National income

accounting, price indices,

capacity utilisation and
unemployment
Mankiw Chapters 1 and 2 and ppt
Introduction

PGP Macroeconomics 2016 2

Introduction to Macroeconomics
“Why do some countries have high rates of inflation while others
maintain stable prices?
“Why do all countries experience recessions and depressions—
recurrent periods of falling incomes and rising unemployment?
“How can government policy reduce the frequency and severity of
these episodes?
“Macroeconomics, the study of the economy as a whole, attempts
to answer these and many related questions.”
Mankiw (2009) 7e p3
“macroeconomists collect data on incomes, prices, unemployment,
and many other variables from different time periods and different
countries. They then attempt to formulate general theories to
explain these data.
“The macroeconomist’s ability to predict the future course of
economic events is no better than the meteorologist’s ability to
predict next month’s weather. But, as you will see,
macroeconomists know quite a lot about how economies work.”
Mankiw (2009) 7e p4

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The 3 main macroeconomic
variables: time series
(historical) data

PGP Macroeconomics 2016 4

US Real GDP since 1900

Source:
Mankiw,
1990

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India GDP at current and constant prices
GDP at market prices (2004-05 = 100) GDP 1950-51
current prices
Rs 104 bn

GDP 1950-51
Rs Billion (log scale)

constant prices
Rs 2,939 bn

GDP 2013-14
current prices
Rs 1,13,551 bn
1958-59

1976-77

1994-95
1950-51
1952-53
1954-55
1956-57

1960-61
1962-63
1964-65
1966-67
1968-69
1970-71
1972-73
1974-75

1978-79
1980-81
1982-83
1984-85
1986-87
1988-89
1990-91
1992-93

1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
GDP 2012-13
Year
constant prices
Constant Prices Current Prices
Rs 61,958 bn

Arindam Das-Gupta
Macroeconomics 1
Measuring Macro Source: Reserve Bank of India, Data Base of the
Aggregates 6 Indian Economy
 Inflation rate in the US Economy from 1900

Source:
Mankiw,
1990

PGP Macroeconomics 2016 7

 Growth rate of GDP at constant and current prices and GDP
deflator inflation rate (2004-05 = 100)
25 20.00

20 15.00

GDP deflator inflation (%)

10.00
15
% growth rate

5.00
10
0.00
5
-5.00

0 -10.00

-5 -15.00
1961-62

1977-78
1979-80

1993-94
1995-96

2011-12
1951-52
1953-54
1955-56
1957-58
1959-60

1963-64
1965-66
1967-68
1969-70
1971-72
1973-74
1975-76

1981-82
1983-84
1985-86
1987-88
1989-90
1991-92

1997-98
1999-00
2001-02
2003-04
2005-06
2007-08
2009-10

2013-14
Year
Current less constant Constant Prices Current Prices

Arindam Das-Gupta
Macroeconomics 1
Measuring Macro
8 Source: Reserve Bank of India, Data Base of the
Aggregates
Indian Economy
 GDP at market and PPP exchange rates

Arindam Das-Gupta
Macroeconomics 1
Source: Samuelson, et. al.(2010), Economics, 19/e,
Measuring Macro 9
Aggregates Special Indian Edition, New Delhi: Tata McGraw Hill
India: per capita income at constant prices
Per Capita Personal Disposable Income (2004 -05 Rs)
40,000
1950-51: Rs 7216.40
35,000 1970-71: Rs 9505.70
1990-91: Rs 12,755.40
30,000
2013-14: Rs 36,116.80
y = 5812.8e0.0235x
2004-05 RUPEES

25,000
R² = 0.8824
20,000

15,000

10,000

5,000

0
1978-79
1950-51
1952-53
1954-55
1956-57
1958-59
1960-61
1962-63
1964-65
1966-67
1968-69
1970-71
1972-73
1974-75
1976-77

1980-81
1982-83
1984-85
1986-87
1988-89
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
Arindam Das-Gupta
Macroeconomics 1
Measuring Macro Source: Reserve Bank of India, Data Base of the
10
Aggregates Indian Economy
 Unemployment in the US Economy since 1900

Source:
Mankiw,
1990

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Unemployment in India
• Developed country unemployment: Frictional, Cyclical and Structural
• Unemployment: % of labour force not having jobs
• Labour force: Persons looking for work
• Discouraged worker effect: Persons dropping out of labour force.
• Sample based measures of unemployment by NSSO or Labour Bureau:
• Usual Principal Status (UPS) basis: not working but seeking/available for work
(i.e. in labour force) for most of the reference year. [2010-11 estimate (labour
bureau) 3.8% of LF]
• Also Usual Principal and Subsidiary Status (UPSS) [3.3%]
• Current Weekly Status (CWS) basis: not worked even for one hour but in labour
force during the reference week [6.3%]
• Current Daily Status (CDS) basis: total person days of unemployment of all
persons in the labour force during the reference week. [4.6%]
• Anatomy of unemployment in India
• Cyclical unemployment of some concern for educated and white collar
• Much more serious is underemployment and disguised unemployment
• Open structural unemployment is much less serious in India (next slide)
Arindam Das-Gupta
Macroeconomics 1 Measuring Macro
Aggregates 12
 Capacity utilisation in India
• Manufacturing/Services capacity utilisation: Unutilised capacity is a more serious
measure of economic weakness than unemployment in developing countries
• No officially accepted measure (unofficial and partial by NCAER, and quarterly by RBI based on IIP for
manufacturing)

Business Cycles (Blue line) and Capacity Utilization (Red line)

2005-Q1 to 2011-Q3. Range of CU: 85% to 100%

Arindam Das-Gupta
Macroeconomics 1
Measuring Macro
Aggregates Source: Mukherjee and Misra, 2012, RBI.
13
Economic Models:
Introduction

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 Economic Models

Source:
Mankiw,
1990
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 Example: The supply-demand model

Qd = D(P,Y) = 60-10P+2Y, Qs = S(P) = 2P,

Source:
Mankiw,
Y = income is exogenous = 50.
1990 Equilibrium Qd = Qs : P = 20, Q = 40
PGP Macroeconomics 2016
16
The major macroeconomics models
• The macro world in short run macro theory has 4 aggregate
markets:
• The goods market
• The money market
• The exchange rate market (or the open economy)
• The labour (or factor) market
• These are looked at in 4 models:
• Goods market only: The Keynesian Cross model
• Goods and money markets: The IS-LM Model
• Subsidiary models: Models of money demand and money supply
• Goods market, money market and exchange rate market (all for an
open economy): The Mundell Fleming model
• Goods market, money market and labour market: Aggregate Supply
and Aggregate Demand (AS-AD) model
• Glance at “The Mother of all Models” Appendix to Ch 13 p405.
• Other models for the long run and very long run will not be
looked at in this course.
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Defining and measuring
GDP

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Stocks and Flows

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 The circular flow of income

Source:
Mankiw, PGP Macroeconomics 2016 20
1990
A more complete Circular Flow

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Measuring National Income
• DEFINITION: GROSS DOMESTIC PRODUCT is: The value of all
final goods and services produced for the marketplace during
a given time period within a country's borders.
• Key concepts:
• Value: market prices or factor cost
• Final vs intermediate goods
• Value added
• Existing versus new (“produced”)
• For the marketplace
(problem of marketed goods: employer marries her/his housekeeper)
• “Within a country’s borders” vs “by a country’s nationals”

• Identities are equations that are always true or true by

definition: (a+b)2  a2 + 2ab + b2

22
Identities: National Income Aggregates
Gross National Product (GNP) less Net Factor Income Payments to Nationals
from the ROW 

Gross Domestic Product less Depreciation (or Capital Consumption

(GDPmp or Y) Allowance) 

Net Domestic Product at Market Prices less Net Indirect Taxes (TI)
(NDPmp) (ie Indirect Taxes less Subsidies) 

NDP at Factor Cost (also called National less Retained Earnings of Corporations
Income or NDPfc) plus Net Transfer Payments from Govt and
Private Organisations 

Personal Income (PI) less Personal Taxes (TP) 

Disposable Income (Yd).

Note: Index of Industrial Production (IIP)

• compiled monthly by CSO
• quick estimate of industrial production and growth used widely for policy
planning and judging state of economy
23
Some rules for computing GDP
1. To add together goods or services of different kinds use their
market value
2. Used goods: Not included in GDP since GDP covers only
production during the year
3. Additions to inventories: These are included (as part of
investment)
4. Intermediate goods and Value Added: Intermediate goods are
goods that exist temporarily in the process of production:
1. Wheat Flour Bread
Since the value of wheat and flour are included in the value of bread
including both in GDP is DOUBLE COUNTING.
Two ways to proceed: Include only the VALUE ADDED at each stage
OR: Include only the value of the FINAL GOOD (bread).
5. Housing services and other imputations such as government
services: If not sold in the market, market prices do not exist:
They have to be imputed (estimated).
1. Problem: Measuring the Underground Economy – not done.

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Nominal versus real GDP
• Nominal GDP: GDP measured in todays prices
• Real GDP (also called GDP in constant prices): GDP
measured in the prices of a chosen BASE YEAR
• Example of real GDP in 2010 in 2009 prices

• The GDP Deflator is the ratio of nominal GDP to real GDP.

The %change in the GDP deflator is used as one of two main
measures of inflation
PGP Macroeconomics 2016 25
GDP from the expenditure side
• Expenditures ≡ Income ≡ Production
• So GDP from the expenditure side is the third way to
measure GDP (besides value added and value of final
goods):
• Expenditure is divide into 4 categories
• Consumption (C): Goods bought for current use
• Investment (I): Goods bought for future use – mainly by
business
• Government expenditure (G): Gods purchased by the
government
• Net exports (NX): The value of net sales to foreigners
(Exports less imports). Can be negative
• If GDP is denoted Y, then Y ≡ C + I + G + NX
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Some macroeconomic identities for a
simplified economy
• Y  C + I + G + (NX) (Income-Expenditure Identity)
• Yd  Y - T (Disposable Income Identity, T  TP - TR)
• Yd  C + S (Household Budget)
• G-T  Fiscal Deficit (Government Budget)
• Above:
• T  Net taxes  Personal Taxes (TP) – Transfers (TR)
• NX: Current account surplus
• S  Household saving
• S-I : Private sector surplus
Fundamental Identity of National Income Accounting
• (S-I) -NX  (G-T)
• “If the fiscal deficit exceeds the private sector surplus, the fiscal deficit
must spill over into foreign markets and affect the current Ac surplus”

PGP Macroeconomics 2016 27

Measures of inflation
• What is a Price Index: A weighted average value of prices of
different goods and services.
• GDP deflator versus Consumer Price Index (CPI)
• GDP deflator: Index of all goods and services produced
• Weights: quantities of goods purchased in the current year (Paasche
Index)
• CPI: Index of all goods and services purchased by consumers.
• Weights: quantities of goods bought in a base year (Laspeyres Index)
• Example:

• What is inflation: The % change in a price index over a

specified time period (usually one quarter or 1 year)
• Can be the annual growth rate (compound growth)
• Or Year-on-year growth rate (growth during past full year)
PGP Macroeconomics 2016 28
Inflation measures in India
• GDP Deflator
• CPI – urban and rural
• Index available monthly
• Wholesale price index (WPI)
• Index available weekly
• Inflation (y-o-y) based on weekly index also called headline inflation
• Core inflation: Manufacturing sector WPI
• Also food inflation
• To be introduced: Producer Price Index (PPI) to replace WPI

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Exercise

PGP Macroeconomics 2016 30

 Solution to exercise 1
2000 2010
Nominal GDP (100*50k)+(500k*10) = (120*60k)+(400k*20) =
10,000k 15200k
2010 Real (120*50k)+(400k*10) =
GDP in 2000 10,000k
prices
Implicit price 15200/10000 = 152
deflator =
GDPn/GDPr
Fixed weight [(100*50K)+(500k*10)*100]/ [(120*60k)+(500k*20)]*100/
price index 10K = 100 [(50k*100)+(10*500k)] = 160
Laspayres Index (fixed weight) overstates inflation and Paasche Index
understates inflation. Geometric average = Fischer’s ideal index

PGP Macroeconomics 2016 31

Example 2
• 1.Robotland is a country which has no government and no interaction with the rest of
the world. It produces only two goods: (i) Screws which are used as intermediate
goods by car firms and also final consumer goods by Robot households; and (ii) Cars
which are a capital good for firms and also a consumer good for households. Cars are
perfectly durable and do not depreciate. The table below gives industry-wise figures
for Robotland for 2088 AD.
Production in Robotland in 2088 AD (All figures are in 1000s of Robotland $)
Industry Gross Value Sales To Sales to Increase in Wages, Rent,
of Output Households Firms Inventories Interest Paid

Screws 200 100 100 -- 100

Cars 300 150 150 20 80

• Note that, as a general rule, cash outlays by firms on investment goods are not
counted as a current cost of production of firms (only depreciation is taken as a
current cost in actual national accounting).
• a. Calculate the total amount of profit made in each sector.
• b. Calculate Robotland's GDP in 2088 AD by the value added, expenditure and
income methods.
• c. Calculate household saving in Robotland.

PGP Macroeconomics 2016 32

Example 2 contd
• d.Suppose that prices of Screws and Cars were $20 and $2000 per unit
respectively in 2088 AD. Assume that production, sales, etc remained the
same in physical units in Robotland in 2089 AD but prices of Screws and
Cars rose by 10% and 5% respectively compared to 2088. Calculate the
GDP deflator and the CPI using 2088 as the base year (for the CPI use
quantities bought by households in 2088 as your fixed bundle of goods).
Solution to ex 2

(a) Profit = Gross revenue – intermediate purchases (excluding additions to inventory)

Screws: 100. Cars: 300 – 80 – 100 = 120
(b) GDP Expenditure side: Consumption (household purchases) 250.
Investment (firm purchases) + addition to inventories: 170
GDP Income side: Income screws: 200.
Income cars: Rent etc + profits + addition to inventories: 80+120+20 = 220
GDP Value added: VA Screws: 200. VA cars (300-100)+20 = 220
(c) Household saving = household income – consumption. Household income = 100+120+
100+80 = 400. Consumption = 250. So saving = 150.
(d) GDP deflator for 2089
[(22x10)+(2100x0.15)] / [(20x10)+ (2000 x 0.15)]
CPI: Same as GDP deflator since no change in quantities between 2088 and 2089.
33
Problem 3
What is the impact of these events on GDP and its
components?
• a. Miss Tina buys a personal computer.
• b. Mr Rashid buys $10,000 of Airtel stock.
• c. Mrs Swamy buys a (recreational) boat from a Goa
shipyard. The shipyard had used components bought from
Japan earlier this year to make the boat.
• d. Vodafone buys $1000 worth of paper clips which are
used up by its office staff during the year.
• e. The government gives all Senior citizens a $100 transfer.

PGP Macroeconomics 2016 34