Macroeconomics deals with the aggregate economic variables of an economy. It also takes into account various interlinkages which may exist between the different sectors of an economy.

Macroeconomics emerged as a separate subject in the 1930s due to Keynes.

Circular Flow of Income

The macro economy can be seen as working in a circular way. The firms employ inputs supplied by households and produce goods and services to be sold to households. Households get the remuneration from the firms for the services rendered by them and buy goods and services produced by the firms. Hence you can imagine the aggregate income of the economy going through the two sectors, firms and households, in a circular way.

Aggregate value of goods and services produced in the economy can be calculated by any of the three methods:

  1. measuring the aggregate value of factor payments (income method)
  2. measuring the aggregate value of goods and services produced by the firms (product method)
  3. measuring the aggregate value of spending received by the firms (expenditure method)

The aggregate consumption by the households of the economy is equal to the aggregate expenditure on goods and services produced by the firms in the economy.

In the product method to avoid double counting, you need to deduct the value of intermediate goods and take into account only the aggregate value of final goods and services.

Gross Domestic Product (GDP)

Gross domestic product (GDP) is the market value of all the final goods and services produced within a country (domestic means within a country) in a year.

Net Domestic Product = GDP - Depriciation

Gross National Product (GNP)

Gross National Product (GNP) is the market value of goods and services produced within your country + income from abroad.

GNP = GDP + Incoming Money from Abroad - Outgoing Money to Abroad

GNP = GDP + Factor income earned by the domestic factors of production employed in the rest of the world - Factor income earned by the factors of production of the rest of the world employed in the domestic economy.

Hence, GNP = GDP + Net factor income from abroad

Net National Product = GNP - Depriciation

National Income: Net National Product at factor cost

NNP at factor cost = National Income (NI) ≡ NNP at market prices - (Indirect taxes - Subsidies)

Real GDP and Nominal GDP

If you measure the GDP of a country in two consecutive years and see that the figure for GDP of the latter year is twice that of the previous year, we may conclude that the volume of production of the country has doubled. But it is possible that only prices of all goods and services have doubled between the two years whereas the production has remained constant.

Therefore, in order to compare the GDP figures (and other macroeconomic variables) of different countries or to compare the GDP figures of the same country at different points of time, you cannot rely on GDPs evaluated at current market prices. Real GDP is calculated in a way such that the goods and services are evaluated at some constant set of prices (or constant prices). Nominal GDP is simply the value of GDP at the current prevailing prices.

GDP Deflator: The ratio of nominal to real GDP is called GDP Deflator.

Calculation of GDP

GDP is calculated by three methods. Theoretically, all three of them should give same final number, but in reality there will be slight difference between each of them.

1. Expenditure Method

In this method, calculate the money spent (expenses) by everyone.

GDP (Expenditure) = Consumption + Investment + Government Spending + (Exports - Imports)

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

2. Income Method

In this method, you calculate everyone’s income. But some people may be running business on credit or sometimes payments are delayed. Thus, it may not give the correct picture for the given year.

3. Production Method

Consumer Price Index (CPI)

This is the index of prices of a given basket of commodities which are bought by the representative consumer.