UNIT - V: MACRO ECONOMICS & BUSINESS: Nature, concept & Measurement of National Income. Classical and Keynesian approaches; Inflation: Types, causes and measurement of inflation. Philips curve; stagflation; Trade cycles causes and policies to counter trade cycles.

1. Business Economics
V UNIT
Macro Economics and Business
Concept of National Income
National income is an uncertain term which is used interchangeably with national
dividend, national output and national expenditure. On this basis, national income has been
defined in a number of ways. In common parlance, national income means the total value of
goods and services produced annually in a country.
Definitions of National Income:
According to Marshall: “The labour and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material and immaterial
including services of all kinds. This is the true net annual income or revenue of the country or
national dividend.” In this definition, the word ‘net’ refers to deductions from the gross
national income in respect of depreciation and wearing out of machines. And to this, must be
added income from abroad.
The important concepts of national income are:
1. Gross Domestic Product (GDP)
2. Gross National Product (GNP)
3. Net National Product (NNP) at Market Prices
4. Net National Product (NNP) at Factor Cost or National Income
5. Personal Income
6. Disposable Income
Let us explain these concepts of National Income in detail.
1. Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market value
of all final goods and services currently produced within the domestic territory of a country in
a year.
Four things must be noted regarding this definition.
First, it measures the market value of annual output of goods and services currently produced.
This implies that GDP is a monetary measure.
Secondly, for calculating GDP accurately, all goods and services produced in any given year
must be counted only once so as to avoid double counting. So, GDP should include the value
of only final goods and services and ignores the transactions involving intermediate goods.
Thirdly, GDP includes only currently produced goods and services in a year. Market
transactions involving goods produced in the previous periods such as old houses, old cars,
factories built earlier are not included in GDP of the current year.
Lastly, GDP refers to the value of goods and services produced within the domestic territory
of a country by nationals or non-nationals.
2. Gross National Product (GNP): Gross National Product is the total market value of all
final goods and services produced in a year. GNP includes net factor income from abroad
whereas GDP does not. Therefore,
GNP = GDP + Net factor income from abroad.
Net factor income from abroad = factor income received by Indian nationals from abroad –
factor income paid to foreign nationals working in India.

2. 3. Net National Product (NNP) at Market Price: NNP is the market value of all final goods
and services after providing for depreciation. That is, when charges for depreciation are
deducted from the GNP we get NNP at market price. Therefore’
NNP = GNP – Depreciation
Depreciation is the consumption of fixed capital or fall in the value of fixed capital due to
wear and tear.
4.Net National Product (NNP) at Factor Cost (National Income): NNP at factor cost or
National Income is the sum of wages, rent, interest and profits paid to factors for their
contribution to the production of goods and services in a year. It may be noted that:
NNP at Factor Cost = NNP at Market Price – Indirect Taxes + Subsidies.
5. Personal Income: Personal income is the sum of all incomes actually received by all
individuals or households during a given year. In National Income there are some income,
which is earned but not actually received by households such as Social Security
contributions, corporate income taxes and undistributed profits. On the other hand there are
income (transfer payment), which is received but not currently earned such as old age
pensions, unemployment doles, relief payments, etc. Thus, in moving from national income
to personal income we must subtract the incomes earned but not received and add incomes
received but not currently earned. Therefore,
Personal Income = National Income – Social Security contributions – corporate income taxes
– undistributed corporate profits + transfer payments.
Disposable Income: From personal income if we deduct personal taxes like income taxes,
personal property taxes etc. what remains is called disposable income. Thus,
Disposable Income = Personal income – personal taxes.
Disposable Income can either be consumed or saved. Therefore,
Disposable Income = consumption + saving.
MEASUREMENT OF NATIONAL INCOME
Production generate incomes which are again spent on goods and services produced.
Therefore, national income can be measured by three methods:
1. Output or Production method
2. Income method, and
3. Expenditure method.
Let us discuss these methods in detail.
1. Output or Production Method: This method is also called the value-added method. This
method approaches national income from the output side. Under this method, the economy is
divided into different sectors such as agriculture, fishing, mining, construction,
manufacturing, trade and commerce, transport, communication and other services. Then, the
gross product is found out by adding up the net values of all the production that has taken
place in these sectors during a given year.
In order to arrive at the net value of production of a given industry, intermediate goods
purchase by the producers of this industry are deducted from the gross value of production of
that industry. The aggregate or net values of production of all the industry and sectors of the
economy plus the net factor income from abroad will give us the GNP. If we deduct

3. depreciation from the GNP we get NNP at market price. NNP at market price – indirect taxes
+ subsidies will give us NNP at factor cost or National Income.
The output method can be used where there exists a census of production for the year. The
advantage of this method is that it reveals the contributions and relative importance and of the
different sectors of the economy.
2. Income Method: This method approaches national income from the distribution side.
According to this method, national income is obtained by summing up of the incomes of all
individuals in the country. Thus, national income is calculated by adding up the rent of land,
wages and salaries of employees, interest on capital, profits of entrepreneurs and income of
self-employed people.
This method of estimating national income has the great advantage of indicating the
distribution of national income among different income groups such as landlords, capitalists,
workers, etc.
3. Expenditure Method: This method arrives at national income by adding up all the
expenditure made on goods and services during a year. Thus, the national income is found by
adding up the following types of expenditure by households, private business enterprises and
the government: -
(a) Expenditure on consumer goods and services by individuals and households denoted by
C. This is called personal consumption expenditure denoted by C.
(b) Expenditure by private business enterprises on capital goods and on making additions to
inventories or stocks in a year. This is called gross domestic private investment denoted by I.
(c) Government’s expenditure on goods and services i.e. government purchases denoted by
G.
(d) Expenditure made by foreigners on goods and services of the national economy over and
above what this economy spends on the output of the foreign countries i.e. exports – imports
denoted by
(X – M). Thus,
GDP = C + I + G + (X – M).
Keynesian Theory of National Income Determination
According to Keynes, there can be different sources of national income, such as government,
foreign trade, individuals, businesses and trusts.
For determining national income, Keynes had divided the different sources of income
into four sectors namely’ household sector, business sector, government sector, and foreign
sector.
Determination of National Income in Two-Sector Economy:

4. The determination of level of national income in the two-sector economy is based on
an assumption that two-sector economy is an economy where there is no intervention of the
government and foreign trade.
Keynes believed that there are two major factors that determine the national income
of a country. These two factors are Aggregate Supply (AS) and Aggregate Demand (AD) of
goods and services.
In addition, he believed that the equilibrium level of national income can be estimated
when AD=AS. Before representing the relationship between AS and AD on a graph, let us
understand these two concepts in detail.
Aggregate Supply:
AS can be defined as total value of goods and services produced and supplied at a particular
point of time. It comprises consumer goods as well as producer goods. When goods and
services produced at a particular point of time is multiplied by the respective prices of goods
and services, it provides the total value of the national output. The national output is the
aggregate supply in the form of money value. The Keynesian AS curve is drawn based on an
assumption that total income is equal to total expenditure.
The formula used for aggregate income determination:
Aggregate Income = Consumption(C) + Saving (S)
Aggregate Demand:
AD refers to the effective demand that is equal to the actual expenditure. Aggregate effective
demand refers to the aggregate expenditure of an economy in a specific time frame. AD
involves two concepts, namely, AD for consumer goods or consumption (C) and aggregate
demand for capital goods or investment (I).
Therefore, the AD can be represented by the following formula:
AD = C + I
Therefore, AD schedule is also termed as C+I schedule. According to Keynes theory of
national income determination in short-run investment (I) remains constant throughout the
AD schedule, while consumption (C) keeps on changing. Therefore, consumption (C) acts as
the major determinant or function of income (Y).
The consumption function can be expressedas follows:
C = a + bY
Where, a = constant (representing consumption when income is zero)
b = proportion of income consumed = ∆C/∆Y
By substituting the value of consumption in the equation of AD, we get:
AD = a + bY + I

5. The equilibrium condition of national income determination can be expressed as
follows:
Aggregate demand = Aggregate supply
C + I = C-HS
Therefore, I = S
Thus, the national income can be determined by using either aggregate demand and aggregate
supply schedules or investment and savings schedules. These two methods of income
determination are classified as income-expenditure approach and saving- investment
approach.
Income-Expenditure Approach:
Income-expenditure approach refers to the method in which the aggregate demand and
aggregate supply schedules are used for the determination of national income.
In this method, the equilibrium point is achieved when the following condition is
satisfied:
C+I=C+S
As, C + S = Y, therefore, the equilibrium condition of national income determination
would become:
Y = C + I
At equilibrium point, the consumption is equal to:
C = a + bY
Substituting the value of C in the national income equilibrium condition, we get:
Y = a + bY + I
Or, Y (1- b) = a + I
Thus, Y = 1/1-b (a + I)
For the determination of national income with the help of income-expenditure approach, let
us assume that the consumption function is C = 200 + 0.50Y and I = 150.
In such a case, the national income can be calculated as follows:
Y = C + I
Y = 200 + 0.50Y+ 150
Y = 1/1-0.50(200 + 150)
Y = 1/.50(350)
Y = 700
Therefore, the national income equilibrium in this case is at Rs. 700. The graphical
representation of national income determination with the help of income-expenditure
approach is shown in Figure-4:

6. In Figure-4, the schedule of C + S shows the aggregate supply of income while the C + I
schedule denotes the aggregate demand. Aggregate demand schedule is drawn by adding C
and I schedules. Aggregate demand and aggregate supply schedule intersect each other at
point E and the Income level at this point is Rs. 700.
This implies that the national income in the two-sector economy is Rs. 700. In short-
run, the equilibrium point remains constant that is the level of national income remains
constant. If there is any type of increase or decrease in the aggregate supply/demand, then
they themselves fluctuate in a manner, so that they reach back at the equilibrium point.
Saving-Investment Approach:
Saving-investment approach refers to the method in which the saving (S) and investment (I)
are used for the determination of national income. The condition for achieving equilibrium
with the help of saving-investment approach is that the saving and investment are equal (I =
S).
Let us take the previous assumption that consumption function is equal to C = 200 + 0.50 Y
and I = 150 for the determination of national income by using the saving-investment
approach.
In such a case, the saving function can be determined as follows:
Y = C + S
Or,
S = Y-C
S = Y – (a + bY)
S = Y – a – bY
S = -a + (l-b) Y
Therefore, in the present case, the saving function would be:
S = -200 + (1 -0.50) Y
S = – 200 + 0.50 Y
At equilibrium point I = S, therefore, the national income equilibrium would be:
150 = -200 + 0.50 Y
Y= 700

7. The national income level at equilibrium point is same in both the cases, income-expenditure
approach and saving-investment approach. Figure-5 provides a graphical representation of
national income determination by using the saving-investment approach:
In Figure-5, equilibrium point is at E where the investment and saving curve intersects each
other. The national income at equilibrium level is Rs. 700.
Inflation
Inflation and unemployment are the two most talked-about words in the contemporary
society.
These two are the big problems that plague all the economies.
Meaning of Inflation:
Inflation is often defined in terms of its supposed causes. Inflation exists when money supply
exceeds available goods and services. Or inflation is attributed to budget deficit financing. A
deficit budget may be financed by the additional money creation. But the situation of
monetary expansion or budget deficit may not cause price level to rise. Hence the difficulty
of defining ‘inflation’.
Types of Inflation:
As the nature of inflation is not uniform in an economy for all the time, it is wise to distin-
guish between different types of inflation.
A. On the Basis of Causes:
(i) Currency inflation:
This type of inflation is caused by the printing of currency notes.
(ii) Credit inflation:
Being profit-making institutions, commercial banks sanction more loans and advances to the
public than what the economy needs. Such credit expansion leads to a rise in price level.
(iii) Deficit-induced inflation:
The budget of the government reflects a deficit when expenditure exceeds revenue. To meet
this gap, the government may ask the central bank to print additional money. Since pumping
of additional money is required to meet the budget deficit, any price rise may the be called
the deficit-induced inflation.
(iv) Demand-pull inflation:

8. An increase in aggregate demand over the available output leads to a rise in the price level.
Such inflation is called demand-pull inflation
(v) Cost-push inflation:
Inflation in an economy may arise from the overall increase in the cost of production. This
type of inflation is known as cost-push inflation
B. On the Basis of Speed or Intensity:
(i) Creeping or Mild Inflation:
If the speed of upward thrust in prices is slow but small then we have creeping inflation.
(ii) Walking Inflation:
If the rate of annual price increase lies between 3 p.c. and 4 p.c., then we have a situation of
walking inflation. When mild inflation is allowed to fan out, walking inflation appears. These
two types of inflation may be described as ‘moderate inflation’.
(iii) Galloping and Hyperinflation:
Walking inflation may be converted into running inflation. Running inflation is dangerous. If
it is not controlled, it may ultimately be converted to galloping or hyperinflation. It is an
extreme form of inflation when an economy gets shattered.
Causes of Inflation:
Inflation is mainly caused by excess demand/ or decline in aggregate supply or output.
Former is called demand-pull inflation (DPI), and the latter is called cost-push inflation
(CPI).
Factors Affecting Demand:
1. Increase in Money Supply:
Inflation is caused by an increase in the supply of money which leads to increase in aggregate
demand. The higher the growth rate of the nominal money supply, the higher is the rate of
inflation. Modem quantity theorists do not believe that true inflation starts after the full
employment level. This view is realistic because all advanced countries are faced with high
levels of unemployment and high rates of inflation.
2. Increase in Disposable Income:
When the disposable income of the people increases, it raises their demand for goods and
services. Disposable income may increase with the rise in national income or reduction in
taxes or reduction in the saving of the people.
3. Increase in Public Expenditure:
Government activities have been expanding much with the result that government
expenditure has also been increasing at a phenomenal rate, thereby raising aggregate demand
for goods and services. Governments of both developed and developing countries are
providing more facilities under public utilities and social services, and also nationalising
industries and starting public enterprises with the result that they help in increasing aggregate
demand.
4. Increase in Consumer Spending:
The demand for goods and services increases when consumer expenditure increases.
Consumers may spend more due to conspicuous consumption or demonstration effect. They

9. may also spend more whey they are given credit facilities to buy goods on hire-purchase and
instalment basis.
5. Cheap Monetary Policy:
Cheap monetary policy or the policy of credit expansion also leads to increase in the money
supply which raises the demand for goods and services in the economy. When credit expands,
it raises the money income of the borrowers which, in turn, raises aggregate demand relative
to supply, thereby leading to inflation. This is also known as credit-induced inflation.
6. Deficit Financing:
In order to meet its mounting expenses, the government resorts to deficit financing by
borrowing from the public and even by printing more notes. This raises aggregate demand in
relation to aggregate supply, thereby leading to inflationary rise in prices. This is also known
as deficit-induced inflation.
7. Expansion of the Private Sector:
The expansion of the private sector also tends to raise the aggregate demand. For huge
investments increase employment and income, thereby creating more demand for goods and
services. But it takes time for the output to enter the market.
8. Black Money:
The existence of black money in all countries due to corruption, tax evasion etc. increases the
aggregate demand. People spend such unearned money extravagantly, thereby creating
unnecessary demand for commodities. This tends to raise the price level further.
9. Repayment of Public Debt:
Whenever the government repays its past internal debt to the public, it leads to increase in the
money supply with the public. This tends to raise the aggregate demand for goods and
services.
10. Increase in Exports:
When the demand for domestically produced goods increases in foreign countries, this raises
the earnings of industries producing export commodities. These, in turn, create more demand
for goods and services within the economy.
Factors Affecting Supply:
There are also certain factors which operate on the opposite side and tend to reduce the aggre-
gate supply.
Some of the factors are as follows:
1. Shortage of Factors of Production:
One of the important causes affecting the supplies of goods is the shortage of such factors as
labour, raw materials, power supply, capital, etc. They lead to excess capacity and reduction
in industrial production.
2. Industrial Disputes:
In countries where trade unions are powerful, they also help in curtailing production. Trade
unions resort to strikes and if they happen to be unreasonable from the employers’ viewpoint’
and are prolonged, they force the employers to declare lock-outs. In both cases, industrial
production falls, thereby reducing supplies of goods. If the unions succeed in raising money
wages of their members to a very high level than the productivity of labour, this also tends to
reduce production and supplies of goods.
3. Natural Calamities:

10. Drought or floods is a factor which adversely affects the supplies of agricultural products.
The latter, in turn, create shortages of food products and raw materials, thereby helping
inflationary pressures.
4. Artificial Scarcities:
Artificial scarcities are created by hoarders and speculators who indulge in black marketing.
Thus they are instrumental in reducing supplies of goods and raising their prices.
5. Increase in Exports:
When the country produces more goods for export than for domestic consumption, this
creates shortages of goods in the domestic market. This leads to inflation in the economy.
6. Lop-sided Production:
If the stress is on the production of comforts, luxuries, or basic products to the neglect of
essential consumer goods in the country, this creates shortages of consumer goods. This again
causes inflation.
7. Law of Diminishing Returns:
If industries in the country are using old machines and outmoded methods of production, the
law of diminishing returns operates. This raises cost per unit of production, thereby raising
the prices of products.
8. International Factors:
In modern times, inflation is a worldwide phenomenon. When prices rise in major industrial
countries, their effects spread to almost all countries with which they have trade relations.
Often the rise in the price of a basic raw material like petrol in the international market leads
to rise in the price of all related commodities in a country.
Measures to Inflation
The various methods are usually grouped under three heads:
Monetary measures, fiscal measures and other measures.
1. Monetary Measures:
Monetary measures aim at reducing money incomes.
(a) Credit Control
(b) Demonetisation of Currency
(c) Issue of New Currency
2. Fiscal Measures:
Monetary policy alone is incapable of controlling inflation. It should, therefore, be
supplemented by fiscal measures. Fiscal measures are highly effective for controlling
government expenditure, personal consumption expenditure, and private and public
investment.
The principal fiscal measures are the following:
a. Reduction in Unnecessary Expenditure
b. Increase in Taxes
c. Increase in Savings
d. Surplus Budgets
e. Public Debt
3. Other Measures:
The other types of measures are those which aim at increasing aggregate supply and reducing
aggregate demand directly:
a. To Increase Production
b. Rational Wage Policy

11. c. Price Control
d. Rationing
Conclusion:
From the various monetary, fiscal and other measures discussed above, it becomes clear that
to control inflation, the government should adopt all measures simultaneously. Inflation is
like a hydra-headed monster which should be fought by using all the weapons at the
command of the government.
The Phillips curve
The Phillips curve shows the relationship between unemployment and inflation in an
economy. Since its ‘discovery’ by British economist AW Phillips, it has become an essential
tool to analyse macro-economic policy.
Explaining the Phillips curve
The curve suggested that changes in the level of unemployment have a direct and predictable
effect on the level of price inflation. The accepted explanation during the 1960’s was that a
fiscal stimulus, and increase in AD, would trigger the following sequence of responses:
1. An increase in the demand for labour as government spending generates growth.
2. The pool of unemployed will fall.
3. Firms must compete for fewer workers by raising nominal wages.
4. Workers have greater bargaining power to seek out increases in nominal wages.
5. Wage costs will rise.
6. Faced with rising wage costs, firms pass on these cost increases in higher prices.
Exploiting the Phillips curve
It quickly became accepted that policy-makers could exploit the trade off between
unemployment and inflation - a little more unemployment meant a little less inflation.
Stagflation
Definition: Stagflation is stagnant economic growth, high unemployment and high inflation.
It's an unusual situation because inflation is not supposed to occur when the economy is
weak. Consumer demand drops enough to keep prices from rising. Slow growth in a
normal market economy prevents inflation.

12. Causes
Stagflation occurs when the government or central banks expand the money supply at the
same time they constrain supply.
The most common culprit is when the government prints currency. It can also occur when
central bank monetary policies create credit. Both increase the money supply. That creates
the inflation.
At the same time, other policies slow growth. That happens if the government increases
taxes. It can also occur when the central bank raises interest rates. Both prevent companies
from producing more. When conflicting expansionary and contractionary policies occur, it
can slow growth while creating inflation. That's stagflation.
Stagflation in the United States only occurred during the 1970s. The federal government
manipulated its currency to spur economic growth. At the same time, it restricted supply with
wage-price controls.
In 2004, Zimbabwe's policies caused stagflation. The government printed so much money it
went beyond stagflation and turned into hyperinflation.