Monetrix The Finance and Economics Club of MDI

Gyaan@ Finstreet Macro Economics Concepts

Monetrix The Finance and Economics Club of MDI Macroeconomics is the field of economics that studies the behaviour of the economy as a whole. It examines whole economic systems and how different sectors interact. It looks at economy-wide phenomena such as changes in unemployment, national income, rate of growth, and price levels. For example, macroeconomics would look at the factors that determine your average living costs. National economic policies and complexities of

industrial production are also studied. It deals primarily with aggregates (total amount of goods & services produced by society) and general level of prices. It addresses issues such as level of growth of national output (GNP & GDP), interest rates, unemployment, and inflation. In this compendium, we would try to understand a few macroeconomic concepts which we daily come across in news, discussions, and economic analysis.

Gross National Product (GNP) GNP stands for the monetary value of all goods and services that are (i) currently produced, (ii) sold through the official market, (iii) not resold or used in further production, (iv) produced by the nationally owned resources (factors of production), and (v) valued at the market prices (current or constant). GNP is a flow concept and includes only those items that are produced during the period of time for which the GNP stands. GNP accounts for only those goods and services, which are traded through the official market. Thus, it ignores the do it yourself activities as well as the un/under reported productions. For instance, housewives activities, social services and other unpaid works are excluded. Similarly, unreported productions triggered by the desire to avoid excise duties or for other reasons are not included in GNP. This gives rise to black or parallel economy, which has two components: legal but un/under reported and illegal like gambling, prostitution, narcotics, smuggling, etc. However, self-consumption of production by the producer and rent on owner-living houses are included in GNP. Intermediate goods are not included in GNP, for avoiding double counting. Therefore, only the value of final goods or alternatively values added at each stage of production are included in it. It excluded non-productive transactions such as purely financial transactions and second hand sales. The former are of three types: public transfer payments, private transfer payments and buying and selling of securities (shares or bonds).

Monetrix The Finance and Economics Club of MDI GNP belongs to the nation, and thus, it must be produced by its owned factors of production only. Since some factors like labour, entrepreneur and capital are globally mobile and MNCs are operating in many countries including India, a part of this GNP is produced abroad and a part of foreign GNP is produced under a national territory. Thus, if an Indian professor takes up a four month Visiting Professorship in a US University, his income in USA is the part of Indias GNP and similarly the profit that a MNC makes in India, is not a part of Indias GNP. GNP at market price is inclusive of the indirect taxes (Ti), net of subsidies (S) as it values the goods at the prices paid by the end users. To get GNP at factor cost (GNP F), one must deduct net indirect taxes from GNPM:

GNPF = GNPM - Ti +S

Gross Domestic Product (GDP) It refers to the value of the goods and services produced within the nations geographical territory, irrespective of the ownership of the resources. Therefore, salary of an Indian visiting professor in USA is the GDP of USA and the dividend earned by a foreign company in India constitutes GDP of India. In view of this, while GNP consists of income produced by the nations owned resources irrespective of the place of production, GDP refers to income produced within the nations territory irrespective of the ownership of the resources that produced it. The difference between the two concepts is accounted for by the net factor income earned abroad (NIA). Thus, GDPF = GNPF -NIA From the point of view of the employment generation at home, GDP is more relevant than GNP, and hence, the former often receives a greater attention than the latter.

Net National Product (NNP) NNP is GNP minus depreciation. NNP is measured at factor cost and market prices. NNPFC = NNPMP - indirect taxes + subsidies NNPFC is globally known as national income. Similarly, NDP is GDP minus depreciation.

Monetrix The Finance and Economics Club of MDI Price Index A price index is a device for measuring price level changes by tracking the price of a designated bundle of goods through time with respect to a base year. A price index will allow us to measure inflation and convert nominals to reals. To construct a price index: 1. 2. 3. 4. Select a base year. Price Index for base year = 100 Select a bundle of goods, whose prices will be monitored over time. Compute the cost of the goods in your bundle in the base year. Compute the cost of the goods in your bundle in the year you wish to compare to the base year (year i). 5. Apply the following formula: PI(i) = (Cost of bundle in year I ) / (Cost of bundle in base year) x 100 where PI(i) is the price index in year i.

Inflation Inflation means a steady and sustained rise in the general level of price. There are as many prices as the number of goods and services. All these individual prices are combined into one, which is called the general (macro) price that is the price of a unit of all goods and services. This general price is obtained as a weighted average of individual prices. The weight of the various component items are determined by the relative significance of that item in all the items during the base period. Now, rate of inflation means the percentage rate of change of this price index. There are six price index series in India: 1. GDP deflator: is a measure of the price of all the goods and services included in GDP. This includes only the final goods. 2. WPI: The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. The Indian WPI figure is released weekly on every Thursday and influences stock and fixed price markets. The Wholesale Price Index focuses on the price of goods traded between corporations. This index is officially used for calculation of inflation. 3. 4. 5. Consumer Price Index for industrial workers (CPI IW) Consumer Price index for rural labourer (CPI RL) Consumer Price Index for agricultural labourer (CPI AL)

Monetrix The Finance and Economics Club of MDI 6. Consumer Price Index for urban non manual employees (CPI UNME) While the CPI UNME is published by Central Statistical Organisation, the others are published by the Department of Labour.

Balance of Payments The balance of payments (BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year. The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). The balance, like other accounting statements, is prepared in a single currency, usually the domestic. Foreign assets and flows are valued at the exchange rate of the time of transaction. According to the IMF definition: "Balance of Payments is a statistical statement that summarizes transactions between residents and nonresidents during a period." The balance of payments comprises the current account, the capital account, and the financial account. Now, the IMF has restated the capital account as the capital and financial account. Together, these accounts balance in the sense that the sum of the entries is conceptually zero. 1. The current account consists of the goods and services account, the primary income account and the secondary income account. It is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). 2. The capital and financial account consists of asset inflows and outflows, such as international purchases of stocks, bonds and real estate. The capital account records all transactions between a domestic and foreign resident that involves a change of ownership of an asset. It is the net result of public and private international investment flowing in and out of a country. This includes foreign direct investment, portfolio investment (such as changes in holdings of stocks and bonds) and other investments (such as changes in holdings in loans, bank accounts, and currencies).

Monetrix The Finance and Economics Club of MDI Exchange Rate The Foreign Exchange Rate is the value of a foreign currency relative to the domestic currency. The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. Earlier, before the Second World War, Gold Standard was used. Therein, a region's common medium of exchange was paper notes that were normally freely convertible into pre-set, fixed quantities of gold. Then the Bretton Woods Agreement came, wherein, after the Second World War, a system similar to a Gold Standard was established. Under this system, many countries fixed their exchange rates relative to the U.S. dollar. The U.S. promised to fix the price of gold at $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold. Later, due to balance of payment crisis and other factors, the exchange rate system was changed to floating exchange rate around 1971. The basic types of exchange rate regimes are: 1. Floating exchange rate, where the market dictates the movements of the exchange rate. Floating rates are the most common exchange rate regime today. For example, the dollar, euro, yen, and British pound all float. However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called managed float or a dirty float. 2. Pegged float, where the central bank keeps the rate from deviating too far from a target band or value. The currency is pegged to some band or value, either fixed or periodically adjusted. 3. Fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar. Fixed rates are those that have direct convertibility towards another currency. In case of a separate currency, also known as a currency board arrangement, the domestic currency is backed one to one by foreign reserves. A pegged currency with very small bands (< 1%) and countries that have adopted another country's currency and abandoned its own also fall under this category.