Understanding Macroeconomics and Circular Flow

Macroeconomics Overview

• Focus on macroeconomics with the same effort as Indian Economic Development.
• Macroeconomics involves studying aggregates like national income and output.

Circular Flow of Income

• Circular flow illustrates how income circulates in an economy.
• Involves interactions between households and firms.
• Households provide factor services (land, labor, capital, entrepreneurship) to firms.
• Firms produce goods and services.
• Households receive factor payments in return for their services.
• Households spend income on goods and services (consumption expenditure).

Phases of Circular Flow

• Generation Phase: Firms begin production using factor services.
• Distribution Phase: Firms pay households for their services.
• Disposition Phase: Households spend their income on goods and services.

Circular Flow Definition

• Cycle of income generation in production, distribution to factors of production, and circulation from households to firms through consumption expenditure.

Flow Variable

• Measured over a period of time, e.g., production in 2024.

Stock Variable

• Measured at a specific point in time, e.g., money in your pocket right now.
• Example: Income is a flow variable; wealth is a stock variable.

Real Flow

• Flow of factor services from households to firms and goods/services from firms to households.

Money Flow

• Flow of factor payments between firms and households.

Other Terms

• Stock variable is also called static.
• Flow variable is also called dynamic.
• Real flow is also called physical flow.
• Money flow is also called nominal flow.

Domestic Territory

• Area administered by a government where people, goods, and capital can circulate freely.
• Includes ships, aircraft, embassies, consulates, floating platforms, and oil/natural gas rigs of resident entities.

Normal Resident

• Individual residing in a country for over a year with their center of economic interest in that country.

Factor Income

• Income received by factors of production for their services in the production process.
• Ex: receiving fees for teaching

Transfer Income

• Income received without rendering any productive service in return.
• Ex: Receiving ₹100 as a gift
• Factor income is an earning concept; transfer income is a receipt concept.

Final Goods

• Purchased by the ultimate consumer for consumption or investment, with no further production.

Intermediate goods

• Goods used for resale or further production, staying within the production boundary until they are sold to the end user.

Determining Final vs. Intermediate Goods

• Depends on use, not inherent nature.
• Milk purchased by a consumer is a final good; milk purchased by a tea seller is an intermediate good.

Consumer goods

• Goods that directly satisfy the wants of consumers

Capital Goods

• Goods that are bought by firms

Gross Investment

• Total investment made in a year.

Depreciation

• Decrease in the value of fixed assets due to normal wear and tear, passage of time, and expected obsolescence.

Net Indirect Tax (NIT)

• The difference between indirect taxes and subsidies.

Net Factor Income from Abroad (NFIA)

• Difference between factor income received from abroad and factor income paid abroad.
• Components: compensation of employees, income from property and entrepreneurship, and net retained earnings.

Key Concepts

• Domestic territory is also called economic territory.
• Factor income is also called earned income.
• Transfer income is also called unearned income.
• Investment is also called capital formation.
• Depreciation has other names.
• Subsidies are also called economic assistance.

National Income Aggregates

• Four net aggregates and four gross aggregates.
• GDP at MP, GDP at FC, GNP at MP, GNP at FC.
• NDP at MP, NDP at FC, NNP at MP, NNP at FC.
• NDP at FC is domestic income, and NNP at FC is national income.
• Market price reflects market value; factor cost reflects money value.

Methods of Calculating National Income

• Value Added Method, Income Method, and Expenditure Method.

Value Added Method

• Measures the market value of all final goods and services produced by each enterprise within the domestic territory.
• Results in GVA at MP (Gross Value Added at Market Price).

Value of Output

• The market value of goods and services produced during a period.

Intermediate Consumption

• Value of non-factor inputs used in the production process.

Formula:

• Value Added = Value of Output - Intermediate Consumption

Double Counting

• Repeated inclusion of the same product at different stages, leading to overestimation.

Avoiding Double Counting

• Use either the final output method or the value-added method.

Income Method

• Calculates national income in terms of payments made to primary factors of production.

Main components:

• Profit, Rent & Royalty, Interest, Mixed Income, Compensation of Employees

Expenditure Method

• Calculates national income by summing all expenditures in the economy.
• Expenditures = Government Final Consumption Expenditure (G), Gross Domestic Capital Formation (I), Net Exports (NX), & Private Final Consumption Expenditure (C).

Formula:

• Net Exports = Exports - Imports.

Gross Domestic Capital Formation

• Includes fixed capital formation and change in stock.

Real vs Nominal GDP

• National Income at Current Prices: Uses current prices and quantities.
• National Income at Constant Prices: Uses current quantities, but prices from the base year.
• Real GDP BETTER INDEX

Formula:

• Real GDP = (Nominal GDP / Price Index) * 100

GDP Deflator

• Measures average price levels of all goods and services in an economy.

Formula:

• Price Index = (Nominal GDP / Real GDP) * 100

GDP and Welfare Limitations:

• GDP may not accurately reflect welfare due to factors like distribution, price changes, non-monetary exchanges, externalities, population growth, and composition of GDP.

The Barter System

• Exchange of goods or services without using money.
• Limitations: lack of double coincidence of wants, common measure of value, standard for deferred payments, store of value.

The Barter System and Money

• Money solves the limitations of barter.
• Money Definition : Accepted as a medium of exchange and measure of value, store of value, and standard of deferred payments.
• Functions of Money: Medium of exchange, measure of value, store of value, and standard of deferred payment.

Money Supply

• Total money volume held by the public at a specific point in time and stock concept.
• Measures: M1, M2, M3, and M4 (M1 is most important) and includes currency with the public, demand deposits in commercial banks, and other deposits with the RBI.

Commercial banks

• Accept deposits, grants loans, and make investments to earn money.
• Essential job: Accept deposits and provide loans.
• Money Creation: also called money multiplier and is based on the Legal Reserve Ratio (LRRR).

Money Multipler Forumla

• 1 / LRR and explains how comersial banks can create new deposits beyond the initial receipt from a depositor.

Central Bank

• Apex body that regulates the banking system of a contury.
• Functions: issue currency, act as the government's banker and advisor, and control the money supply.
• Functions as Curreny Authority, Banker, regulator, director, etc

Monetary Instruments for controlling Money

• Repo Rate: Interest rate at which commercial banks borrow from the RBI.
• Bank Rate: Interest rate on long-term loans from the RBI.
• Reverse Repo Rate: Interest paid by the RBI on commercial banks' deposits.
• Open Market Operations (OMO): Buying and selling government securities.
• Legal Reserve Ratio

Legal Reserve Ratio

• Mainly done over selling and buying of assets that the banks needs and is split into
  • Cash Reserve Ratio (CRR): Banks' deposit percentage held with the RBI.
  • Statutory Liquidity Ratio (SLR): Minimum deposit percentage banks must hold themselves.
• Qualitative instruments for controlling Money
  • Moral Suasion: persuasion with the banks
  • Selective Credit Control: Selective measures like ending money distribution for come industries

Bank and Money additional Concepts

• Margin Requirements: difference between a Loan amount and Security Amount.
• Repurchase Rate = also calling Repo Rate
• Discount Rate = also calling Back Rate
• Varied Reserve Ratio = also calling Legal Reserve Ratio

Aggregate Demand

• AD (also called Aggregate Expediture): total goods value all economy sectors are planning for a given income level during a period.
• AD is mainly represented by = C +I+G+X-M

Aggregate Supply

• (Overal Aggregate Supply = Overall Income from all suppliers over a given time period.
• Savings are based on what is either Consumed or Saved
• Can be explained as AD = either Consumed (C) + Investment (I)
• AS (Aggregate Supply can be drawn over C+Savings

Graphical Plot

• Shows Linear Plot with Fixed point on I showing Investment (I)
• Aggregate Supply Plot is basically straight at 45% of Investment

AD/AS table examples shown in video

• Fixed point (Y) is Income

Consumption Functions

• Refer to how consumption has a relationship with Income.
• Breakeven: Consumption Matches Expediture, Showing ZERO SAVINGS
• Consumption Curve where income with consumption happens that point is equal

Saving Point

• Where Income higher than Expediture, leading to an increased Savings Account

Propensity Types

-Average Propensity to Consume (C /Y)
-Average Propensity to Save (S/Y)
-Marginal Propensity to Consume (Delta C / Delta Y)
-Marginal Propensity to Save  (Delta S / Delta Y)

BreakEven and Income Relationship

• Saving (S and )Income Relationships Relationship with Income (S and Income) = Saving Fucntion Point Where 0 Point for the Saving to income = Breakeven Point

Investment Relationship

• Inducated investment, that is made by Profits

Planned and Actual

• Planned also called EX ANTE
• Actual also called EX POST

Employment

• Full employment means workers both Willing and Happy works with jobs being given as one.

Demand

• Can be described as Income Demand or Decrees with some or Less Demand
• Income is directly proportion to DEMAND, the high the one is the Higher the other is

Equiblirium Points

• Kinestisian Theory: Where Points is Achieed at (AD =AS) , which Savings Point Matches Investment Point
• Equilibrium Points 1 of 2.*
• achieved when plan is achieve equal to goods available
• s = i

Multiplier Concepts

• when government Invests in the sector it generates more INCOME
• Investment will lead to Income
• Ratio Of Change in Income will Change to Investment

Multiplier Forumlas

• Multiplier Formula for calculating the amount =
• Min Value should be equal to 1

Minimum AND MAximum Vale

• Max Value is Infinite

Multiplier Relationship

Is Opposite to Marginal propensity value

Excess Demand

• Occurs that any demand increases
• Results in Inflationary -Reasons: People willing to expend lots of money

Measures to Control Excess Demand

-Fiscal Policy by Central Givernment: Government Expenduture and Taxes
-Moluntary (Instrument done by Resevered Banks: Banks Rates, etc

Deficit Demand

The opposite of excess demand: there is not enough money, etc

• Prices all Drop and are not enough buyers for it

Government Bidget Overview

• yearly budget report with estimated expenduture
• Aim is to allocate Resources to Increase both Revenue and Social Welfare
• Tax those that have it and give to those that lack it

Government Budget Components

• Two type which is Recipt and Expenduture
• Recipt and Expenduture can either increase Liability or Asset
• Receiving can only happen one to Assets goes DONW or Liabilities goes UP
• Expenduture can only happen if assets Increase or Liabilities Decrease

Recipt Types

• Divided into Revenue or CAPITAL
• Revenue either is Niether create Liabilities or reduce Government Assets or Capital, while The other is either CREAT a Liabiliets OR Reduce the Government Assert
• Revenue always has to Ne Recuring
• Capital NEVER HAS TO RECUR
• Types include Interst
• Types Include Borrowings, such as loans (Borroings increases Liability)
• Another example: Divestment (Reduces the value of assets)

Expenduture Types

• Expenses are divided into Revenue or CAPITOL
• Revenue is recurring, such, salary and maintenence, repairs, etc where Neither does it Create Assets or Reduceds Liabilities
• Capital is Non-Recurring either it creates AN ASERTS, or reduce Liabilities

Types of Budget Balances

• Where (Expenduture (Equall) Recpit = Balanced Budget

• Where Receipets increased, but expenditure is at minimum == Sirplus Balance

• Where Expenditure increases, by Receipets Decrease == Defficit

• The three points that causes defficits is always Reveneue, Fisical(total) And Primary

• If your Revenuse increased (more then recipt === Revenvue Defiicit, similar with all types

• Primary defficit : Fisical-Incereteate

Foreign exchange

• The rates that our government works is
• fixed: the rates are fixed
• floating: Based on market forces and factors
• Managed: Determined by all makets

Balance of payment

• Accounting that record and exports (both imports and out) with the residents or outside -Record Economics Transaction -Has good/vidiable items, services/invidiable iteams, Transter /Unilitateral -Also deals with Landings and capital

Credit and debits

• Has credit and debit Sides depending on Assets