1. NATIONAL INCOME: CONCEPTS AND MEASUREMENT

1.1 Meaning and Definition

National Income refers to the total value of all final goods and services produced within a country during a given period (usually a year).
It measures the economic performance and living standard of a nation.

$National Income = \sum (Value of Final Goods and Services)$

1.2 Basic Concepts

Concept	Definition	Symbol / Example
GDP (Gross Domestic Product)	Market value of all final goods & services produced within domestic territory.	$G D P = C + I + G + (X - M)$
GNP (Gross National Product)	GDP + Net factor income from abroad (NFIA).	$G N P = G D P + N F I A$
NNP (Net National Product)	GNP – Depreciation (capital consumption allowance).	$N N P = G N P - D e p r e c i a t i o n$
NNP at Factor Cost	NNP at Market Price – Indirect Taxes + Subsidies.	$N I = N N P_{f c}$
Personal Income (PI)	Income received by individuals before tax.	$P I = N I - (U n d i s t r i b u t e d P r o f i t s + C o r p o r a t e T a x e s$ $+ S o c i a l S e c u r i t y) + T r a n s f e r P a y m e n t$
Disposable Income (DI)	Income available for consumption & saving after tax.	$D I = P I - D i r e c t T a x e s$

1.3 Measurement Methods

Output (Production) Method:
- Measures total value added at each stage of production.
- Suitable for industrial economies.
$N I = \sum (V a l u e o f O u t p u t - I n t e r m e d i a t e C o n s u m p t i o n)$
Income Method:
- Sums all factor incomes: wages, rent, interest, profit.
$N I = W + R + I + P$
Expenditure Method:
- Sums all expenditures on final goods & services.
$N I = C + I + G + (X - M)$

1.4 Difficulties in Measurement

Double counting
Non-monetized sector
Illegal income and black money
Imputed values (e.g., owner-occupied housing)
Changing prices (inflation adjustment)

⚙️ 2. DETERMINATION OF OUTPUT AND EMPLOYMENT

2.1 Classical Theory of Employment (Say’s Law)

Core Assumptions:

Flexible prices and wages
Perfect competition
Full employment is the normal situation
Savings automatically equals investment via interest rate adjustment
Money is neutral (only medium of exchange)

Say’s Law of Markets:

“Supply creates its own demand.”

Hence, no general overproduction is possible. Unemployment is voluntary.

2.2 Keynesian Theory of Employment

Keynes (1936) rejected the classical view of automatic full employment.

Main propositions:

Employment depends on effective demand.
Effective Demand = Aggregate Demand (AD) = Aggregate Supply (AS).
Involuntary unemployment can persist due to deficiency of demand.

Aggregate Demand Function:

$A D = C + I$

Aggregate Supply Function:

$A S = f (N)$

Equilibrium Employment:
Occurs when

$A D = A S$ If

$A D < A S$ , unemployment arises.

2.3 Differences between Classical and Keynesian Models

Basis	Classical	Keynesian
Employment Level	Always full employment	May be less than full
Price & Wage	Flexible	Rigid in short run
Interest Role	Balances saving & investment	Investment depends on expectations
Government Role	Laissez-faire	Active fiscal policy
Money	Neutral	Non-neutral (affects output)

🏠 3. CONSUMPTION FUNCTION

3.1 Definition

Proposed by Keynes, the consumption function shows the relationship between consumption (C) and income (Y):

$C = f (Y)$

or $C = a + b Y$

where:

$a$ = autonomous consumption (independent of income)
$b$ = MPC = marginal propensity to consume

3.2 Marginal and Average Propensities

Measure	Formula	Meaning
MPC (Marginal Propensity to Consume)	$\frac{Δ C}{Δ Y}$	Change in consumption per unit change in income
APC (Average Propensity to Consume)	$\frac{C}{Y}$	Fraction of income spent on consumption

3.3 Psychological Law of Consumption (Keynes)

As income increases, consumption increases but by a smaller amount.

Thus: $0 < M P C < 1$

3.4 Determinants of Consumption

Income and wealth
Expectations and confidence
Distribution of income
Rate of interest
Fiscal policy
Credit availability

3.5 Theories of Consumption

Theory	Economist	Main Idea
Absolute Income Hypothesis	Keynes	Consumption depends on current income.
Relative Income Hypothesis	Duesenberry	Consumption depends on relative social status.
Permanent Income Hypothesis	Milton Friedman	Consumption depends on long-term (permanent) income.
Life Cycle Hypothesis	Modigliani	Individuals plan consumption over lifetime.

💸 4. INVESTMENT FUNCTION

4.1 Definition

Investment refers to expenditure on capital goods for future production.

$I = f (r, M E C, E x p e c t a t i o n s)$

4.2 Types of Investment

Induced Investment: Depends on income level.
Autonomous Investment: Independent of income.
Gross vs. Net Investment: Gross includes replacement; net = gross – depreciation.

4.3 Marginal Efficiency of Capital (MEC)

$M E C = \frac{E x p e c t e d A n n u a l R e t u r n s}{S u p p l y P r i c e o f C a p i t a l}$

Investment continues until

$M E C = R a t e o f I n t e r e s t$

4.4 Determinants of Investment

Rate of interest
Business expectations
Technological progress
Demand for products
Government policy
Availability of credit

🔁 5. MULTIPLIER AND ACCELERATOR

5.1 Multiplier Concept (Kahn & Keynes)

An initial increase in investment leads to a multiple increase in income and employment.

$k = \frac{1}{1 - M P C}$

$Δ Y = k \cdot Δ I$

Example:
If $M P C = 0.8$ $M$ , then

$k = 5$ ;
→ ₹1 crore investment increases income by ₹5 crore.

5.2 Accelerator Principle

Investment depends on the rate of change of output or income.

$I_{t} = v (Y_{t} - Y_{t - 1})$

where

$v$ = capital-output ratio.

The accelerator magnifies small changes in income into larger changes in investment.

5.3 Interaction of Multiplier and Accelerator (Super-Multiplier)

When both effects combine, economic fluctuations amplify — explaining business cycles.

💰 6. DEMAND FOR MONEY

6.1 Classical Theory (Quantity Theory of Money)

$M V = P T$

Money demand is only for transactions.
$V$

$V$ and $T$

$T$ are constant → money supply determines price level.

6.2 Keynesian Liquidity Preference Theory

Demand for money arises for:

Transactions motive (M₁)
Precautionary motive (M₂)
Speculative motive (M₃)

$L = L_{1} (Y) + L_{2} (r)$

At equilibrium: $M = L (Y, r)$

6.3 Friedman’s Modern Quantity Theory

$M_{d} = f (Y_{p}, r_{m}, r_{b}, r_{e}, π^{e})$

Money is treated as one of the assets; demand depends on permanent income and returns on other assets.

💵 7. SUPPLY OF MONEY

7.1 Definition

Money supply is the total stock of money (currency + deposits) available in the economy at a given time.

7.2 Measures of Money Supply (India – RBI Classification)

Measure	Components
M1 (Narrow Money)	Currency with public + Demand deposits + Other deposits with RBI
M2	M1 + Post office savings deposits
M3 (Broad Money)	M1 + Time deposits with banks
M4	M3 + Total post office deposits

7.3 High-Powered Money (Reserve Money)

$H = C + R$

where
C = currency held by public,
R = reserves of banks with the central bank.

7.4 Money Multiplier

$m = \frac{1}{C R + R R}$

Total money supply:

$M = m \times H$

🏦 8. IS–LM MODEL APPROACH

8.1 IS Curve (Investment–Saving Equilibrium)

Represents equilibrium in the goods market:

$Y = C (Y) + I (r) + G$

Downward-sloping — as interest rate ↓, investment ↑, output ↑.

8.2 LM Curve (Liquidity–Money Equilibrium)

Represents equilibrium in the money market:

$M / P = L (Y, r)$

Upward-sloping — as income ↑, demand for money ↑ → higher interest rate.

8.3 General Equilibrium

The intersection of IS and LM curves gives simultaneous equilibrium in both goods and money markets.

Situation	Description
IS right of LM	Excess demand → inflationary pressure
IS left of LM	Excess supply → unemployment

8.4 Fiscal and Monetary Policy in IS–LM

Fiscal Policy: Shifts IS curve (ΔG or ΔT).
Monetary Policy: Shifts LM curve (ΔM).
Crowding-out effect: Expansionary fiscal policy may raise interest rates, reducing private investment.

📈 9. INFLATION AND PHILLIPS CURVE

9.1 Inflation

Definition:
Sustained rise in general price level over time.

$I n f l a t i o n R a t e = \frac{P_{t} - P_{t - 1}}{P_{t - 1}} \times 100$

9.2 Types of Inflation

Type	Basis
Demand-pull	Excess aggregate demand
Cost-push	Increase in production costs
Creeping / Galloping / Hyper	Based on speed of inflation

9.3 Phillips Curve (A.W. Phillips, 1958)

Shows an inverse relationship between unemployment and inflation.

Short-run Phillips Curve (SRPC):
Inflation ↓ → Unemployment ↑.

Long-run Phillips Curve (LRPC):
Vertical at natural rate of unemployment (NAIRU).

Milton Friedman:
Argued no long-run trade-off — expectations adjust.

9.4 Expectations-Augmented Phillips Curve

$π = π^{e} - β (u - u_{n})$

where
π = actual inflation, πᵉ = expected inflation, u = unemployment, uₙ = natural rate.

🔄 10. BUSINESS CYCLES

10.1 Definition

Business cycles are recurrent fluctuations in economic activity (output, employment, income) around the long-term growth trend.

10.2 Phases

Expansion – rising output, investment, employment.
Peak – full employment, inflationary pressure.
Recession – decline in output and demand.
Trough – lowest point; high unemployment.
Recovery – renewed growth begins.

10.3 Theories of Business Cycles

Theory	Economist	Key Idea
Monetary Theory	Hawtrey	Fluctuations in credit and money supply
Keynesian Theory	Keynes, Hicks	Demand deficiency and multiplier–accelerator interaction
Schumpeterian Theory	Schumpeter	Innovations and technology cycles
Real Business Cycle Theory	Kydland & Prescott	Productivity shocks drive fluctuations

🏛️ 11. MONETARY AND FISCAL POLICY

11.1 Monetary Policy

Definition: Actions by the central bank to control money and credit to achieve economic stability.

Instruments:

Quantitative: CRR, SLR, Bank Rate, OMO, Repo.
Qualitative: Credit control, moral suasion, margin requirements.

Objectives:

Price stability
Employment
Economic growth
Exchange rate stability

11.2 Fiscal Policy

Definition: Government policy related to taxation, expenditure, and borrowing to influence economic activity.

Policy Type	Description
Expansionary	↑G, ↓T → boosts demand, reduces unemployment
Contractionary	↓G, ↑T → controls inflation

Fiscal Deficit:

$F i s c a l D e f i c i t = T o t a l E x p e n d i t u r e - (R e v e n u e R e c e i p t s + N o n - d e b t C a p i t a l R e c e i p t s)$

$F i sc a l De f i c i t = T o t a l E x p e n d i t u re - (R e v e n u e R ece i pt s + N o n - d e b t C a p i t a l R ece i pt s)$

Crowding Out:
Higher government spending may raise interest rates, reducing private investment.

12. RATIONAL EXPECTATIONS HYPOTHESIS (REH)

12.1 Concept

Proposed by John Muth (1961) and popularized by Robert Lucas (1972).

People form expectations about the future using all available information, including knowledge of government policies.

12.2 Implications

Markets are forward-looking and efficient.
Systematic policy changes (like predictable monetary expansion) have no real effect on output or employment — only on prices.
Economic agents do not make systematic errors.

$Y = Y^{*} + α (π - π^{e})$

→ If expectations are correct,

$π = π^{e}$ , hence $Y = Y^{*}$

12.3 Policy Ineffectiveness Proposition (Lucas)

Under rational expectations, anticipated fiscal and monetary policies are neutral; only unexpected policies can influence real variables.

12.4 Critique of Rational Expectations

Overly idealized: assumes perfect information processing.
Empirical evidence: short-run effects of policy still observed.
Bounded rationality: humans have cognitive limits (Herbert Simon).
Sticky prices and wages: prevent instant adjustment.

Summary Table — Unit 2: Macroeconomics

Topic	Core Concept / Definition	Key Formula / Relation	Major Economist(s)
National Income Accounting	Measures the total market value of all final goods and services produced in a year.	$Y = C + I + G + (X - M)$ ; $G N P = G D P + N F I A$	Simon Kuznets
Classical Employment Theory	Employment determined by real wage, Say’s Law — “Supply creates its own demand.”	$S = I$ via interest rate; $Q = f (L)$	J.B. Say, Ricardo, Pigou
Keynesian Employment Theory	Employment depends on effective demand (AD = AS).	$A D = C + I$ ; equilibrium when $A D = A S$	J.M. Keynes
Consumption Function	Consumption depends on income: $C = a + b Y$	$M P C = \frac{Δ C}{Δ Y}$ $A P C = \frac{C}{Y}$	J.M. Keynes
Theories of Consumption	Consumption behavior: absolute, relative, permanent, life-cycle.	–	Keynes, Duesenberry, Friedman, Modigliani
Investment Function	Investment depends on MEC (expected return) and rate of interest.	$M E C = \frac{R}{C}$ ; invest until $M E C = r$	J.M. Keynes
Multiplier Effect	Change in income due to change in investment.	$k = \frac{1}{1 - M P C}$ ; $Δ Y = k \cdot Δ I$	R.F. Kahn, J.M. Keynes
Accelerator Principle	Investment depends on change in income/output.	$I_{t} = v (Y_{t} - Y_{t - 1})$	J.M. Clark, Samuelson
Super-Multiplier	Combined effect of multiplier and accelerator.	$k^{'} = \frac{1}{1 - b - a v}$	Hicks, Samuelson
Demand for Money (Keynes)	Liquidity preference: transaction, precaution, speculative motives.	$L = L_{1} (Y) + L_{2} (r)$	J.M. Keynes
Modern Demand for Money	Money as an asset; depends on returns on other assets.	$M_{d} = f (Y_{p}, r_{m}, r_{b}, r_{e}, π^{e})$	Milton Friedman
Supply of Money	Total money stock available (currency + deposits).	$M = m \times H$ ; $m = \frac{1}{C R + R R}$	RBI, Friedman
IS–LM Model	Simultaneous equilibrium in goods (IS) and money (LM) markets.	IS: $Y = C + I + G$ : $M / P = L (Y, r)$	Hicks, Hansen
Inflation	Persistent rise in general price level.	$Inflation Rate = \frac{P_{t} - P_{t - 1}}{P_{t - 1}} \times 100$	Fisher, Keynes
Phillips Curve	Short-run trade-off between inflation and unemployment.	$π = π^{e} - β (u - u_{n})$	A.W. Phillips, Friedman
Business Cycles	Recurrent fluctuations in output and employment.	Phases: Expansion → Peak → Recession → Trough → Recovery	Schumpeter, Hicks
Monetary Policy	Central Bank control over money & credit to stabilize economy.	Instruments: CRR, SLR, Repo, OMO	RBI, Keynes, Friedman
Fiscal Policy	Government expenditure and taxation to manage demand.	$FD = T E - (R R + N D C R)$	Keynes
Crowding-Out Effect	Expansionary fiscal policy raises interest rates, reducing private investment.	$Δ I_{p} < 0$ $Δ$ when $i ↑$	Hicks, Hansen
Rational Expectations Hypothesis	People use all available information to form expectations.	$Y = Y^{*} + α (π - π^{e})$	J. Muth, R. Lucas
Policy Ineffectiveness (New Classical)	Anticipated policy changes have no real effect on output.	$π = π^{e} \Rightarrow Y = Y^{*}$	Lucas, Sargent
Critique of REH	Overestimates rationality; ignores sticky prices and bounded rationality.	–	Herbert Simon, Tobin

📚 SUGGESTED READINGS

Mankiw, N.G. – Macroeconomics
Dornbusch & Fischer – Macroeconomics
Ahuja, H.L. – Modern Economics
Froyen, R. – Macroeconomics: Theories and Policies
D.N. Dwivedi – Macroeconomics: Theory and Policy
Blanchard, O. – Macroeconomics
Snowdon & Vane – Modern Macroeconomics: Its Origins, Development and Current State

📚 SUGGESTED READINGS

Mankiw, N.G. – Macroeconomics
Dornbusch & Fischer – Macroeconomics
Ahuja, H.L. – Modern Economics
Froyen, R. – Macroeconomics: Theories and Policies
D.N. Dwivedi – Macroeconomics: Theory and Policy
Blanchard, O. – Macroeconomics
Snowdon & Vane – Modern Macroeconomics: Its Origins, Development and Current State

UGC NET Economics UNIT 2-MACROECONOMICS

1. NATIONAL INCOME: CONCEPTS AND MEASUREMENT

1.1 Meaning and Definition

1.2 Basic Concepts

1.3 Measurement Methods

1.4 Difficulties in Measurement

⚙️ 2. DETERMINATION OF OUTPUT AND EMPLOYMENT

2.1 Classical Theory of Employment (Say’s Law)

2.2 Keynesian Theory of Employment

2.3 Differences between Classical and Keynesian Models

🏠 3. CONSUMPTION FUNCTION

3.1 Definition

3.2 Marginal and Average Propensities

3.3 Psychological Law of Consumption (Keynes)

3.4 Determinants of Consumption

3.5 Theories of Consumption

💸 4. INVESTMENT FUNCTION

4.1 Definition

4.2 Types of Investment

4.3 Marginal Efficiency of Capital (MEC)

4.4 Determinants of Investment

🔁 5. MULTIPLIER AND ACCELERATOR

5.1 Multiplier Concept (Kahn & Keynes)

5.2 Accelerator Principle

5.3 Interaction of Multiplier and Accelerator (Super-Multiplier)

💰 6. DEMAND FOR MONEY

6.1 Classical Theory (Quantity Theory of Money)

6.2 Keynesian Liquidity Preference Theory

6.3 Friedman’s Modern Quantity Theory

💵 7. SUPPLY OF MONEY

7.1 Definition

7.2 Measures of Money Supply (India – RBI Classification)

7.3 High-Powered Money (Reserve Money)

7.4 Money Multiplier

🏦 8. IS–LM MODEL APPROACH

8.1 IS Curve (Investment–Saving Equilibrium)

8.2 LM Curve (Liquidity–Money Equilibrium)

8.3 General Equilibrium

8.4 Fiscal and Monetary Policy in IS–LM

📈 9. INFLATION AND PHILLIPS CURVE

9.1 Inflation

9.2 Types of Inflation

9.3 Phillips Curve (A.W. Phillips, 1958)

9.4 Expectations-Augmented Phillips Curve

🔄 10. BUSINESS CYCLES

10.1 Definition

10.2 Phases

10.3 Theories of Business Cycles

🏛️ 11. MONETARY AND FISCAL POLICY

11.1 Monetary Policy

11.2 Fiscal Policy

12. RATIONAL EXPECTATIONS HYPOTHESIS (REH)

12.1 Concept

12.2 Implications

12.3 Policy Ineffectiveness Proposition (Lucas)

12.4 Critique of Rational Expectations

Summary Table — Unit 2: Macroeconomics

📚 SUGGESTED READINGS

📚 SUGGESTED READINGS

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