Chapter 5: Economic Analysis – NISM-Series-XV Research Analyst Exam Study Notes Download PDF Book
What are the Basic Principles of Microeconomics
Microeconomics is the study of the behaviour of individuals and their decisions regarding consumption and purchases based on current prices. It investigates how these decisions signal to the economy about where to direct productive activities. Microeconomics believes that consumer demand drives the prices and production levels of goods and services in an economy. It focuses on decision-making drivers and how individual choices impact the overall supply, demand, and pricing of specific goods and services. Additionally, it encompasses the “theory of the firm,” analysing how firms strategize to maximise profits, including decisions about inputs, outputs, prices, production levels, and managing profits and losses.
Topic Pointers:
- Study of Individual Behavior: Microeconomics examines how individuals decide what to buy and consume, influenced by current prices.
- Consumer Demand as a Driver: Emphasises that consumer demand primarily determines the prices and production levels in an economy.
- Focus on Decision Making: Investigates the factors influencing individuals’ choices and how these choices affect supply, demand, and prices.
- Theory of the Firm: Extends to firms, studying their strategies for profit maximisation and decision-making regarding production and pricing.
- Price Determination: Helps understand how prices for goods and services are set in an economy based on individual and firm behaviour.
- Distribution of Goods and Services: Looks at how goods and services are distributed among participants in an economy.
- Understanding Free Market Economy: Microeconomics is essential for comprehending the workings of a free market economy.
- Economic Distribution Analysis: Analyses how goods and services are allocated among various participants in the economy.
Example: Consider a situation where the price of a popular smartphone decreases. Microeconomics would study how this price change influences consumer choices (more people might buy the phone), affects the supply (manufacturers might produce more phones), and impacts the overall market for smartphones. It would also examine how the smartphone company decides on its production levels and pricing strategy in response to consumer demand.
What are the Basic Principles of Macroeconomics
Macroeconomics is the branch of economics that focuses on the economy as a whole, rather than individual households or firms (as in microeconomics). It concentrates on broad economic factors such as unemployment rates, gross domestic product (GDP), overall price levels, inflation, savings and investment rates. These factors are often influenced significantly by public policies, primarily shaped by the government’s fiscal policy and the central bank’s monetary policy. The discipline was greatly influenced by the work of John Maynard Keynes, particularly his book “General Theory of Employment, Interest and Money.”
Topic Pointers:
- Study of the Economy as a Whole: Macroeconomics looks at the “big picture” of the economy, different from microeconomics’ focus on individual entities.
- Key Economic Factors: Focuses on aggregate supply and demand, encompassing variables like unemployment, GDP, inflation, savings, and investment rates.
- Influence of Public Policies: Highlights how changes in government and central bank policies can significantly affect these macroeconomic factors.
- Fiscal and Monetary Policies: Fiscal policy (government decisions) and monetary policy (central bank actions) are major influencers in macroeconomic activity.
- Keynesian Contribution: Emphasises the revolutionary impact of John Maynard Keynes’s work on macroeconomic analysis.
- Economic State Understanding: Helps in understanding the overall condition of an economy, including production, consumption, price levels, growth, and quality of life.
- Income, Savings, and Investment Drivers: Aids in understanding factors driving income, savings, investments, and employment in an economy.
- Policy Formulation Aid: Assists in developing economic policies aimed at long-term growth and stability.
- International Trade Analysis: Facilitates understanding of international trade aspects like exports, imports, balance of payments, and exchange rate dynamics.
- Global Economic Interlinkages: Provides insights into how different economies are interconnected and influence each other.
Example: Consider the impact of a government stimulus package on the national economy. Macroeconomics would analyse how this policy affects overall economic factors like increasing GDP, changing unemployment rates, or influencing inflation levels. It would also look at the broader effects on savings and investment rates across the economy.
Introduction to Various Macroeconomic Variables
In macroeconomics, various variables play a role in shaping the economic stability and growth of a country. Policymakers, such as governments and central bankers, aim to achieve low unemployment rates, price stability, and steady economic growth. However, controlling these variables can be challenging, as economies naturally experience cycles of booms and busts. The effectiveness of policy actions, like adjusting interest rates, can be influenced by uncontrollable factors, leading to varying outcomes in different economic conditions.
Topic Pointers:
- Economic Stability and Growth Goals: Governments and central banks aim to promote economic stability and growth through policy decisions.
- Challenges in Policy Implementation: Despite good intentions, achieving desired outcomes can be difficult due to the complexity of economic variables.
- Key Macroeconomic Goals: These include maintaining low unemployment rates, ensuring price stability with low inflation, and fostering steady growth in economic outputs.
- Impact of Uncontrollable Factors: Various uncontrollable variables can affect the success of policy measures, such as interest rate adjustments.
- Variability in Economic Conditions: Different countries may adopt different strategies based on their specific economic conditions to achieve common macroeconomic goals.
- Example of Policy Limitations: The Reserve Bank of India’s (RBI) efforts to control inflation through interest rate hikes in 2011-2013 were less effective due to persistently high food prices.
- Economic Cycles: Recognition that economies naturally go through cycles of expansion (booms) and contraction (busts).
- Need for Detailed Study: For an in-depth understanding of macroeconomic variables, consultation of specialised books and literature is recommended, as brief definitions provide only a basic overview.
Example: The example of RBI’s intervention in 2011-2013 to control inflation by raising interest rates illustrates the complexity of macroeconomic variables. Despite the standard policy action of increasing rates to reduce inflation, the continued high prices of food items led to the policy not achieving its intended result. This situation highlights the challenges policymakers face in controlling macroeconomic variables, as external factors can significantly impact the effectiveness of their strategies.
What is National Income
National income of an economy is defined as the total value of all final goods and services produced within a country over a specific period of time. It is calculated through measures such as gross domestic product (GDP) and gross national product (GNP).
Topic Pointers:
- National income is measured through three methods:
- Product method: Calculates national income by finding the total value of all final goods and services produced.
- Income method: Sums up all incomes earned by factors of production within the economy.
- Expenditure method: Sums up all expenditures made on final goods and services in the economy.
- Computation of national income involves large-scale data collection on production, income, and spending across all sectors of the economy.
- Key measures are GDP which measures the value of all final goods and services produced within a country, and GNP which measures the value of all final goods and services produced by domestically owned factors of production irrespective of location.
Example: If the GDP of a country in 2022 was $2 trillion, then the national income of that country for 2022 is $2 trillion. This means the total value of all final goods and services produced within that country in 2022 was $2 trillion.
What are Product Method for National Income
The product method measures national income by calculating the aggregate monetary value of all final goods and services produced in the different sectors of the economy like agriculture, industry, and services over a specific time period.
Topic Pointers:
- Final goods refer to goods that reach the end consumers rather than being used in further production processes as intermediate goods.
- The product method sums up the money value of all final goods and services produced sector-wise.
- The sectors included are – agriculture, industry, and services. Output of each sector is calculated separately.
- Intermediate goods which are used up in making final goods are excluded from output calculation to avoid double counting.
- The national income is then estimated by aggregating the final output across the three sectors.
Example: If the final output of agriculture sector was $500 billion, industry sector was $900 billion and services sector was $600 billion in 2022. Then the national income by product method is $500 billion + $900 billion + $600 billion = $2,000 billion for the year 2022.
Income Method for National Income
The income method measures national income as the total factor income earned by all individuals in the economy over a specific time period. As per Robert Kiyosaki, the working population can be categorised into – Employees, Professionals, Entrepreneurs, and Investors.
Topic Pointers:
- Employees earn wages and salaries as factor payments for their labour.
- Professionals like doctors, lawyers etc. earn income by selling their services.
- Entrepreneurs earn profits, including undistributed corporate profits.
- Investors earn interests, rents, and dividends as return for providing capital.
- National income by income method sums up all the above factor payments.
- It includes: Wages & Salaries + Rents & Interests + Profits + Dividends
Example: If total wages and salaries paid in 2022 was $500 billion, total rents and interests earned was $600 billion, total profits and dividends was $900 billion. Then, national income by income method is $500 billion + $600 billion + $900 billion = $2,000 billion for 2022.