CBSE Class 12 Economics

What macroeconomics studies

Macroeconomics studies the economy as a whole. It deals with aggregates such as total output, the general price level, total employment, aggregate saving and investment, and the balance between exports and imports. Microeconomics studies how individual units, a single consumer, a single firm or a single market, decide and interact.

The two approaches ask different questions about the same economy. Microeconomics asks why the price of wheat rose, which is a question about one market. Macroeconomics asks why prices in general rose, or why total output fell, which are questions about the whole economy at once. A conclusion that holds for one unit does not always hold for the whole: if a single household saves more, it becomes richer, but if every household saves more and spends less, total demand falls, firms sell less and total income falls.

Macroeconomics is also concerned with the working of government policy. Fiscal policy (taxes and government spending), monetary policy (the supply of money and credit) and the external sector (trade and exchange rates) are all tools whose effects are aggregate.

Goods

Goods are classified by what happens to them in production and use, and the classification matters because national income counts only some of them.

Consumption goods and capital goods

Consumption goods satisfy wants directly. Bread, a bus ticket, a haircut and a television in a living room are consumption goods or services. They can be durable (a refrigerator) or non-durable (milk), but both kinds are consumed by households.

Capital goods are used to produce other goods and are not used up in a single production period. A lathe, a delivery van, a factory building and a computer used for accounting are capital goods. They raise the economy's capacity to produce in future years. The same physical item can be either: a car bought by a household is a consumption good, while a car bought by a taxi company is a capital good. What matters is its use.

Final goods and intermediate goods

Final goods are goods that have reached their final user and will not be processed further or resold within the year. They are bought for consumption or for investment. Intermediate goods are goods used up in a production process within the year, or resold. Flour bought by a bakery to make bread is an intermediate good, while the same flour bought by a household to make chapatis at home is a final good.

The test is again what the good is used for, not what it is. Milk sold to a sweet shop that turns it into sweets is intermediate; milk sold to a family for drinking is final. Capital goods are final goods, even though they help produce other goods, because they are not used up within the year. Their wearing out is counted separately as depreciation.

The distinction exists to prevent double counting. If flour, bread and the bakery's sales were all added to national output, the flour would be counted once as flour and again inside the price of bread. Only final goods are counted, or equivalently only the value added at each stage.

Stocks and flows

A stock is a quantity measured at a point in time. A flow is a quantity measured over a period of time and has a time dimension, such as per month or per year.

A bath filling with water gives the standard picture: the water in the bath at a moment is a stock, and the water running in through the tap each minute is a flow. A flow changes a stock over time. Investment, a flow, adds to the capital stock. National income, output, saving and consumption are flows; capital, wealth and the stock of money are stocks.

Capital, gross investment and depreciation

Capital stock is the total of the capital goods in an economy at a moment. Gross investment is the total addition to the capital stock in a year: the value of new machinery, buildings and other capital goods produced and added, together with any addition to inventories. It includes capital goods bought just to replace worn-out ones.

Depreciation, or consumption of fixed capital, is the loss of value of capital goods in a year through normal wear and tear and expected obsolescence. It does not include losses from rare events such as a flood or an earthquake, which are treated as unexpected.

Net investment is what is left of gross investment after replacing the capital that wore out:

Net investment is the actual increase in the capital stock. If it is zero, the economy is only replacing what it uses, and its productive capacity does not grow. If it is negative, the capital stock is shrinking.

Worked example

An economy has a capital stock of Rs 4,000 crore at the start of a year. During the year it produces new capital goods worth Rs 600 crore, and Rs 250 crore of the existing capital wears out.

The capital stock at the start and the end are stocks; the Rs 600 crore, the Rs 250 crore and the Rs 350 crore are flows over the year.

Other basic ideas

An economic territory is the geographical territory administered by a government, within which people, goods and capital move freely. It includes the country's ships and aircraft operating internationally, its embassies and consulates abroad, and its fishing vessels and oil rigs in international waters. A normal resident is a person or institution whose centre of economic interest lies in the country, who ordinarily lives there and has lived there for a year or more. Domestic income counts what is produced within the economic territory, whoever produces it, while national income counts what is earned by normal residents, wherever it is produced.

Factor income is income paid to the owners of the factors of production: wages and salaries to labour, rent to land, interest to capital and profit to entrepreneurship. Transfer payments are receipts for which nothing is given in return in the current period, such as pensions, scholarships and gifts, and they are not included in national income because no production is behind them.