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CHAPTER NO 1 Introduction 1 MICRO ECONOMICS The term' Micro’ is derived from the a Greek word ‘MIKROS’ which means ‘small’. so microeconomic is the study of economic actions of individuals. Economic units which are small come under Microeconomic study. Micro means a “Millionth ” part. It deals with a small part or small component of national economy of a country . It is the study of particular unit rather than all units combined. Definitions: According to BOULDING Microeconomics is the study of particular firm, particular household, individual price, wage , income , industry and particular commodity. In the words of Prof . McConnell “Microeconomics is concerned with specific economic units and a detailed consideration of the behavior of those individual units”. MACROECONOMICS The term ‘Macro’ as used in English language is derived from the Greek word ’MAKROS’ which means large. Macroeconomics is the study of economics system as a whole . It is the study of overall conditions of an economy e.g. its total production, total consumption, total saving ,total investment etc. It deals with aggregates such as national income , output , employment and general price level .It is therefore also called ‘aggregate economics'. It thus deals not with one family but with all the families, not with one firm but with all the firms in an economy: not with one industry but with the entire industrial structure of an economy. Definitions: In the words of Boulding .”Macroeconomics deals not with individual quantities as such, but with aggregates of these quantities, not with individual income but with national income , not with individual output but with national output.” According to Shapiro. “Macroeconomics deals with the functioning of the economy as a whole.” OBJECTIVES The objective of studying macroeconomics is to: Help you learn how the national economy works. Enable you to understand such issues as: Why key economic variables are at their present levels? What may be the likely future paths of these variables? Causes and consequences f recessions, inflation, etc. What the government can do about these problems? Side effects of government actions. Pros and cons of free trade versus trade restrictions. IMPORTANT ISSUES IN MACROECONOMICS Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? Why are there recessions? Can the government do anything to combat recessions? Should it?? What is the government budget deficit? How does it affect the economy? Why do the economies have such a huge trade deficit? Why are so many countries poor? What policies might help them grow out of poverty? The field covered by macroeconomics is as under: Macroeconomics studies the concepts of national income , its different elements , methods of its measurement etc. It studies the problems of employment and unemployment . Different factors of determining employment such as aggregate demand , aggregate supply , total consumption, total savings , and total investment etc. Changes in the demand and supply of money have a great bearing on the levels of employment . Thus under macroeconomics functions and theories of money ,banks and financial institutions are studied. Problems concerning inflation ,deflation are part of study of macroeconomics. SCOPE OF MACROECONOMICS CONTINUED Macroeconomics also studies the problems concerning economic growth and standard of living , besides the study of government fiscal and monetary policies it studies the factors and retard growth and those which brings the economy on the path of development. It also studies the principles determining trade among different countries .Policies of free trade and protection , studies of tariffs quota and foreign aid comes under the study of macroeconomics. It deals with the fluctuations in the level of employment ,expenditure and general price level and how these business fluctuations can be controlled. Macroeconomics is the study of aggregate mode model of the economy, with specific focus on problems associated with those models : the problems of growth , business cycles , unemployment , and inflation . The macroeconomic study is designed to explain low supply and demand in the aggregate .Thus the key macroeconomic concepts are growth , business cycles, unemployment, and inflation. Following are the uses of macroeconomics: It is only through macroeconomic analysis that we can have an idea of an economy’s aggregate output, income, consumption, saving , employment and the like . It gives a bird’s eye view of the entire economy. Macroeconomics is of special importance for poor countries in understanding their basic problems and in suggesting various ways and means to reach the destination of economic development. Macroeconomics has brought into light , a great value of the national income and social accounting studies, without which no economic policy or plan can be formulated. Macroeconomics analysis helps us in understanding and regulating the economic fluctuations. Macroeconomics explains level of full employment or near full employment, because all the determinants of employment i.e. aggregate demand and aggregate supply, aggregate consumption, aggregate investment, aggregate savings etc. , come under macroeconomics study. Macroeconomics or economics aggregates provides us great help in understanding inflationary gaps and how to fill up both these gaps. Macroeconomics analysis is suitable to all systems. Capitalistic , socialistic, and mixed economic systems are making use of macroeconomics. Macroeconomics provides modern governments , a solution to the problems of an economy like unemployment , rising and falling prices , problems of over production etc. DIFFERENCE BETWEEN MICRO AND MACROECONOMICS The main difference between micro and macroeconomics are the following: 1. In microeconomics the letter ‘I’ for individuals and in macroeconomics the letter ‘A’ for aggregates is significant. Microeconomics give a microscopic view of some specific component of the economy, whereas , macroeconomics gives a bird’s eye view’ or the macroscopic view of the economy. 2. Microeconomics studies the problems of scarcity and choice at the level of individual ,a household , a firm or an industry, Whereas macroeconomics studies the problems of scarcity and choice at the level of an economy as a whole. 3. Microeconomics and macroeconomics are based on a different set of assumptions. Certain variables are assumed to be constant in microeconomics , whereas they are assumed to be changing in macroeconomics and vice versa. DIFFERENCE BETWEEN MICRO AND MACROECONOMICS CONT….. Allocation of resources is the central issue in microeconomics .Determination of overall level of output (and employment ) is the central issue in macroeconomics. F0cusing on the entire economy , method of study in microeconomics is often described as ‘ general equilibrium analysis’ . On the other hand , focusing on specific market(s) , like commodity market or factor market, method of study of microeconomics is often described as ‘ partial equilibrium analysis’. Microeconomics deals with individual and individuals are mortal . Man dies after passing some lifetime in the world. Therefore , the tool of the study of microeconomics i.e. man is mortal . On the other hand , Macroeconomics is concerned with the aggregate . It studies the problems of the whole economy .The tool of its study is society , Society never ends .Man may come and man may go but the society never ends .So therefore Macroeconomics study is immortal. DIFFERENCE BETWEEN MICRO AND MACROECONOMICS CONT….. Microeconomics analysis is simple , whereas, macroeconomics analysis is complex. In macroeconomics the assumptions of ‘other things being equal ‘ and the assumption of ‘full employment’ are presumed whereas these assumptions have no relevance under macroeconomics. CHAPTER 2 National Income and its Measurement 16 CHAPTER OUTLINE Meaning and definition of NI Significance of National Income Factors effecting the volume of National Income Various concept of NI. Three approaches used to measure NI. 1. 2. 3. Product approach Income approach Expenditure approach Difficulties in measuring NI. 17 Explanation of some terms Goods. All those tangible things which are used to satisfy human needs are called goods. There are two types of goods 1. Consumer goods. Those goods which the consumer are consuming in routine life are called consumer goods. 2. Capital goods. Those goods which are used to produce more goods are called capital goods. Such as plants & machines, buildings etc. 18 Services. All those economic actions which satisfy human wants and needs are done for money rewards are known as services. There are two types of services : 1. Physical service. The service which is done 2. Mental service. That actions which are done mentally physically by a person is known as physical service such as labor, barber, cobbler, tailors etc. for satisfying human needs are called mental services. For example the service of doctor, engineer, professors, etc. 19 DEFINITION TO NATIONAL INCOME National Income is the monetary value of all goods and services produced in a country during the course of one year, including income derived from abroad. 20 IT MAINLY INCLUDE THE OUTPUT OF THE FOLLOWING SECTORS: • • • • • • • Agriculture Industry Natural Resources Trade Transport & communication Health & education Banking 21 SIGNIFICANCE OF NI It seeks to measure the level production in the country in one year. of We can know whether the economy is growing or declining by comparing it with the previous years . 22 CONT`D National income shows contributions by various sectors in the economic development of economy. Living standard and economic welfare of the people can be compared with other countries. 23 From National Income Data we can see the employment situation sector wise. By Looking the National Income Data we can see which sector of the economy is week so we can focus on it to improve its performance. 24 FACTORS INFLUENCING THE VOLUME OF NI: Natural Resources:A Country having large deposits of natural resources will have large production and hence large volume of national income. Human Resources:If the human resources of a country are healthy ,well-educated and trained, the production of the country will be large and hence large volume of national income. 25 Man-made Resources:If man-made sources are greater in number,it will increase the volume of business in the country and hence volume of national income. Credit Facilites:Credit facilities in a country will increase the volume of business activities in a country and hence volume of national income. 26 Technology:A country having advanced technology will have maximum production and hence will have large volume of national income. Political Stability:if a country is politically stable, Local and foreign investment will be high so production and national income will be high. 27 Various Concepts of National Income GDP or ( Gross Domestic Product) GDP shows the money value of all final goods and services produced only within the geographical boundaries of a country using the natural resources of the country. 28 GNP OR ( GROSS NATIONAL PRODUCT) GNP or Gross national product is the money value of all final goods and services produced by the people within and outside the country for one year. GNP = GDP + (exports – imports) Exports of both physical goods and services Import of both physical goods and services 29 NNP OR ( NET NATIONAL PRODUCT) NNP is the monetary value of all output after deducting depreciation allowances from GNP. In producing GNP we consume or use up some capital like equipments and machinery, these capital goods falls in its value due to wear and tear in the production process.This wear and tear of machines is called depreciation. 14 CONT`D Thus : NNP = GNP – Depreciation allowances 31 NDP OR ( NET DOMESTIC PRODUCT) NDP is the monetary value of all output after deducting depreciation allowances from GDP. In producing GDP we consume or use up some capital like equipments and machinery, these capital goods falls in its value due to wear and tear in the production process.This wear and tear of machines is called depreciation. 14 CONT`D Thus : NDP = GDP – Depreciation allowances 33 PI OR ( PERSONAL INCOME) Personal income = National income – Corporate income tax – undistributed profit + transfer payments ( pension, old age benefits, unemployment fund etc) In personal income of an individual direct taxes are also included such as income tax. 34 DPI OR ( DISPOSABLE PERSONAL INCOME) DPI is the amount which is left with individuals after paying direct taxes.This is the money income which individuals can either spend or save as possible as they can according to their needs and wants. DPI = Personal income – Direct tax. DPI = Consumption + Saving 35 PER CAPITA INCOME Per Capita Income is the average income per head of the country. Per Capita Income is obtained by dividing the National Income of a country by its population. Per Capita Income = National Income Population 36 MEASUREMENT OF NI There are three methods which are used to measure National Income: PRODUCTION OR Value Added METHOD Income Method Expenditure Method 37 PRODUCT METHOD OR VALUE ADDED METHOD The national income is calculated by adding up the net values of all production that has taken place in different sectors of economy during a year. in this method the economy is divided into various sectors such as…. Agriculture industry Infrastructure Banking Health Education Transport and communication etc. 38 CONT’D..... The net market or money value of all these sectors is added and the result is coming as national income. Example….. production sectors Net value (billions) Agriculture 340 industry 210 Trade 290 Transport & communication 200 Health & education 250 Banking 160 NATIONAL INCOME 1450 39 PRECAUTIONS REGARDING PRODUCT METHOD OR VALUE ADDED METHOD: Following are the precautions regarding product method or value added method: 1. Value of the sale and purchase of second hand goods is not included in value added. Because , value of second hand goods is already accounted for during the year they were produced. 2. Goods produced for personal use will also be included in estimating value added . Because, these goods are like those produced for market . They are simply not sold owing to their own need by the producer. 3. Value of intermediate goods is not included in the estimation of value added . Because , value of intermediate goods is already included in the value of final goods . 4. Commission earned on account of the sale and purchase of second hand goods is included in the estimation of value added . Because commission is reward for the services rendered. CONTINUE……. 5. Imputed rent on the owner occupied house is also taken into account . Because , all houses have rental value, no matter these are self occupied or rented out. 6. Services for self consumption is not considered while estimating value added . Simply because , it is difficult to estimate their market value , like , for example , services of housewives. 7. Income from illegal activities is not included in national income. INCOME METHOD This approach explains that money value of all the final goods and services produced in a year goes into the hands of the enterpreneure who in turn distribute it among the four factor of production. This constitutes the annual aggregate income/ rewards of the four factors of production, whose sum or total makes the National Income through income method. 42 CONT’D We will make it clear from the following hypothetical table: S.No. Rewards(per annum) Total amount (Billion Dollars) 1 Wages and Salaries 150 2 Interest 50 3 Rent 100 4 Profits 200 National Income 500 43 PROBLEMS REGARDING INCOME METHOD Following are the main difficulties in the use of product method: 1. It is difficult to differentiate between intermediate and final goods. For example a farmer is selling wheat on a flour mill . So for the flour mill the value of wheat is an intermediate good and for the farmer it is final good. Now this flour mill will sell this flour on a baker , so flour is final good for flour mill and intermediate good for the baker. Now the baker will sell it to a shopkeeper. So value of output = $ 40 +$60+ $80+$100 = $280 2. Difficulties in calculating depreciation cost. 3. Difficulty regarding valuation of the product method. 4. Difficulty regarding measuring self consumption goods. 5. Statistical difficulties as in underdeveloped economies farmers and small business firms do not keep proper accounts. EXPENDITURE METHOD The amount of expenditure by the people on consumer goods produced by either the private or public sector and capital goods produced by either the private or public sector and either inside or outside the country, summing up together, would be the National Expenditure/National income. In order to arrive at National Expenditure we would have to calculate various expenditures which are as follow: o Personal consumption expenditure o Gross domestic private investment o Govt. expenditure on goods and services o Gross domestic public investment o Export surplus o Net foreign investment 45 CONT’D We will make it clear with the help of a hypothetical table: S.NO. Items Amount (Billion Dollars) 1 Personal consumption expenditure 400 2 Gross domestic private investment 100 3 Govt. expenditure on goods & services 50 4 + Gross domestic public investment 25 5 Export surplus 10 6 Net foreign investment 15 7 8 9 G.N.P - Depreciation allowances N.N.P 600 25 575 10 + Govt. subsidies 50 11 - Indirect taxes 95 12 - Transfer payment 25 13 - Statistical discrepancy 5 National Income 500 46 DIFFICULTIES IN THE MEASUREMENT OF NATIONAL INCOME So far we have discussed the methods of measuring the National Income. Now we will take up the obstacles which prevent us from arriving at the most appropriate calculation of national income. These difficulties are generally prevailing in the third world countries. shortage of statistical data: one of the main problems in measuring national income is that there is shortage of statistical data. Furthermore, there is also absence of statistical and technical procedures which are not generally adopted and people generally do not keep up to date on their earnings, expenditure etc. Lack of trained manpower: the problem arises as there is a shortage of manpower to be employed to data collect the data regarding national income, for example , in Afghanistan statistical division is unable to provide reliable data on all aspects of the economy. 47