = GNP at
Market Price – Depreciation.
• NNP at Factor Cost: Net output evaluated at factor prices.
NNP at Factor Cost = NNP at Market Prices
– Indirect Taxes + Subsidies (or)
= GNP at Market Prices
– Depreciation – Indirect taxes + Subsidies
Concepts of National Income

21. Concepts of National Income
• Domestic Income or Product: Income generated or
earned by the factors of production within the
country from its own resources is called domestic
income or domestic product. Domestic Income =
National Income – Net Income earned from abroad.
• Personal Income: Personal Income is the total
income received by the individuals of a country from
all sources before direct taxes. Personal Income =
National Income – Undistributed Corporate Profits –
Profit Taxes – Social Security Contributions +
Transfer Payments + Interest on Public Debt.

22. Concepts of National Income
• Disposable Income: income that accrues after direct taxes have
actually been paid. Disposable Income = National Income –
Business Savings – Indirect taxes plus Subsidies – Direct
Taxes on Persons – Direct Taxes on Business – Social Security
Payments + Transfer Payments + Net Income from abroad.
• Real Income: Real income is national income expressed in
terms of a general level of prices of a particular year taken as
base. Real NNP = Current Year NNP x Base year Index / Current
Year Index.
• Per Capital Income: The average income of the people of a
country in a particular year is called per capital income for that
year. Per capita income = national income / population. Real
per capita income = real national income / population.

23. Concepts of National Income
• Nominal GDP
– Value of output measured at actual prices (current dollar output)
– Does not correct for inflation
Nominal GDP = Current year Quantities x Current year Prices
• Real GDP
– Value of output based on prices of some base period (“constant” dollar
output)
– eliminates effect of inflation
Real GDP = Current year Quantities x Base year Prices
GDP Deflator = Nominal GDP x 100
Real GDP

24. Concepts of National Income
Nominal GDP Real GDP
1992
(base year)
127 127
1994 160 143

25. Concepts of National Income
GDP Deflator = Nominal GDP • 100
Real GDP
1992 GDP Deflator = 127• 100 = 100.0
127
1994 GDP Deflator = 160 • 100 = 111.9
143

26. Concepts of National Income
Change in GDP Deflator (Inflation) from 1992 to
1994:
= (1994 Deflator - 1992 Deflator) • 100
1992 Deflator
= (111.9 - 100.0) • 100 = 11.9%
100.0

27. Methods of Measuring National Income
• Product Method: Total value of final goods and services produced
in a country during a year is calculated at market prices.
• Income Method: The net income payments received by all citizens
of a country in a particular year are added up i.e. net incomes that
accrue to all factors of production.
• Expenditure Method: The total expenditure incurred by the society
in a particular year is added together- includes personal
consumption expenditure, net domestic investment, government
expenditure on goods and services and net foreign investment.
• Value Added Method: Difference between the value of material
outputs and inputs at each stage of production is the value added.

28. Difficulties in National Income Measurement
• Difficulty of defining ‘nation’ in the terminology national income.
• There are a number of goods and services which are difficult to be
assessed in terms of money.
• The failure to distinguish properly between a final and an
intermediate product.
• Income earned through illegal activities are not included in national
income.
• Transfer payments- these earnings are a part of individual income
and also government expenditure.

29. Difficulties in National Income Measurement
• Capital gains or loss to property owners excluded from GNP
because they do not result from current economic activities.
• All inventory changes at original cost not replacement costs
included in GNP measure.
• Depreciation valuation adjustment is full of statistical difficulties.
• With price increase, monetary NI increases though production may
have gone down & with price fall monetary NI falls though
production may have gone up.
• Monetary NI an underestimation of real NI.
• Public services cannot be estimated correctly.

30. Difficulties in Developing Countries
• Large non-monetized sector.
• Lack of occupational specialization.
• Several productive activities do not enter market transactions.
• Many people do not keep accounts.
• Adequate and correct production and cost data are not
available.

31. Business Cycles
• The term business cycle refers to the recurrent
ups and downs in the level of economic
activity, which extend over several years.
• Individual business cycles may vary greatly in
duration and intensity.
• All display a set of phases.

32. Business Cycles
• The Business Cycle allows people to
understand the direction the economy (GDP)
is going (growing or shrinking) and plan
accordingly.
• The economy follows the Business Cycle
regularly.

33. Business Cycle - Phases
Peak
Trough
Peak

34. Expansion
• During a period of expansion:
– Wages increase
– Low unemployment
– People are optimistic and spending money
– High demand for goods
– Businesses start
– Easy to get a bank loan
– Businesses make profits and stock prices increase

35. Peak
• When the economic cycle peaks:
– The economy stops growing (reached the top)
– GDP reaches maximum
– Businesses can’t produce any more or hire more
people
– Cycle begins to contract

36. Contraction
• During a period of contraction:
– Businesses cut back production and layoff people
– Unemployment increases
– Number of jobs decline
– People are pessimistic (negative) and stop
spending money
– Banks stop lending money

37. Trough
• When the economic cycle reaches a trough:
– Economy “bottoms-out” (reaches lowest point)
– High unemployment and low spending
– Stock prices drop
But, when we hit bottom, no where to go but
up!
UNLESS….

38. Recession/Depression
• A prolonged contraction is called a recession
(contraction for over 6 months)
• A recession of more than one year is called a
depression

39. What keeps the Business Cycle Going?
• 4 variables cause changes in the Business
Cycle:
1. Business Investment
When the economy is expanding, sales and profit
keep rising, so companies invest in new plants
and equipment, creating new jobs and more
expansion. In contraction, the opposite is true

40. What Keeps the Business Cycle Going?
2. Interest Rates and Credit
Low interest rates, companies make new
investments, adding jobs. When interest rates
climb, investment dries up and less job growth
3. Consumer Expectations
Forecasts of an expanding economy fuels more
spending, while fear of a recession decreases
consumer spending

41. What keeps the Business Cycle Going?
4. External Shocks
External Shocks, such as disruptions of the oil
supply, wars, or natural disasters greatly
influence the output of the economy
Ex. 1992-2000 was the longest period of expansion
in U.S. history. Early in 2001, signs of contraction
appeared, though the Bush administration
denied it. The Sept. 11th 2001 terrorist attacks
quickly caused the business cycle to shift into a
contraction.

42. Who Cares?????
• Why should you care about the business cycle
and economy?
• Lots of reasons!

43. “Don’t quit that job!”
• If the economy is going into a contraction,
jobs will become more scarce. If you quit, you
may not find another job!
• But, if the economy is in a period of
expansion, jobs are readily available. It may be
a good time to switch careers.

44. “Should I make a big purchase?”
• Only if you know that you won’t lose your job
in a contraction. So, buy your house during an
expansion.
HOWEVER,
• When the economy starts to slow down
(contraction), interest rates will decrease.
Wait to buy a house until the rates drop to a
low point, if you are sure you won’t lose your
job.