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Managerial Economics - Module 5.pptx
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- 2. Topics • Instruments ofMacro 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 MacroEconomics •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 • Studiesthe 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 • EconomicAgent 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 ofMacro 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 CircularFlow 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 ofIncome -Figure
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- 10. Types of CircularFlow 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 sectoreconomy 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 CircularFlow • 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 ina 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 insingle sector economy In single sector economy we have only either household sector or Business sector.
- 15. CFI in twosector 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 FourSector-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 • Itmeans 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 NationalIncome • 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 NationalIncome • 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 NationalIncome • 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 NationalIncome • 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 NationalIncome • 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 NationalIncome Nominal GDP Real GDP 1992 (base year) 127 127 1994 160 143
- 25. Concepts of NationalIncome 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 NationalIncome 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 MeasuringNational 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 NationalIncome 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 NationalIncome 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 DevelopingCountries • 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 • Theterm 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 • TheBusiness 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 aperiod 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 theeconomic 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 aperiod 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 theeconomic 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 prolongedcontraction is called a recession (contraction for over 6 months) • A recession of more than one year is called a depression
- 39. What keeps theBusiness 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 theBusiness 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 theBusiness 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????? • Whyshould you care about the business cycle and economy? • Lots of reasons!
- 43. “Don’t quit thatjob!” • 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 makea 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.