Prelims Capsule

Prelims Capsule: Introduction to Macro Economics

You have read or reading for an economics course, and—for good or for ill—it has changed the way you understand the world. Economics, you now understand, is all around you, all the time.

Answer this question below:

I want to buy iPhone 7+, Mac Book pro, or an Audi Car, trip to Europe, but my income is only Rs 35000 a month. Will I be able to buy any of it?

No. I will have to be satisfied with a Micromax phone in place of iPhone, a basic Lenovo laptop instead of a Mac Book Pro, a bike instead of a car and trip to Kashi instead of Europe.

People have to make choices because of scarcity, the fact that they don’t have enough resources to satisfy all their wants.

Economics studies how people allocate resources among alternative uses.

  • Macroeconomics studies national economies, and microeconomics studies the behavior of individual people and individual firms.

Economists assume that people work toward maximizing their utility, or happiness, and firms act to maximize profits.

Economic Agents

  • Economies run on people, firms, and governments requiring and buying things, all these are called Economic agents.
  • A need exists, i.e., my need for a phone is called demandand that need is fulfilled by firm, in my case the firm called Micromax, this is called supply.
  • Students of microeconomics spend time learning about the behavior of supply and demand in individual markets.
  • Students of macroeconomics are interested in the economy as a whole, so the emphasis is on aggregate (that is, total) demand for goods and services and aggregate (total) supply.

Aggregate Demand and Aggregate Supply

  • Aggregate demandis the total demand for goods and services produced in the economy. That is the amount of total spending on domestic goods and services in an economy.
  • Aggregate demand is important because (along with aggregate supply) it determines a country’s
    • Price levelstherefore its inflation rate.
    • Changes in aggregate demand also impact the level of
  • Without understanding aggregate demand, policy-makers can’t control the economy. The main tools that policy-makers have are monetary and fiscal policy, which work by influencing aggregate demand.
  • Aggregate demand=C+I+G+X−M
    • consumption spending, C;
    • investment spending, I;
    • government spending, G; and
    • spending on exports, X, minus imports M.
  • Aggregate supply is the total quantity of goods and services output firms in the entire economy will produce and sellin a given time periodat given price levels—in other words, the real GDP.
  • Aggregate supply is the relationship between price levels and the amount of goods and services an economy produces.
  • Shifts in aggregate supply can come from changes in the size and quality of labor, technological innovation, wage increases, higher production costs, changes in producer taxes and subsidies, and changes in inflation.

Factors of Production

The factors of production are inputs used in the supply of goods and services.


  • We need land and other natural resources for building an industry, for harnessing of wind power or generating the solar power or any kind of the production. Land encompasses within it all form natural resources including raw materials.
  • Some nations have natural resources for example the vast expanse of farm land in the fertile Northern Plains of India and the oil in the Gulf Countries, all of which form the component of Land for study purposes. Some countries don’t have natural resources and rely on import.


  • Labour is the human input into production e.g. the supply of workers available and their productivity. India is rich in labour.
  • An increase in the size and the quality of the labour force is vital if a country wants to achieve growth.


  • Fixed capital includes machinery, equipment, new technology, factories and other buildings
  • Working capital means stocks of finished and semi-finished goods (or components) that will be either consumed in the near future or will be made into consumer goods.
  • Infrastructure – a crucial type of capital. Examples of infrastructure include road & rail networks; airports &ports; telecommunication networks etc.
  • The World Bank regards infrastructure as an essential pillar for economic growth in developing countries. India is often cited as a country whose growth prospects are being limited by weaknesses in national infrastructure.


  • Regarded by some as a specialized form of labour input.
  • An entrepreneur is an individual who supplies products to a market to make a profit
  • Entrepreneurs will usually invest their own financial capital in a business and take on the risks.
  • Their main reward is the profit made from running the business



  • Wage, interest, rent, and profit payments for the services of the factors of production labor, capital, land, and entrepreneurship respectively in return for productive services.
  • In the circular flow, these are payments made by the business sector for factor services purchased from the household sector through the financial markets.

Circular Flow of Income

  • The circular flow of income or circular flow is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. between economic agents.
  • The circular flow analysis is the basis of national accounts there for macroeconomics.

Simple Two Sector Economy:

Material and Non-Material Goods:


  • Material goods are those which are tangible. They can be seen, touched and transferred from one place to another. For example, cars, shoes, cloth, machines, buildings, wheat, etc., are all material goods.
  • Non-material goods are intangible for they do not possess any shape or weight and cannot be seen, touched or transferred. Services of all types.


Economic and Non-economic Goods:


  • Economic goods are those which have a price and their supply is less in relation to their demand or is scarce. The production of such goods requires scarce resources having alternative uses. For example, land is scarce and is capable of producing rice or wheat.
  • If the farmer wants to produce wheat he will have to forgo the production of rice. The price of wheat equals the production of rice forgone by the farmer.
  • Thus economic goods relate to the problem of economizing scarce resources for the satisfaction of human wants. In this sense, all material goods are economic goods.
  • Non-economic goods are called free goods because they are free gifts of nature. They do not have any price and are unlimited in supply. Examples of non-economic goods are air, water, sunshine, etc.
  • The concept of non-economic goods is relative to place and time. Sand lying near the river is a free good but when it is collected in a truck and carried to the town for house construction, it becomes an economic good.


Consumers’ Goods and Producers’ goods:

  • Consumers’ goods are those final goods which directly satisfy the wants of consumers. Such goods are bread, milk, pen, clothes, furniture, etc.
    • Single-use Consumers’ Goods:These are goods which are used up in a single act of consumption. Such goods are foodstuffs, cigarettes, matches, fuel, etc.
    • Durable-use Consumers’ Goods:These goods can be used for a considerable period of time. It is immaterial whether the period is short or long. Such goods are pens, tooth brushes, clothes, scooters, TV sets, etc.


  • Capital or Producers’ Goods are those goods which help in the production of other goods that satisfy the wants of the consumers directly or indirectly, such as machines, plants, agricultural and industrial raw materials, etc.
    • Single-use Producers’ Goods:Theses goods are used up in a single act of production. Such goods are raw cotton, coal used in factories, paper used for printing books, etc. When once used, these goods lose their original shape.
      • Intermediate Goods (inputs):Goods sold by one firm to another for resale or for further production are called intermediate goods. They are single-use producers’ goods that are transformed to manufacture final goods.
    • Durable-use Producers’ Goods:These goods can be used time and again. They do not lose their usability through a single use but are used over a long period of time. Capital goods of all types such as machines, plants, factory buildings, tools, implements, tractors, etc. are examples of durable-use producers’ goods.

Final Goods:

  • On the other hand, goods sold not for resale or for further production but for personal consumption or for investment are called final goods. On the basis of this definition, a particular good or service may be classified intermediate good or final good.
  • For instance, the water sold by the municipal corporation to commercial and industrial undertaking is an intermediate good because it is used by them for further production. The water sold to individual households is final good because it is used for personal consumption.
  • Similarly, the postal services sold to business houses are intermediate goods and those to households are final goods.

Note:The distinction between intermediate and final goods is of much importance in the computation of national income. It is especially so while computing national income by the product method or value added method which we will study in next post.


Based on the price elasticity of Demand:


Demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables, such as the prices and consumer income.


  • Inferior good: An increase in income causes a fall in demand of the good such a good is called Inferior Good.
    • An example, of an inferior good is thatstreet side Chole we eat. When your income rises you eat less of the street side food andeat more high quality restaurants.
  • Normal good: This means an increase in income causes an increase in demand. When you earned 20k you may have only 2 branded jeans, with increasing income you’d buy more branded jeans.
  • Luxury good. An increase in income causes a bigger increase in demand of such a good. For example, HD TVs would be luxury or a Sedan Car.
    • When income rises, people spend a higher % of their income on the luxury good. (Note: a luxury good can be a normal good, but a normal good isn’t necessarily a luxury good)
  • Complementary goods: Goods which are used together, e.g. Personal Computer and Speaker, TV and a DVD player.
  • Substitute goods: Goods which are alternatives, e.g. A Thumbs Up or a Coke are substitute goods.
  • Giffen good: A rare type of good, where an increase in price causes an increase in demand. The income effect comes into place; a rise in the price causes you to buy more of this good because you can’t afford more expensive goods.
    • For example, if the price of wheat rises, a poor person may not be able to afford Chickenanymore, so has to buy more wheat.
  • Veblen/Snob good: A good where an increase in price encourages people to buy more of it. This is because they think more expensive goods are better.
  • Public goods: The goods with characteristics which could be provided by government only without any competition, e.g. Police Service, Defence, Railways in India
  • Merit goods: Goods which people may underestimate benefits of. e.g. education.
  • Demerit goods. Goods where people may underestimate costs of consuming it. e.g. smoking, drugs.
  • Private goods: Goods which do have rivalry and excludability. The opposite of a public good.
  • Free goods:A good with no opportunity cost, e.g. breathing air, sunlight.


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