Chapter 5: MACROECONOMICS
Developing and Developed economies
The World Bank in its World Development Report (2010)
classified the various countries on the basis of Gross
National Income (GNI) per capita
Developing countries are divided into
Low income countries with 2009 GNI per capita of $ 936 and below
Middle income countries with GNI per capita ranging
between $ 936 and $ 11,455
High income Countries which are mostly members of the Organisation for Economic Cooperation and Development and have Per capita GNI of $11456 or more.
Middle income countries are currently 72% of all countries of the world followed by high income (16%) and then low income (11%).
World Bank, World Development Indicators show that have a high average annual growth rate of GDP than middle income and high income economies.
However not all high income economies are developing as oil exporting countries are not developed but have a high income due to exports.
BASIC CHARACTERISTICS OF THE INDIAN ECONOMY AS DEVELOPING ECONOMY
Deficits and their Definitions
government expenditure - government income
import expenditure – export revenue
= revenue deficit – grants given to state for
building capital assets
[RD]: refers to the
revenue expenditure being in excess of revenue deficit.
= revenue expenditure – revenue income
[FD]: difference between
the government’s total expenditure and its total receipts
deficit = net borrowing from home + borrowing from RBI +
borrowing from abroad.
[PD]: gross fiscal
deficit – net interest payments.
The Fiscal Responsibility and
Budget Management Act want to reduce fiscal deficit to 3%
of GDP by 31-3-2017 and E.R.D to 0% of GDP by 31st
R.D > E.R.D > P.D > B.D
expenditure > plan expenditure
> capital receipt
National Income and Gross Domestic Product
The macroeconomic variable that
considers the addition when the Indian worker earns in foreign
countries and subtractions of income earned by foreigners in
India is called gross national product.
GDP + factor income earned by domestic factors of production
employed in foreign – factor income earned by foreign factors
of production employed in India.
NNP = GNP – depreciation.
When the indirect taxes and
subsidies are adjusted from the N.N.P we get N.N.P
at factor cost or national income.
N.N.P at market prices – indirect taxes + subsidies
Net disposable income = N.N.P
[market price] + current transfers [salaries, pensions, fees
is the GDP is the GDP that is evaluated by considering the goods
and services at a constant rate.
is the GDP that is evaluated at the current prevailing price.
= nominal GDP / real GDP
In the absence of indirect taxes
or subsidies the GDP is equal to the national income.
Consumer and Wholesale Price Index
Consumer price index and
wholesale price index are ways to measure change of prices in an
economy. We calculate the prices of commodities in two years –
base year and current year. The latter is expressed as a
percentage of the former. This gives us the CPI / WPI of that
GDP is taken as a measure of
welfare of a country but it isn’t one as:
GDP isn’t uniform and it may indicate an increase but this
can be concentrated in a handful of people and the majority
might be worse off. This means that the GDP isn’t an indicator
of the well being of the people.
exchanges: many activities aren’t evaluated in non
monetary terms. Barter exchanges are not in monetary terms and
hence don’t get registered in the GDP. This is a case of
underestimation of GDP. Hence the GDP of a country doesn’t give
an indication of productive activity or well being of a country.
the benefits or harm an entity causes to another for
which it doesn’t pay. Example, if a factory producing goods
disposes wastes in the river then the pollutant can kill the
fishes and harm the livelihoods of fishermen. The factory
doesn’t pay and hence such negative externality isn’t counted in
the GDP. There could be positive externality too. Hence GDP
might not indicate the actual welfare of the people.
National income [Rs. 84 lac Cr.] and the Per capita income [Rs.
74000] have been rising every year. Share of services in the
Gross Value Added at basic price [current] is 60% (including
construction) and in that highest share is of “Financial and
real estate service”.
circulation of money: the number of
times a unit of money changes hands during a unit period of
When the interest rate is high
people expect it to fall and so convert their money into bonds.
Thus speculative demand for money is low. When people feels the
rates are too low they convert bonds to money anticipating an
increase in the interest rates. Thus speculative demand for
money is higher.
demand for money is inversely proportional to rate of
payments [BOP]: it is a record of
transactions of goods, services and assets of residents of a
country with the rest of the world.
BOP has two components – current
account and capital account.
Fig 1: Balance of Payments
Current account records exports
and imports in goods and services and transfer payments. Trade
in services is called as invisible
trade as they aren’t seen to cross national borders. This
includes factor income and non factor income.
Transfer payments are receipts
which a country’s citizens receive for free i.e. Remittances,
gifts, grants. India is number 1 in receiving remittances
[approx $70 billion].
India has a current account
deficit as the import of goods is higher than the income
received from remittances and services. But India has a capital
account surplus due to large FDI, FII and external borrowings.
The overall BOP is positive for India.
trade [BoT]: balance of exports
and imports of goods.
A country is said to be in Balance of Payments equilibrium when the sum of current account and
capital account is zero.
When a country has negative
balance of payments its monetary authority sells foreign
exchange to finance deficit. When the country has positive
balance of payments its monetary authority buys foreign
BOP being positive is usually bad
for exporters as the rupee appreciates and BOP negative is usually bad for importers
as rupee weakens.
Fig 2: Balance of trade
Foreign Exchange Reserves of India
- Gold reserves with RBI
- Foreign exchange assets with RBI
- Special drawing rights with IMF
- Reserves of foreign exchange in IMF.
BALANCE OF TRADE AND BALANCE OF PAYMENT
The exports and imports of a country should be roughly equal in value, since the foreign exchange
earned by exports is necessary to finance imports, but such a balance is rarely achieved.
The difference in value between
imports and exports is referred to as the balance of trade. If exports exceed imports a country is
said to have a favourable balance of trade, while if imports exceed exports it has an adverse balance of
The balance of trade only takes account of visible trade or the value of actual goods transferred
from one country to another. But there are many other ways in which foreign exchange can be
earned or spent. These are collectively called invisible trade which accounts for a quarter of all
transactions with foreign countries can be worked out. This is called the balance of payments.
Transactions which bring money into the country are called invisible exports and can be of
Payment for financial services including insurance, banking, brokerage, and other services
carried out on behalf of foreigners.
Payment of transport services such as shipping or air transport of passengers or freight.
Britain and certain other European countries have large invisible earnings in these two fields
because of their importance in trade and financial dealings.
Expenditure by foreign tourists. This is often an extremely important source of foreign
Interest and dividends on foreign investments. India is earning a substantial amount in
the form of interest and profit on foreign investment, annually.
Remittance from emigrants. Many emigrants send money to their families and thus countries
like India, which have supplied large number of emigrants, may receive considerable foreign
exchange in this way.
Loans and aids from foreign countries or international organisations. Many underdeveloped
countries receive aid or loans to finance development, while other countries may obtain
loans to cover balance of payments deficits.
Q.With reference to Balance of Payments, which of the following constitutes/constitute the Current Account?
Balance of trade
Balance of invisibles
Special Drawing Right
Select the correct answer using the code given below. (UPSC CSAT 2014)
2 and 3
1 and 3
1, 2 and 4
Ans . C
Balance of Trade and Balance of invisibles are part of “Current Account”.
Q.Which of the following organizations brings out the publication known as ‘World Economic Outlook’? (UPSC CSAT 2014)
Ans . A
World Economic Outlook is released by IMF
Q.The substitution of steel for wooden ploughs in agricultural production is an example of (UPSC CSAT 2015)
labour-augmenting technological progress
capital-augmenting technological progress
capital-reducing technological progress
None of the above
Ans . B
Capital” in an economic context means machinery or capital goods which can be employed to produce other goods.
Substitution of steel can be considered as the substitution of a lesser machine by a better machine. This encourages steel production. Hence it is a capital-augmenting technological progress.
Q.The problem of international liquidity is related to the non-availability of (UPSC CSAT 2015)
Ans . C
The concept of international liquidity is associated with international payments.
These payments arise out of international trade in goods and services and also in connection with capital movements between one country and another.
International liquidity refers to the generally accepted official means of settling imbalances in international payments which is basically dollars and hard currencies.
Q.In the Index of Eight Core Industries, which one of the following is given the highest weight? (UPSC CSAT 2015)
Ans . B
Electricity has 10.32% weightage; steel 4.9%; coal 4.38%; fertilizers 1.25%.
Q.With reference to Union Budget, which of the following, is/are covered under Non-Plan Expenditure?
Salaries and pensions
Select the correct answer using the code given below. (UPSC CSAT 2014)
2 and 3 only
1, 2, 3 and 4
Ans . C
Non plan expenditure is all expenditure which is incurred every year and not a part of state and central five year plan. It is salary, pensions etc which doesn't build capital in the economy.
Q.The sales tax you pay while purchasing a toothpaste is a (UPSC CSAT 2014)
tax imposed by the Central Government.
tax imposed by the Central Government but collected by the State Government
tax imposed by the State Government but collected by the Central Government
tax imposed and collected by the State Government
Ans . D
Sales tax is a tax levied and collected by the State.