Macroeconomics: introduction

An economy that has no economic transactions (trade in goods, services, and capital) with the rest of the world.

Disposable income = Personal income − Direct taxes

Direct taxes (income tax, property tax, etc.) are deducted from personal income because they are compulsory payments to the government and are not available to households for spending. The remaining amount is the income that people can freely use for consumption and saving.

Money performs the following functions:

1. Primary functions

• Medium of exchange: Money is generally accepted as a means of payment for goods and services. It removes the need for a double coincidence of wants under the barter system and makes exchange easy.
• Measure of value (unit of account): Money serves as a common unit in which the value of all goods and services is expressed and compared. Prices are quoted in terms of money.

2. Secondary functions

• Store of value: Money can be saved for the future because it is durable and its value is relatively stable. It transfers purchasing power from the present to the future.
• Standard of deferred payment: Money is used to settle debts and future payments such as loans, rent, taxes and salaries. This makes borrowing and lending possible.
• Transfer of value: Money allows purchasing power to be transferred from one person to another or from one place to another easily, for example through cheques, drafts and remittances.

3. Contingent functions

• Distribution of national income: Money helps in distributing national income among the factors of production in the form of rent, wages, interest and profit.
• Basis of credit: Money is the basis of the entire credit system, as loans are granted and repaid in money.
• Store of liquidity and maximisation of satisfaction: Money is the most liquid asset, so people can hold it and use it to buy whatever gives them the greatest satisfaction.

Thus, money acts as a medium of exchange, a measure of value, a store of value and a standard of deferred payment, and it also helps in the smooth working of the economy.

National income is the total value of final goods and services produced in a country in a year. Measuring it faces these difficulties.

1. Non-monetary (subsistence) transactions: Output consumed by farmers or bartered is not sold in the market, so it is hard to value.
2. Unpaid household services: Housework by family members is not counted, which understates income.
3. Double counting: Counting intermediate goods along with final goods overstates the figure.
4. Illegal and black-market activities: Unreported incomes and smuggling are not recorded.
5. Lack of reliable data: Statistics are incomplete or inaccurate, especially from the informal sector.
6. Price changes: Inflation or deflation makes comparison over years difficult unless real values are used.
7. Depreciation estimate: The value of capital consumption is hard to calculate correctly.
8. Public services: Services of government such as defence and administration have no market price.
9. Transfer payments and capital gains: It is difficult to decide whether to include them.

Gross Domestic Product (GDP) is the total market value of all final goods and services produced within the geographical boundary of a country in one year, regardless of whether the producers are citizens or foreigners.

The two primary functions of money are:

1. Medium of exchange: money is generally accepted in payment for goods and services, removing the difficulties of barter.
2. Measure of value (unit of account): the values of all goods and services are expressed in terms of money, as prices.

Secondary functions of money

1. Standard of deferred payments: money is used to settle debts and credit transactions that are payable in the future, since its value is relatively stable and it is generally accepted. Loans, salaries and instalments are expressed in money.
2. Store of value: people can save purchasing power in the form of money and use it later. Money is the most liquid asset.
3. Transfer of value: money allows value to be moved easily from one place to another, and from one person to another, for example by cheque, bank transfer or mobile wallet.

Contingent functions of money

1. Basis of the credit system: banks create credit and lend on the basis of money deposits, and the credit system works through money.
2. Distribution of national income: money helps divide the national product among the factors of production (rent, wages, interest and profit) by fixing their rewards in money.
3. Maximisation of satisfaction: money lets consumers compare the marginal utility of goods with their prices and allocate their income to get maximum satisfaction; producers likewise compare costs and returns.
4. Liquidity and capital formation: money is the most liquid form of wealth, which can be quickly converted to any asset, and it helps to mobilise savings for investment.

Definition

National income is the total money value of all final goods and services produced by the nationals of a country in one year, including net factor income from abroad. Equivalently, it is the total income earned by the factors of production (rent, wages, interest and profit) in a year.

1. Income method

In this method national income is the sum of all incomes earned by the owners of factors of production in a year:

• Rent: income of landowners
• Wages and salaries: compensation of employees, including bonuses and benefits
• Interest: income of capital owners
• Profit: income of entrepreneurs, including corporate profits and mixed income of the self-employed
• Net factor income from abroad (NFIA)

$NI = \text{Rent} + \text{Wages} + \text{Interest} + \text{Profit} + NFIA$

Transfer payments (pensions, scholarships, allowances) and income from sale of second-hand goods are excluded, because they do not reflect current production.

2. Expenditure method

In this method national income is the sum of all expenditure on final goods and services produced in a year:

• Consumption (C): household spending on goods and services
• Investment (I): private investment in capital goods, buildings and changes in inventories
• Government spending (G): government purchases of goods and services
• Net exports $(X - M)$: exports minus imports

$GDP = C + I + G + (X - M)$

Adding net factor income from abroad gives GNI, and subtracting depreciation and indirect taxes plus subsidies gives national income at factor cost:

$NI = GDP + NFIA - \text{Depreciation} - \text{Indirect taxes} + \text{Subsidies}$

Only final goods are counted, to avoid double counting.

Conclusion: Both methods should give the same result because the total value of output equals the total income generated, which equals total expenditure.

National income is the total money value of all final goods and services produced by the nationals of a country in one year, including net income from abroad. It is also the total of incomes (rent, wages, interest and profit) earned by the factors of production in a year.

Money supply is the total stock of money available in an economy at a particular time, held by the public. It includes currency (notes and coins) in circulation and deposits with banks, such as demand deposits, as defined by the central bank (for example, M1 and M2).

Expenditure method of measuring national income

The expenditure method measures national income by adding up all the spending made on final goods and services produced in the economy in a year. It follows from the idea that whatever is produced is bought by someone, so total output equals total expenditure.

Components

1. Private consumption expenditure (C): spending by households on durable goods, non-durable goods and services.
2. Gross private domestic investment (I): spending by firms on machinery, buildings, equipment and additions to inventories.
3. Government final consumption expenditure (G): government spending on goods and services, such as salaries, defence, health and education. Transfer payments are excluded.
4. Net exports $(X - M)$: export earnings minus import payments.

$GDP_{MP} = C + I + G + (X - M)$

From GDP to national income

$GNI = GDP + \text{Net factor income from abroad}$ $NNI_{FC} = GNI - \text{Depreciation} - \text{Indirect taxes} + \text{Subsidies}$

Precautions

• Only final goods and services are counted, to avoid double counting.
• Transfer payments and purchases of second-hand goods and financial securities are excluded.
• Imports are deducted because they are not produced domestically.
• Production for self-consumption should be estimated at market value.

Difficulties: unrecorded transactions in the informal sector, non-monetary activities, and poor data make accurate measurement hard in countries like Nepal.

Money is anything generally accepted as a medium of exchange and a means of settling debts. Its functions are grouped as primary and secondary.

Primary functions

1. Medium of exchange: Money removes the need for barter, where a double coincidence of wants was required. A farmer sells rice for Rs and uses those rupees to buy cloth, so exchange is split into two easy steps: sale and purchase.
2. Measure of value (unit of account): The value of every good and service is expressed in money prices, such as Rs 120 per kg of rice. This makes it easy to compare values, keep accounts and calculate profit and loss.

Secondary functions

1. Store of value: Money lets people keep purchasing power for the future. Income received today can be saved in cash or a bank and spent later. This function weakens when inflation is high.
2. Standard of deferred payments: Loans, rent, salaries and instalments to be paid in the future are fixed in money terms, which makes credit contracts possible.
3. Transfer of value: Money moves purchasing power from one person or place to another, for example by cheque, bank transfer or remittance to a village from abroad.

The primary functions are the basic reasons money exists. The secondary functions follow from them and add convenience to modern credit and saving.

Inflation is a continuous and general rise in the price level of goods and services over time, which reduces the purchasing power of money.

Gross National Product (GNP) is the total market value of all final goods and services produced by the nationals of a country in one year, wherever they live. $GNP = GDP + \text{net factor income from abroad}$.

The circular flow of income shows how income and expenditure move continuously between the sectors of an economy. A two-sector economy has only households and firms, with no government, no foreign trade, and no saving or investment.

Roles

1. Households own the factors of production (land, labour, capital and entrepreneurship) and are the consumers of goods and services.
2. Firms are the producers. They hire factors from households and sell goods and services to them.

Flows

1. Real flow: Households supply factor services to firms, and firms supply goods and services to households.
2. Money flow: Firms pay households rent, wages, interest and profit (factor income), and households spend this income on firms' products (consumption expenditure).

Diagram (described): Draw firms and households as two boxes. The upper loop carries factor services from households to firms and factor payments (income) from firms to households. The lower loop carries goods and services from firms to households and consumption expenditure from households to firms. The loops form a circle.

Equilibrium

Since households spend all their income, there are no leakages or injections:

$\text{Income }(Y)=\text{Expenditure }(C)=\text{Output}$

So national income measured by the income method, the expenditure method and the product method gives the same value.

In a real economy, saving, taxes and imports are leakages, while investment, government spending and exports are injections.

National income is the total money value of all final goods and services produced by a country in one year, together with net income from abroad.

Methods of measuring national income

1. Product (output or value-added) method: National income is found by adding the value added by all producing sectors, or the market value of all final goods and services, avoiding double counting. $GDP=\sum \text{value added}$
2. Income method: The incomes earned by factors of production in producing output are added up: wages and salaries, rent, interest, profit and mixed income, plus net factor income from abroad.
3. Expenditure method: All spending on final goods and services is added up: $GDP=C+I+G+(X-M)$ where $C$ is consumption, $I$ investment, $G$ government spending, $X$ exports and $M$ imports.

In theory all three methods give the same result.

Challenges in Nepal

1. Large non-monetary (subsistence) sector: Much farm output is consumed by the producer and not sold, so it is difficult to value.
2. Unorganised and informal sector: Small businesses, street trade and home production keep no records.
3. Illiteracy and lack of accounts: Many producers do not keep accounts and give incorrect information.
4. Lack of reliable data: Statistics are incomplete and scattered, and the statistical system is weak.
5. Unpaid household work: The work of housewives and family labour is not counted.
6. Illegal and hidden activities: Smuggling, tax evasion and black-market trade are not recorded.
7. Remittance and informal transfers: Money sent through hundi is not recorded.
8. Double counting and price changes: Difficulty in separating final from intermediate goods, and in adjusting for inflation to find real income.

Conclusion: Because of these difficulties, Nepal's national income figures are only estimates. Better statistics, more formal records and improved surveys are needed.

Personal income is the total income received by individuals and households from all sources (wages, rent, interest, profit and transfer payments) in a year, before personal income tax is deducted.

Per capita income is the average income per person in a country, found by dividing national income by the total population:

$\text{Per capita income}=\frac{\text{National income}}{\text{Population}}$

Money is anything that is generally accepted as a medium of exchange and a measure of value, and by which debts are settled. Examples are coins, notes and bank deposits.

Primary functions

1. Medium of exchange: Money is accepted in exchange for goods and services, removing the problem of double coincidence of wants in barter.
2. Measure of value (unit of account): Money expresses the value of all goods in a common unit, which makes comparison and accounting easy.

Secondary functions

1. Standard of deferred payments: Money is used to settle credit and loans in the future, because it has a stable value over time.
2. Store of value: Money lets people save purchasing power to use later.
3. Transfer of value: Money allows value to be moved from one place or person to another easily.

Contingent (additional) functions, sometimes also noted: money helps in the distribution of national income among factors of production, acts as the basis of credit, and provides liquidity and a measure of the net worth of assets.

Conclusion: The primary functions give money its essential character, and the secondary functions arise from them and make the economy run smoothly.

The measurement of national income is more difficult in developing countries like Nepal than in developed countries for the following reasons.

1. Large non-monetised sector: Much of agriculture is subsistence-based, and many goods are consumed by the producer or bartered. These have no market price, so they are hard to value.
2. Illiteracy and poor record-keeping: Many farmers and small traders do not keep accounts, and cannot give accurate information.
3. Large informal sector: A large share of activities, such as street vending, home production and small workshops, is unregistered and untaxed.
4. Unreliable and inadequate statistics: Data collection systems are weak, with limited trained staff and resources.
5. Occupational specialisation is lacking: People work in more than one occupation, such as farming and wage labour, which makes classifying output difficult.
6. Unpaid family labour: Housework and family work in farms and businesses go unrecorded.
7. Illegal activities and tax evasion: Smuggling, black-market incomes and under-reporting of income reduce accuracy.
8. Remittance and open border: Large remittance inflows and trade through the open border with India are difficult to measure.
9. Double counting and depreciation: With few clear records, intermediate goods and capital consumption are hard to separate.

For these reasons, estimates of national income in Nepal are only approximate and usually lower than the true figure.