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CP 102: Managerial Economics Presented to : Dr. Arup Barman (Associate Professor) Presented by : Biswajit Bhattacharjee (19)
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Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Jan 20, 2015

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Page 1: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

CP 102: Managerial Economics

Presented to : Dr. Arup Barman (Associate Professor)

Presented by : Biswajit Bhattacharjee (19)

Page 2: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Contents

• Macro Economics Aggregates, Concept : GNP GDP NNP

..……….• Aggregate Demand and Aggregate Consumption

………...• Gross Domestic Savings and Gross Domestic Capital Formation

…………• WPI, CPI, and Inflation: Indian Scenario; Implication or Business

...……..• Consumption Function

…………

Page 3: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

That branch of economics which determines the level of total economic activity in any nation. For example, macroeconomics studies the gross or total national product, aggregate national income, and general price level.

Introduction to Macroeconomics

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NATIONAL INCOME

CONCEPTS & MEASUREMENT

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• The total market value of all final goods and services produced in the economy in a year.

• It includes payments made to all resources in the form of wages, interest, rent and profits.

INTRODUCTION

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• First, it measures the market value of annual output.

• Second, for calculating national income accurately all goods and services produced in any given year must be counted only once and not more than once

National Income (cont…)

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Gross National Product: It is the total market value of all final goods and services produced in a year. In other words, it is total production by factors of production owed by that nation.

• 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.

CONCEPTS OF NATIONAL INCOME

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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

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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.

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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.

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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.

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DIFFICULTIES IN NATIONAL INCOME MEASUREMENT

• 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.

• Capital gains or loss to property owners excluded from GNP because they do not result from current economic activities.

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DIFFICULTIES IN NATIONAL INCOME MEASUREMENT

• 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.

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In macroeconomics, aggregate demand (AD) is the total demand for final goods and services in the economy (Y) at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country when inventory levels are static.

Aggregate demand

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AD = C+I+G+(X-M)• C is consumption (may also be known as consumer

spending),• I is Investment,• G is Government spending,• X-M is Net export,

– X is total exports, and– M is total imports.

Aggregate demand (cont…)

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Aggregate supply/demand graph

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Aggregate Consumption

• Macroeconomists are interested in aggregate consumption for two distinct reasons.

• First, aggregate consumption determines aggregate saving, because saving is defined as the portion of income that is not consumed.

• Because aggregate saving feeds through the financial system to create the national supply of capital, it follows that aggregate consumption and saving behaviour has a powerful influence on an economy’s long-term productive capacity.

• Second, since consumption expenditure accounts for most of national output, understanding the dynamics of aggregate consumption expenditure is essential to understanding macroeconomic fluctuations and the business cycle.

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Aggregate Consumption (Cont…)

• Microeconomists have studied consumption behaviour for many different reasons, using consumption data to measure poverty, to examine households’ preparedness for retirement.

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Gross Domestic Saving• Gross Domestic Saving is the Gross Domestic Product

minus final consumption.• The saved money is either kept with the public or is

invested back.• When the money is invested back, we come to the figures

known as Capital Formation. The Ratio of saving and investments is very important for the economic health of the country.

• Gross Domestic Saving is different from the Gross National Savings, which is equal to gross domestic savings (gross domestic product minus final consumption) plus net income and net current transfers from abroad.

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Gross Domestic Saving (cont…)

• The Gross Domestic Saving has two parts.

• One is Public Sector, another is Private sector.

• The largest segment of Private sector is the Household sector.

• Another segment of the Private sector is the private corporate sector.

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Gross domestic capital formation

• Capital formation means creation of physical assets and non- physical capital consisting of public health efficiency, visible and no visible capital.

• Gross domestic capital formation is the addition to the capital stock within the domestic territory of a country during a year.

• The surplus of production over consumption during a year adds to the capital stock of a country.

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Gross domestic capital formation (cont…)

• Gross capital formation which includes two components such as (a) Gross domestic fixed capital formation (b) change in stock.

• Gross domestic capital formation includes all expenses made by household, business people and Govt, adding new durable goods to the fixed capital stock of a country.

• These assets are in the form of infrastructure such as buildings, roads canals, bridges, means of transport, machinery and other equipments.

Page 23: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Gross domestic capital formation (cont…)

• The difference between sale and purchase of second hand physical assets from abroad is known as the net purchase of second hand goods from foreign countries. It is also added with the fixed capital formation.

• If a country's purchase of second hand assets is more than its sales of such assets, net purchase will be positive.

• But if the sale is more than the purchase the net purchase is negative.

• A negative purchase of second hand assets will reduce the gross domestic capital formation.

Page 24: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Gross domestic capital formation (cont…)

• The change in stock is a flow concept. The change in stock means the stock of raw-materials, semi-finished and finished goods with the producer households, corporate and semi-corporate enterprises. Charge in stock consists of inventories with firms, charge in stock with the Govt and non-Govt. departmental undertaking, charge in live stock.

• There is a difference between change in stocks and fixed capital formation. Change in stocks is determined by short term demand but fixed capital asset is determined by long term demand.

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The wholesale price index number (WPI) measures the relative changes in the prices of commodities traded in the wholesale market.

The various commodities incorporated in WPI in India are divided into three groups, viz.

(i) Primary articles which include 98 commodities like rice, fruit, pulses, vegetables, etc. and non-food articles like cotton, jute, materials, etc.

Wholesale Price Index (WPI)

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(ii) Fuel, power, light and lubricants which include 19 items like coal, petroleum products, electricity, LPG, etc.

(iii) Manufacturing which includes 318 items like textiles, sugar, paper, machinery, chemicals, fertilizers, leather, etc.

Wholesale Price Index (cont…)

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Uses/Advantages or Importance of Wholesale Price Index

• Forecasting Demand and Supply. An increase in WPI is an indication of excess demand. It is a

situation in which demand is greater than supply. A decrease in WPI implies deficient demand. It is a situation in

which demand is less than supply.• Estimation of Monetary Value and Real Value. The WPI can be used to estimate the monetary value and real

value of aggregates like national income, national expenditure etc.

• Indicator of Rate of Inflation. The WPI is applied to calculate the rate of inflation in a

country.

Page 28: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

It measures the relative amount of money necessary to derive equal satisfaction during two periods of time, after taking into consideration the fluctuations in the retail prices of consumer goods during two periods. It always relates to a specified class of people and a specified geographical area.

Consumer Price Index Number (CPI)

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• Formulation of price policy. The CPI are used by the governments to frame policies.

On the basis of these indices the government decides whether the prices are to be controlled, dual price policy should be adopted etc.

• Wage Adjustment. The rate of dearness allowances are decided by the

government on the basis of these indices. These indices are also used for wage contracts and wage agreements with worker.

• Analysis of Markets. The CPI indices are also used for analysis of the market.

Uses or Importance of Consumer Price Index Number (CPI)

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WHAT CPI MEASURES?• It measures Price changes of fixed market

basket of goods and services of constant quality and quantity.

• It tells how much cost of living has risen or fallen due to price changes irrespective of changes in consumer behaviour or quality of goods.

• It does not reflect the cost of living or in house hold consumption expenditure as such but only the influence of price fluctuation on the trend.

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Selection of Markets/Outlets and Cities• Items are selected on the basis of Family

Budget Survey • Markets are selected through retail and

wholesale trade survey.• Outlets are selected on transaction value

basis.• Cities are selected on population basis• Stratified sampling are used for selection of

cities.

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Limitation of CPI

1) Coverage is limited2) Only covers Urban Centres3) Prices may have different trend in rural &

urban centres.4) Rent is computed through construction

input items index instead of rent survey.5) It measures partially inflation not total

consumer’s expenditure.

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Inflation

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InflationDefined as:

– A SUSTAINED RISE IN THE AVERAGE PRICE LEVEL OVER A PERIOD OF YEARS.

Measured by:

– CONSUMER PRICE INDEX = CPI

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Types of Inflation

A. DEMAND PULLDefined as:

- Excess demand pulls up prices

• Often caused by increases in government spending, such as wars

Page 36: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Types of Inflation (cont…)B. COST PUSHDefined as:

- Rising costs drive up prices

Three types:- Wage-price spiral- Profit-push inflation

- Supply-side shocks

Page 37: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Types of Inflation (cont…)Wage-price spiralRising wages force companies to increase prices.Profit-push inflationIn many industries, there are only a small number of

companies.Easy for them to raise prices to protect their profit

margins.Supply-side shocksDramatic and unexpected increases in the prices of

key materials, such as oil or energy in general.

Page 38: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Who is Hurt by Inflation

PEOPLE ON FIXED INCOMES• Nominal Income Income that has not been adjusted for inflation and

decreasing purchasing power.

• Real Income Real income is the income of individuals or nations after

adjusting the inflation.

Anyone who income is fixed over time finds that their real income falls at the same rate that inflation rises.

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Who is Hurt by Inflation (cont…)

LENDERS/CREDITORSLenders, such as banks and credit card companies, lend money to earn a

profit.– To earn a profit, the interest they charge must cover all costs, and be

higher than the rate of inflation.

When lenders lend money, they have an expected rate of inflation at the time of the loan.

– This expected rate of inflation is based on current rate of inflation, plus a guess about the future.

– If lenders guess right about inflation, they earn a profit.

– If lenders guess wrong, they lose money.

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Inflation: Any Winners?

Not everyone loses with low and moderate rates of inflation.- People whose income is flexible.- Borrowers (debtors).

Borrowers win because the real value of their loan repayments decreases at the same rate as inflation rises.

If their incomes rise as well, they are double winners.

Page 41: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Control of Inflation

• Monetary Measures

• Fiscal Measures

• Other Measures

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Consumption function

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Consumption function

• It was developed by John Maynard Keynes.• The Keynesian consumption function is also known

as the absolute income hypothesis, as it only bases consumption on current income and ignores potential future income.

• The relationship between consumption and income is called the consumption function.

• The consumption function is a single mathematical function used to express consumer spending.

• The function is used to calculate the amount of total consumption in an economy.

Page 44: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

John M. Keynes: Absolute Income Hypothesis

• Consumption is a linear function of disposable personal income,

C = C + cY

C = consumption expenditureY = disposable incomeC = autonomous consumption (intercept of the line)c = marginal propensity to consume (slope of the line)

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Properties of Consumption Function

• Consumption is determined by current income• Marginal propensity to consume (MPC = ΔC/ΔY) is

between zero and one (0<c<1) (Proportion of a small change in the disposable income that would be

spent on consumption instead of being saved).

• Average propensity to consume (APC = C/Y) falls as income rises

(Fraction or percentage of disposable after tax personal income spent for consumer goods. It generally varies with the level of income).

Page 46: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Short-run Consumption Function

Disposable income

Consumption expenditure

C = C + cY

C

c

Constant APC

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Empirical Evidence

• High income families have a higher marginal propensity to save (MPS = 1 – MPC)

• High income families have a higher average propensity to save (APS = 1 – APC); APC falls with the level of income

• In the long-run, autonomous consumption falls to zero (C = 0)

Page 48: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

Long-run Consumption Function

C = ćY

Ĉ

ć

Variable APC; Ĉ = 0

Consumption expenditure

Disposable income

Page 49: Managerial/Business Economics : Macro Economics Aggregates : Concept :GNP GDP NNP : Aggregate Demand and Aggregate consumption : Gross Domestic Savings and Gross

PROBLEMS WITH THEKEYNESIAN CONSUMPTION FUNCTION

Theoretical problem: Why should consumption depend only on current income?

Empirical problem: Microeconomic cross section data suggest that the average propensity to consume falls as income goes up

but

Macroeconomic time series data show that the average propensity to consume does not systematically fall with rising income, but that it isroughly constant

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Bibliography

1. AHUJA H. L. “BUSINESS ECONOMICS” 7th Ed. New Delhi : S. CHAND & COMPANY LTD. PP. 585-590

2. Maheshwari Yogesh “Managerial Economics” Prentice Hall India Pvt., Limited. PP. 1803. HAZARIKA PADMALOCHAN “BUSINESS STATISTICS” New Delhi : S. CHAND & COMPANY LTD.

PP. 338-344

• http://en.wikipedia.org/wiki/Measures_of_national_income_and_output• http://www.gobookee.org/mba-short-notes-of-managerial-economics/• http://www.slideshare.net/BabasabPatil/managerial-economic-notes-1st-sem-mba• http://www.economicsonline.co.uk/Managing_the_economy/National_income.html• http://en.wikipedia.org/wiki/Aggregate_demand• http://www.britannica.com/EBchecked/topic/134578/consumption#ref897189• http://en.wikipedia.org/wiki/Inflation• http://en.wikipedia.org/wiki/Consumption_function• © 2009-2013 http://www.gktoday.in

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