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KARPAGAM ACADEMY OF HIGHER EDUCATION, COIMBATOREClass: I MBA Course Name: Managerial Economics
Course Code: 21MBAP103 Unit IV Semester: I Year: 2021-23 Batch
UNIT-IV -National Income and Inflation
SYLLABUS
Macro Economic Indicators - Components of the Macro Economy – Circular flow of economic activities and
income - Two - sector model – Four- sector model – IS-LM analysis. Difference between Normal Residents and
Non-Residents – Domestic territory – Gross and Net Concepts of Income and Product – Market Price and
Factor Cost – Factor Payments and Transfer Payments – National Income Aggregates – Private Income –
Personal Income – Personal Disposable Income – National Disposable Income – Measurement of National
Income – Production Method – Income Method – Expenditure Method. Phases of Business Cycle – Causes of
cyclical movements – Price movements: Inflation, Deflation – Types of Inflation – Effects of Inflation –
Control of Inflation.
Circular Flow of Economic Activity:
The all pervasive economic problem is that of scarcity which is solved by three institutions (or
decision-making agents) of an economy. They are households (or individuals), firms and
government. They are actively engaged in three economic activities of production, consumption and
exchange of goods and services. These decision-makers act and react in such a manner that all
economic activities move in a circular flow.
Households:
Households are consumers. They may be single-individuals or group of consumers taking a joint
decision regarding consumption. They may also be families. Their ultimate aim is to satisfy the
wants of their members with their limited budgets.
Households are the owners of factors of production—land, labour, capital and entrepreneurial
ability. They sell the services of these factors and receive income in return in the form of rent,
wages, and interest and profit respectively.
Prepared by C.Sagunthala, Assistant Professor, Dept of Management, KAHE, Page 1/57
, KARPAGAM ACADEMY OF HIGHER EDUCATION, COIMBATORE
Class: I MBA Course Name: Managerial Economics
Course Code: 21MBAP103 Unit IV Semester: I Year: 2021-23 Batch
Firms:
The term firm is used interchangeably with the term producer in economics. The decision to
manufacture goods and services is taken by a firm. For this purpose, it employs factors of production
and makes payments to their owners. Just as household’s consumer goods and services to satisfy
their wants, similarly firms produce goods and services to make a profit.
Government:
The government plays a key role in all types of economic systems—capitalist, socialist and mixed.
In a capitalist economy, the government does not interfere. It simply establishes and protects
property rights. It sets standards for weights and measures, and the monetary system.
In a socialist economy, the role of the government is very extensive. It owns and regulates the entire
production and consumption processes of the economy, and fixes prices of goods and services. In a
mixed economy, the government strengthens the market system.
It removes its defects by regulating the activities of the private sector and by providing incentives to
it. The government also uses resources to produce goods and services itself which are sold to
households and firms. These decision-making agents take economic decisions to produce goods and
services and to exchange them in order to consume them for satisfying the wants of the whole
economy.
Production, consumption and exchange are the three main activities of the economy.
Consumption and production are flows which operate simultaneously and are interrelated and
interdependent. Production leads to consumption and consumption necessitates production.
In other words, production is a means (beginning) and consumption is the end of all economic
activities. Both production and consumption, in turn, depend upon exchange. Thus these two flows
are interrelated and interdependent through exchange.
The Circular Flow in a Two-Sector Economy:
Prepared by C.Sagunthala, Assistant Professor, Dept of Management, KAHE, Page 2/57
, KARPAGAM ACADEMY OF HIGHER EDUCATION, COIMBATORE
Class: I MBA Course Name: Managerial Economics
Course Code: 21MBAP103 Unit IV Semester: I Year: 2021-23 Batch
In a simplified economy with only two types of economic agents, households or consumers and
business firms, the circular flow of economic activity is shown in Figure. Consumers and firms are
linked through the product market where goods and services are sold. They are also linked through
the factor market where the factors of production are sold and bought.
Consumers and firms have a dual role, and exchange with one another in two distinct ways:
(1) Consumers or households own all the factors of production, that is, land, labour, capital and
entrepreneurship, which are also called productive resources. They sell them to firms for producing
goods and services.
In the diagram, the sale of goods and services by firms to consumers in the product market is shown
in the lower portion of the inner circle from left to right; and the sale of their services to firms by
households or consumers in the factor market is shown in the upper portion of the inner circle from
right to left. These are the real flows of goods and services from firms to consumers which are linked
with productive resources from consumers to firms through the medium of exchange or barter.
(2) In a modem economy, exchange takes place through financial flows which move in the reverse
direction to the “real” flows. The purchase of goods and services in the product market by
Prepared by C.Sagunthala, Assistant Professor, Dept of Management, KAHE, Page 3/57
, KARPAGAM ACADEMY OF HIGHER EDUCATION, COIMBATORE
Class: I MBA Course Name: Managerial Economics
Course Code: 21MBAP103 Unit IV Semester: I Year: 2021-23 Batch
consumers is their consumption expenditure which becomes the revenue of the firms and is shown in
the outer circle of the lower portion from right to left in the diagram.
The expenditure of firms in buying productive resources in the factor market from the consumers
becomes the incomes of households, which is shown in the outer circle of the upper portion from left
to right in the diagram.
The Circular Flow in a Three-Sector Economy:
So far we have been working on the circular flow of a two-sector model of an economy. To this we
add the government sector so as to make it a three-sector closed model of circular flow of economic
activity. For this, we add taxes and government purchases (or expenditure) in our presentation.
Taxes are outflows from the circular flow and government purchases are inflows into the circular
flow. The circular flow in a three-sector economy is illustrated in Figure
First, take the circular flow between the household sector and the government sector. Taxes in the
form of personal income tax and commodity taxes paid by the household sector are outflows (or
leakages) from the circular flow. But the government purchases the services of the households,
makes transfer payments in the form of old age pensions, unemployment relief, sickness benefit,
Prepared by C.Sagunthala, Assistant Professor, Dept of Management, KAHE, Page 4/57
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