The classical economist

Department of Distance and Continuing Education, University of Delhi

B.A.(Hons.) Economics - DSC-4
B.A. (Programme) - DSC-3 (Minor)
Semester-II
Course Credit-4
INTRODUCTORY MACROECONOMICS
As per the UGCF - 2022 and National Education Policy 2020

Editorial Board and Content Writers

Editorial Board: Prof. J. Khuntia, Devender
Content Writers: Devender
Academic Coordinator: Deekshant Awasthi

Introductory Macroeconomics: Table of Contents

LESSON 1: Introduction to Macroeconomics (1-11)
LESSON 2: Introduction to National Income Accounting (12-36)
LESSON 3: National Product/National Income (37-75)
LESSON 4: Balance of Payments (76-80)
LESSON 5: Money (81-90)
LESSON 6: Measures of Money Supply (91-96)
LESSON 7: Money and Price (97-103)
LESSON 8: Credit Creation (104-110)
LESSON 9: Demand for Money and its Determinants (111-125)
LESSON 10: Tool of Monetary Policy (126-129)
LESSON 11: Classical Macroeconomics: Equilibrium Output and Employment (130-148)
LESSON 12: Keynesian Macroeconomics: Equilibrium Determination a Multiplier (149-164)
LESSON 13: IS-LM Determination (165-178)
LESSON 14: Fiscal and Monetary Multiples (179-188)

LESSON 1: INTRODUCTION TO MACROECONOMICS

Structure:
- Introduction
  - What is Economics?
  - Scope of Economics: Micro and Macro Economics
  - Major Macroeconomic Issues
- Concepts
  - Stocks and Flows
  - Equilibrium and Disequilibrium
  - Partial and General Equilibrium Analysis
- Methods of Macroeconomic Analysis
  - Static Analysis
  - Dynamic Analysis
  - Comparative Statics Analysis
- Self-Assessment Questions
What is Economics?
- Originated with Adam Smith's "An Inquiry into the Nature & Causes of Wealth of Nations" (1776).
- Derived from Greek words 'oikos' (house) and 'nemein' (to manage), meaning managing a household economically.
- Concerned with allocative decisions of individuals, households, businesses, and how society allocates resources.
- Alfred Marshall defined it as a study of mankind's attainment and use of material requisites of well-being.
Scope of Economics: Micro and Macro Economics
- Modern economics has two branches: Microeconomics and Macroeconomics.
- Before 1930s, focus was primarily on microeconomics.
- John Maynard Keynes' "The General Theory of Employment, Interest & Money" (1936) led to increased interest in macroeconomics.
- Microeconomics: Studies individual decision-making units (consumers, firms), focusing on individual-level problems.
- Macroeconomics: Studies the economy as a whole, dealing with aggregates like national output, price level, employment.
- Macroeconomics is also known as the Theory of Income and Employment.
- Dornbusch & Fischer: Macroeconomics is concerned with the behavior of the economy as a whole - with booms and recessions, the economy’s total output of goods and services and the growth of output, the rates of inflation and employment, the balance of payments, and exchange rates.
- Macroeconomics addresses issues like growth rates, job creation, inflation, balance of payments, and policy effectiveness.
Scope of Macroeconomics Includes:
- Theories and models to explain macroeconomic variables and relationships.
- Analyzing inter-relationships between aggregate economic variables to inform economic policies.
- Studying the effects of government (monetary and fiscal) policies on the economy.
- Exploring consequences of policies aimed at reducing unemployment and maintaining stable prices.
- Providing a framework for economic control and guiding the economy toward growth and stability.
- Improving the long-run competitiveness of the economy.
- Addressing monetary problems, economic fluctuations, unemployment, inflation, and balance of payments issues.
Major Macroeconomic Issues:
- Business Cycles: Fluctuations with stages like boom, recession, depression, and recovery.
- Long-run Economic Growth: Continuous increase in national income and per capita income to improve living standards.
- Overall Living Standard: Economic development linked to social welfare; people's ability to afford necessities.
- Inflation: Continuous rise in prices, addressed through monetary and fiscal policies.
- Unemployment: Addressed through government intervention in economic activities.
- Fiscal Imbalances: Government revenue less than expenditure; managed through fiscal policy.
Concepts:
- Stocks and Flows:
  - Stock: Quantity measured at a point in time.
  - Flow: Quantity measured per unit of time.
  - GDP is a flow variable.
  - Examples: Wealth (stock), Income (flow).
- Equilibrium and Disequilibrium:
  - Equilibrium: Forces are balanced, no tendency to deviate.
  - Disequilibrium: Imbalance due to conflicting economic activities.
- Partial and General Equilibrium Analysis:
  - Partial Equilibrium: Analysis of an isolated part of the economy (based on Ceteris Paribus).
  - General Equilibrium: Analysis of the economic system as a whole, considering inter-relationships.
Methods of Macroeconomic Analysis:
- Static Analysis: Studies economic phenomena under static conditions, ignoring time.
- Dynamic Analysis: Traces changes in macroeconomic variables over time, considering time lags.
- Comparative Statics Analysis: Compares equilibrium positions at different points in time; bridges gaps but doesn't explain the path.
- Dynamic analysis studies the whole path of progress, i.e., ‘how’ an economy moves from one position of equilibrium to the other.

LESSON 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING

Structure:
- Introduction
- Gross Domestic Product (GDP)
  - Rules for Computing GDP
  - Real GDP versus Nominal GDP
  - The GDP Deflator
  - Consumer Price Index
- Other Measures of Income
  - Gross National Product (GNP)
  - Net National Product (NNP)
  - National Income (NI)
  - Personal Income (PI)
  - Personal Disposable Income (DI)
  - Private Saving
  - Public Saving
  - National Saving
  - Distinguish between National Income, National Capital & National Wealth
  - Interest Rate
- The Components of Expenditure (GDP)
  - Consumption (C)
  - Investment (I)
  - Government Purchases (G)
  - Net Exports (NX)
- Income Expenditure and The Circular Flow
  - The Circular Flow in 2-Sector Model
  - Computation or GDP from the Circular Flow
  - The Circular Flow in a Three-Sector Model
Introduction:
- Economists use theory and observation to understand the economy.
- National income accounts (GDP, GNP, etc.) help governments assess and manage economic performance.
- Key statistics: Gross Domestic Product (GDP), Consumer Price Index (CPI), Unemployment Rate.
Gross Domestic Product (GDP):
- GDP is the total market value of all final goods and services produced within a country's borders in a given period.
- $GDP = \text{Market value of goods and services produced in the country} + \text{Income earned in the country by foreigners} - \text{Income received by residents from abroad}$
- Two ways to view GDP: (a) Sum of everyone's income, (b) Total expenditure on goods and services.
Rules for Computing GDP:
- Use market prices to value goods and services.
- Exclude used goods sales.
- Production for inventory increases GDP; sale out of inventory does not affect GDP.
- Include only the value of final goods to avoid double counting.
  - Value Added: Value of a firm's output minus the value of intermediate goods.
- Include imputed values for housing services and government services.
Real GDP versus Nominal GDP:
- Nominal GDP: Value of goods and services at current prices (can be misleading).
- Real GDP: Value of goods and services at constant prices (better measure of economic performance).
GDP Deflator:

$GDP Deflator = \frac{Nominal GDP}{Real GDP} * 100$

$Nominal GDP = Real GDP \times GDP deflator$

$Real GDP = \frac{Nominal GDP}{GDP Deflator}$

Consumer Price Index (CPI):

$CPI = \frac{\text{Total Cost of the goods in the current year}}{\text{Total cost of the goods in the base year}} \times 100$

Inflation Rate:

$Inflation Rate = \frac{P<em>t - P</em>{t-1}}{P_{t-1}} \times 100$

Other Measures of Income:
- Gross National Product (GNP): Total income earned by a nation's residents.
  * $GNP = GDP + \text{Factor payments from Abroad} – \text{factor Payments to Abroad}$
- Net National Product (NNP): GNP - Depreciation.

$NNP = GNP - Depreciation$
* National Income (NI): NNP - Indirect Business Taxes.

$National Income (NI) = NNP - Indirect Business Taxes$
* Personal Income (PI): Total income received by individuals.

$Personal Income = National Income + Dividend + Government Transfers to Individuals + Personal \ Interest \ Income-Corporate \ Profits-Social \ Insurance \ Contributions-Net Interest$

*   Personal Disposable Income (DI): Income available to households after taxes.

$Personal Disposable Income = Personal Income – Personal Tax and non-tax Payments$

*   Private Saving: Private disposable income minus consumption expenditure.

$SPvt. = \text{Private disposable income} – \text{Consumption} = (Y-T+TR+INT+NFP) – C$
S = I + CA

*   Public Saving: Government saving, calculated by deducting government purchases from government income.

$Sgovt. = \text{Net govt. income} – \text{govt. purchase } (T-TR-INT) – G$

*   National Saving: Sum of private and public savings.

$National Saving = SPV+ + SGovt.$
S= SPVT + Sgovt. = (y+NFP – T + TR + INT – C) + (T-TR – INT – G) = Y + NFP – C – G

*   Important equation:

$S = I + CA$
If Investment is greater than National Saving S, then the current account balance will be negative.
The current account balance = (NX + NFP).

*   Interest Rate:
    *   Nominal Interest rate = i
    *   Real Interest rate = r
    *   Expected inflation = 𝜋e

Nominal Interest rate is the summation of real interest rate & expected inflation.

$I = r + 𝜋e$

Real interest rate = I – 𝜋e
Fisher’s effect shows the adjustment Process of the nominal Interest rate to the inflation rate.

Components of Expenditure (GDP):
- Consumption (C): Household spending on goods and services.
- Investment (I): Spending on capital equipment, inventories, and structures.
- Government Purchases (G): Spending by federal, state, and local governments.
- Net Exports (NX): Exports minus imports.
National Income Equation:
- Closed economy: Y = C + I + G
- Open economy: Y = C + I + G + NX
Circular Flow:
- Two-sector model (households and firms)
- Three-sector model (households, firms, and government)
- The circular flow of income and expenditure.

LESSON 3 NATIONAL PRODUCT/NATIONAL INCOME

3.1 INTRODUCTION

NP/NI is a measure of the flow of final goods and services that accrues to the normal residents of a country.
3.2 NATIONAL PRODUCT (NP)/NATIONAL INCOME (NI)
Measure of the total amount of goods and services produced by the normal residents of a country during a given period.
Expressed in money values for aggregation.
Is a flow (measured over a period).
Excludes gifts, aid, and illegal goods; includes only production efforts.
Includes goods and services produced by both market and non-market economies (e.g., foods produced on farms for self-consumption, rental values of owner-occupied houses).
Excludes unpaid services of housewives, family members, and current services of consumer durables.
Includes only final goods and services and excludes intermediate consumption.
Refers to production by normal residents, whether at home or abroad.
- GNP = GDP plus net factor income from ROW (Rest of the World).
- NNP = NDP plus net factor income from ROW (Rest of the World).
  3.3 CLASSIFICATION OF THE PRODUCT AGGREGATES ACCORDING TO BASIS OF VALUATION
Goods and services are valued at market prices (including indirect taxes) and factor costs (excluding indirect taxes).
NP valued at market prices is higher than what accrues to producers as factor incomes by the amount of indirect tax revenue collected by the government.
3.4 FROM NATIONAL PRODUCT TO NATIONAL INCOME
Each of the eight product aggregates has an income counterpart detailing the disbursement of receipts from sale into factor incomes, capital consumption allowances, and indirect taxes.
3.5 DIFFERENT PRODUCT / INCOME AGGREGATES AND THEIR INTER-RELATIONSHIP
GNP is a gross measure of current production, including consumption of fixed capital.
NNP is the measure of the final goods and services produced while keeping the country's capital stock intact (NNP = GNP minus capital consumption).
Gross national income is the income counterpart of GNP and net national income is the income counterpart of NNP.
Personal income is not current production; it is the current incomes of persons: spendable income available to individuals before payment of personal taxes. Its relation to National Income (at factor cost) is as indicated below:
National Income (at factor cost), National debt interest + Other government transfers + Current transfers from ROW
Disposable income is simply after-tax personal income, Out of the disposable income, the amount not spent on consumption constitutes saving
Per capita income is the average income which every resident of a country could get if the total national income was distributed equally among all the inhabitants
3.6 CHANGES IN PRICES: NOMINAL AND REAL NATIONAL INCOME
Goods and services which constitute any national or domestic product aggregate have necessarily to be valued in terms of market prices in order to add them together into a meaningful aggregate, and market prices change over time
GNP at current prices -GNP at constant prices. In order to make the 1984-85 GNP figure comparable with that of 1970-71, we deflate the 1984-85 GNP figure
3.7 MEASUREMENT OF NATIONAL INCOME

Economic Basis of Different Methods
Net Output Method value of final product must equal the sum of the productive contributions of all the production units involved in the production process.
3.8 DIFFERENT METHODS OF MEASUREMENT

Net Output Method (The Production Method), This method is also known is the value-added method
The income method views GDP as the sum of factor incomes plus nonfactor costs of production
The expenditure method (or the final products method) measures NP by tracing the disposition of the final goods and services
It is important to classify Industrial Divisions
3.9 THE INCOME METHOD
this method GDP comes from factor incomes plus nonfactor costs
3.10 THE EXPENDITURE (OR FINAL PRODUCTS METHOD)
GDP is expressed in terms C+G+I
Final is the most import attribute
3.11 NATIONAL INCOME AND ECONOMIC WELFARE
NP is an indicator of the standard of living that society is heading for
Economic Welfare and Welfare in General means human welfare
Distribution of NP and Economic Welfare means that the more equitable the distribution of income in a society, the higher will tend to be the amount of welfare accruing to the society as a whole.
Composition of NP and Welfare, Social Costs of NP and Welfare has Increased sharply as a consequence of industrialisation.
3.12 NATIONAL INCOME ESTIMATION IN INDIA
Sporadic Studies from research workers 1940 to the present
National Income Estimates after Independence
Methods of Estimating National Income in India are done through the product method, income method and expenditure method using different industrial divisions
3.13 DIFFICULTIES IN MEASUREMENT OF NATIONAL INCOME IN INDIA
The is the problem of avoiding double counting, existence of a large non-monetary sector in India makes it difficult to measure the value of a large part of the national product.A lot is estimated through data
misreporting
3.14 NATIONAL CAPITAL: CONCEPT AND MEASUREMENT
Real and Financial Capital helps the the layman determine value, means capital can be used for a variety of things
Three types of capital, capital goods, land -resources, inventories, To measure we determine the advantage of a input-output table

LESSON 4 BALANCE OF PAYMENTS

Introduction: The balance of payments is a systematic record of a country's economic transactions with the rest of the world during a given period.
Current Account: Records transactions arising from trade in goods and services, income, and transfers.
- Goods and services account (visible and invisible items)
- Income account (employee compensation and investment income)
- Current transfers (government and other sectors)
Capital Account: Records transactions related to international movements of ownership of financial assets.
- Capital transfers
- Acquisition/disposal of non-produced, nonfinancial assets
- Financial account
Balance of Trade vs. Balance of Payments
- Balance of trade is a narrow concept, while balance of payments is broader.
- Balance of payments includes imports and exports of goods, services, and capital transfers, while balance of trade includes imports and exports of goods only.
Disequilibrium in Balance of Payments: Disequilibrium occurs when total receipts are greater or less than total payments Causes of Disequilibrium:
- Natural causes: Floods, earthquakes, famines, etc.
- Economic causes: Cyclical fluctuations in business activities, exchange rates changes, foreign capital investment flow.
- Political Factors:: Political disturbances like change of the government etc.
- Social cause.: Changes in tastes, preferences affect imports and exports.
  Correcting Disequilibrium Measures:
- Trade Policy Measures: Policies to promote exports and reduce imports.
- Expenditure-Reducing Policies: Monetary and fiscal policies to reduce aggregate expenditure in the economy.
- Expenditure-Switching Policies: Policies that work through changes in relative prices of imports by making cheaper to domestic produced goods
- Exchange Control : If in the international sphere, rate of exchange is flexible, government need resort to a policy of devaluation.

LESSON 5: MONEY

Introduction: Discusses Money and its function and the inefficiencies of Barter Economy giving necessity to use money.
Kinds of Money:
- Commodity money: commonly demanded commodities used as money and is no more practical
- Metal coins: Pieces of brass, copper, iron, silver & gold then Standard coins were issued in their own image, certifying the weight and quality of the metal, followed soon after by: token money i.e. currency notes.
- Bank money with introduction of the banking system, banks accept deposits which can be withdrawn through cheques, bank drafts .etc
Definition of Money: The most important attribute of money is its general acceptability in exchange transactions and in settlement of debts. Money loses its utility the moment public loses confidence in its acceptability in transactions.
Money is also used as a standard measure (a yardstick) of value; current and future deferred payments.
functions: Medium of Exchange, Measure of Value, Standard of Deferred Payments, Store of Value
Role/Importance/Significance of Money:
- Solves inherent problems of a barter economy
- Used for transactions and debts
- Determines prices of goods and factors
- Facilitates credit & transfer of wealth
- Can provide basis of legal activity to the public
- It can cause hardships in time of fluctuation.

LESSON-6 MEASURES OF MONEY SUPPLY

Introduction : Before discussing the supply of money, let us define the demand for money .Unlike other goods and services, money is not demanded for its own and has no direct utility. There are three motives for the demand of money.
- The transaction and precautionary motives. Those were the classical view based on The function Medium of exchange.
- The speculative motive. That was Keynes view based on The function, store of value.
  6.1.2 Components of Money supply The simplest measure of money-supply (denoted by M or M) consists of currency with the public (notes &coins), demand deposits (DD) at commercial banks and other deposits of the Reserve Bank of India (RBI).
  6.13 As of today. the RBI has been publishing data on four alternative measurers of money-supply, M1, M2, M3, and M4: The four measures of money-supply to represent different degrees of liquidity, M1 being the most liquidity and M4 being the
  least liquidity.

LESSON-7 MONEY AND PRICES

Value of money relates to prices of goods and services.
Quantity Theory of Money suggests price level changes are proportional to money quantity (MV = PT).
Equation Evaluation:
- Income and expenditure affects aggregate demand, output, and employment.

**Quantity Theory of Money: MV + M' V ' = PT. **Criticism:
- Fisher has several oversimplification and his approach to economic thought ignores several important economic elements. Not enough details about its function.
The Income and expenditure Approach The changes depend of income over time
Nominal versus real, how its measured

LESSON 8 CREDIT CREATION

The discussion makes it clear that banks can lend more than their deposits
• Explain the credit creation process in a single banking system & multiple banking system. • What are the limitations of credit Creation? • Write a Short Note on: High Powered Money or Money Multiplier
*What happens to banks when they don't calculate well: then the bank has to suspend payments. For stability, The need for putting a limit on the expansion of credit and through it controlling the total supply of money is necessary
- Key Equations:
  M C D H C R + = + M C D C 1 D D D . M/D. + = Then:
  . C R. /D C + + =. D. The High Lows & Equations:
- m. (.c. rd). .m = 1 + 16H + + A H x C rd . + . h C.I=

LESSON-9 DEMAND FOR MONEY AND ITS DETERMINANTS

9.1 Money markets are the combination of aggregate demand and supply curves.
9.2 Money is demanded by the public for specific reasons. Keynes identified 3 that all are realted to rate of return

Transaction Purpose. These needs are directly related with the level of income & + Propotionalty With the level of Income MP Money is also needed, Precautionary or Speculative Theories of Money Demand 9.3.1 In contrast, according to Keynes some people want cash is Speculation but Tobin Portfolio Theory assumes: people want mixes of assets to be safe, it becomes an function where all are realted
- Md = f(rs, rb, 1re, W)
- Expected Real Return * Expected Risk 9.3 As an alternative , Bauman Tobin focuses on how those mix of assets has the Most efficiency with min costs
  - iY/2N + FN
- dC dN = -iY/2N2 + F -0, N = (square) = 1/2*f
  3 Main Assumptions of: Tobin, Port, Folio
  9.4 Monetary equilibrum is a situation where supply and demand is equal
  Self Assesment (9 questions with answers)

LESSON 10: TOOL OF MONETARY POLICY

Monetary policy: Use of monetary instruments to achieve specified goals.
RBI's Responsibility: Explicitly mandated under the Reserve Bank of India Act, 1934.
The Goal(S) of Monetary Policy primary objective is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
Monetary Pollicy Committee's roles
Under the amended RBI Act, the monetary policy making is as under: • The MPC (Monetary Policy Committee) is required to meet at least four times in a year.
The Central Government Notified in the Official Gazette 4 % . The Monetary Policy Framework the rate set by The Government
Central Authority framework that takes 4 steps
(1) three fiscal variable (2) expenditure on goods and services (3) transfer payments to control working process
In addition there are tools to keep rates as low as possible in Monetary policy The most recent tools and operative rates as released by The Reserve Bank today’s web site instruments such open market options and MSF, changes in SLR, CRR that banks use.

LESSON 11: CLASSICAL MACROECONOMICS: EQUILIBRIUM OUTPUT AND EMPLOYMENT

Classical economics emerged as a revolution against an earlier orthodoxy (Mercantilism).
Main elements The Classical View
- Money has no intrinsic value and view is the “ Wealth of Nations