LEARNING OBJECTIVES 1.1 Meaning of Macroeconomics 1.4 Types of Circular Flow 1.2 Circular Flow of Income 1.5 Circular Flow in a Simple Economy 1.3 Stock and Flow (Two-sector Economy) 1.1 MEANING OF MACROECONOMICS The term ‘macro’ has been derived from the Greek ot ‘makrosy which means ‘large’. So, macroeconomics deals with overall performance of the economy. Iris concerned with study of _problems of the economy like inflation, unemployment, poverty, etc. (Macroeconomics is that part of economic theory which studies the behaviour of aggregates of the economy as a whole For example{National income ¥ggregate output, ¥ggregate consumption, ) etc. Its main tools are Aggregate Demand and Aggregate Supply. Difference between Microeconomics and Macroeconomics You have already studied Microeconomics in your previous class. Let us now study the various points of difference between Microegnor jomics and Macroeconomics. — ow Meaning (ow Thcisecoriomes that pat ot ceonGnte ‘Mactoeconomicsis that part ofeconomic ‘Y or? GeY/PC | theory which studies the behaviour of | theory which studies the behaviour of “het Pe _Ccomol & | individual units ofaneconomy. __| aggregates ofthe economy as a whole. WS¥\% “Tools Demand and Supply. Trd?weAy et_| Aggreybts Demand & ASG agate Supply. Basic Objective Itaims to determine price ofa commodity | It aims to determine income and or factors of production. | employment evel of the economy. Itinvolves limited degree of aggregation. | It involves the highest degree of {\.% For example, market demand is derived | aggregation. For example, aggregate © ce by aggregating individual demands of all | demandis derived forthe entire economy. «> . ai buyers in the particular market. eS | __Basic Assumptions _| It assumes all the macro variables to be | Itassumes that all the micro variables, like er se constant.ie,itassumesthatnationalincome, | decisions of households and firms, prices Seb consumption savings etc.areconstant. _| of individual products, etc. are constant. Sab Se CR e \~ 10 : a =PY Introductory Macroeconomic, “price Macroeconomicsisalsoknownas'income 0 known as ‘Pri ‘d Employment Theory’ as itis primarily Microeconomics is als aa Other Name a Tes of commodities concerned with a oflevel of determination of prices o' [eee mena Sn | anil Income, National output. | output, jn p Individual income, individual Examples parate Theory of Macroeconomics ates of the ece working of the economy explain the various macroeconomic core b®?re> Good Need for a Se ad to study the aggreg. Microeconomics failed to study the agg theory, which could explain the jem as well as t0 ¢ snomy asa whole. Asa result, there was : Macroeconomics anced fora separate helps to understand the working of an economic st yurades. SUPP Bx ena x ¢ t ua 1.2. CIRCULAR FLOW OF INCOME eS an i os nite ewlS Ler $ Introduction ; ; The unlimited and recurring wants of human beings have made the production process, a continuous process. In this process, different factors of production: Land, Labour, Capital and Enterprise are combined together for production of goods and services. ' ' + Firms produce goods and services with collective efforts of factors of production supplied by the household sector. © Firm makes payment to the factors of production in the form of rent, wages, interest and profit (known as factor incomes). + The household sector spends this money on the purchase of goods and services produced by the firms. Thus, income flows first from firms to households in the form of factor payments and then, from households to firms in the form of consumption expenditure. Such a flow of money is known as the circular flow of income. Meaning of Circular Flow of Income 1 refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the Jorn of consumption expenditure on goods and services produced by them. Production Phase (Generation of income) Phases of Circular Flow of Income There are 3 different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram: Phase (Distribution of income) 1, Generation Phase: In this phase, firms produce goods and services with the help of factor services, Expenditure Phase (isposition of ncome) Fig.1.1Ss ae chapter? Circular Flow of Income Distribution Phase: This phase involves the flow of factor income (rent, wages, inte} ist | and profit) from firms to the households. | 3, Disposition Phase: In this phase, the income received by factors of production, is spent on the goods and services produced by firms. In this way, income generated in production units reaches back to production units and snakes the circular flow complete. 1.3 STOCK AND FLOW = ‘The concepts of stock and flow are used frequently in macroeconomics. Some of the macro and variables relate to stock, while others relate to flow. Therefore, it is important to unders their meaning so that variables can be categorised as stock or flow. Stock (Stock variable refers to that variable, which is measured at a particular point of time) “For example, stock of goods in the godown as on 31" January, 2024. It means, stock variables are not time dimensional. Some more examples of stock variables are national wealth, national capital, money supply etc. Flow — fivw [I Stock of water (How variable refers to that variable, which is measured inatank over a period of time)For example, production of goods during the month of January 2024, birth rate in the year 2023, national Income in the year 2023 are flow variables. The ‘period of time’ Gould be a day, week) alyear, )It means, flow variables are time dimensional as they are measured for a period of time. Flow of water BS from tank Examples for Better Clarity * The amount of water in tank is the quantity of water in the tank at a given point of time. On the other hand, water flowing into the tank from a tap is a flow of water being added | to the tank per unit of time. | * The total number of houses as on 31° December, 2023 is the stock concept, while the number of houses constructed during the year 2023 is a flow variable. } Difference between Stock and Flow Meaning Stockvariable efersto that varlable, which | Flow variable refers to that variable, which \ is measured at a particular point of time. | is measured over a period of time. Time It does not have a time dimension. Ithas a time dimension as its magnitude Dimension can be measured over a period of time. Nature of concept __| Itisa static concept. Itis a dynamic concept. OdIntroductory Macroeconomics Popul 1, Number of births during 2023, 2. Total number a ae se [3 Revona vest ns 43, Expenditure ortransactionsin money 4, National Wealth. ; : it 4, National Income. 15, Quantity of wheat stored. [eae oes ia as on 31.03.23. Examples Delhi. 1.4 TYPES OF CIRCULAR FLOW “There are two types of circular flows: (i) Real flow: (fl) Money Flow Real Flow Real flow refers to the flow of factor services from households te firms and the corresponding flow of goods and services from firms to houscholds. ‘As scen in the diagram, households provide factor services to goods and services to them as a reward for their productive services: the firms which, in turn, provide + Itis also known as ‘Physical flow’. + Thereis only exchange of goods and services between # of any money. + Real flow determines the magnitude of growth process in an economy. For example, when more factor services are offered to firms, then volume of production will be more and it speeds up the process of economic growth. Money Flow Fig. 1.2 Money Flow refers to flow of factor payments from firms to households for their factor services and corresponding flow of consumption expenditure from households to firms for purchase of goods and services produced by the firms. ) As seen in the diagram, firms make factor Consumption Expenditure payments to households for their factor services (On Goods and Services and households spend this income on purchase of goods and services produced by the firms. * It is also known as ‘Nominal flow’. he two sectors without involvement Factor Services (Land, Labour, Capital & Enterprise) J thy a Goods and Services rl ote * It involves exchange of money between the Factor Payments es (Pent Wages Interest Profit) Difference between Real Flow and Money Flow ea) Meaning It is the flow of goods and services | tisthe flow between firms and households, eS ae Kind of exchange | It Involves exchange of ; i 9 of goods and | Itinvolves exchange of money.Chapter 1 ® Circular Flow of Income = a - - Difficulty in exchange | There may be difficulties of barter system | There isno such difficulty in case of money ___| inexchange of goods and factor services, | flow. Itis also known as Physical Flow. Itis also known as Nominal Flow. “Alternative Name Four Sectors of the Economy The four major sectors in an economy according to the macroeconomic point of view ar 1. Household Sector: It includes consumers of goods and services and also the owners of factors of production. They supply factors like land, labour, capital and entrepreneur and receive income in return in the form of rent, wages, interest and profit respectively. Producing Sector (Firms): It includes all producing firms in the economy. To produce goods and services, the firm hires factors of production from the households. Households consume goods and services to satisfy their wants and firms produce goods and services tomakea profit. 3. Government Sector: It acts in two capacities: + Asa welfare agency, it is involved in maintaining law and order, defence and other services of public welfare. + Asa producer, it produces goods and services in public sector enterprises. 4. Foreign Sector (or External Sector or Rest of the World Sector): This sector includes transactions with the rest of the world. It is involved in export and import of goods and flow of capital between the domestic economy and other countries of the world. 1.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) Asimple economy assumes the existence of only two sectors, i.e. household sector & firm sector. + Households are the owners of factors of production and consumers of goods and services. + Firms produce goods and services and sell them to the households. Itis the simplest form of closed economy”, in which there is no government sector and foreign trade. ty ¥#Ciosed Economy and Open Economy, Closed Economy is an economy which has no economic relations with rest of the world. However, in the current scenario, there is hardly any country which does not have any economic relations with other nations, A closed economy has 3 sectors: Household Sector, Producing Sector and Government Sector, ie. it does not have any Foreign Sector. Open Economy is an economy which has economic relations with rest of the world. In the current scenario, all the nations have economic relations with other nations. An open economy has 4 sectors: Household Sector, Producing Sector, Government Sector and Foreign Sector. In order to make our analysis simple, we take some assumptions: 1. There are only 2 sectors in the economy: Households and Firms. It means, there is no government and foreign sector. So | @@VPPVP@V,; ;\*"|\—\—\—\-, ~ ~- ;- +;Introductory Macroeconomig irms hire factor s Hes factor services only to firms and the fir ervices 2. Household sector supplies only from households. scos and sell heir entire output to the households, duce goods and services and sell their enti ie enlire Grout ; ee ae factor income for their services and spen ton 4. Househo! ds and services. . consumption of tae in the economy, ie, neither the households save from their incomes, 5. ere are No savi Be nor the firms save from their profits. ‘The Circular flow in Two-Sector economy can be better understood with the help of Fig. 14. * The outer loop of diagram shows the real flow, i.e. flow of factor services from households to firms and corresponding flow of goods and services from firms to households. actor Services * The inner loop shows the money flow, ie. flow of factor payments from firms to households and the corresponding flow of consumption expenditure from households to firms. Factor Payment "1 Wages, meres o"* Soods and serviee® Fig. 1.4 Itmust be noted that entire amount of money, which is paid by firms as factor payments is paid back by the factor owners to the firms. So, there isa circular and continuous flow of money income. In the circular flow of income, production generates factor income, which is converted into expenditure, This flow of income continues as production is a continuous activity due tonever- ending human wants. It makes the flow of income circular, ‘Conclusions of Circular Flow ina Simple Economy Ima Two-Sector Economy, the following Conclusions can be drawn: @ Total Production of goods and services by Firms = services by Households. i) Factor Payments by firms = Factor Incomes of households, (i) Consumption Expenditure by households = Factor Income of households. (o) Real Flow in the form of factor services and finel goods and services = } low between firms and households, ee Total Consumption of goods and