Unit 1: National income & theories of money
Managerial Economics-II notes · PTU syllabus (BBAGE 201-18)
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Unit summary
Macroeconomics studies the economy as a whole. This unit covers national income and the problems of measuring it, money — its nature, functions and types — and the theories of the demand for and supply of money.
After this unit you can
- Define national income and its measures
- Explain the methods and problems of measuring national income
- Explain the nature, functions and types of money
- Explain classical, Friedman's and Keynesian theories of the demand for money and the supply of money
PTU syllabus topics
- Measuring national income and problems in measurement
- nature and functions of money
- types of money
- theories of demand for money (Classical, Friedman's restatement, Keynesian liquidity preference)
- theories of supply of money
Product (value added) method
Value added by each sector
Production
Income method
Wages, rent, interest, profit
Distribution
Expenditure method
C + I + G + (X − M)
Spending
Topic 1
National income and its measurement
National income is the total money value of all final goods and services produced by the residents of a country in a year.
- GDP
- Value of final goods and services produced within the country
- GNP
- GDP + net factor income from abroad
- NNP
- GNP − depreciation
- National income (NNP at factor cost)
- NNP at market price − indirect taxes + subsidies
- Per capita income
- National income / population
Product (value added) method
Value added in each sector
Production
Income method
Wages, rent, interest, profit
Distribution
Expenditure method
C + I + G + (X − M)
Disposal
Problems in measurement: non-monetised transactions (household work, farm produce consumed at home), double counting, unreliable data, the informal sector, black money and changing prices.
Topic 2
Nature, functions and types of money
Money is anything generally accepted as a medium of exchange and a measure of value.
| Function | Meaning |
|---|---|
| Medium of exchange | Removes the problems of barter |
| Measure of value | Common unit of account |
| Store of value | Wealth can be saved |
| Standard of deferred payments | Basis for future payments and loans |
Types: commodity money, metallic money, paper money (fiat), bank (credit) money and digital money (UPI, e-rupee).
Topic 3
Theories of the demand for money
- Classical (quantity theory): Fisher's equation MV = PT — money is demanded only for transactions, and prices rise proportionally with the money supply.
- Cambridge cash-balance approach: people hold a fraction k of income as money: M = kPY.
- Keynes's liquidity preference: money is demanded for transactions, precaution and speculation motives; speculative demand falls as the interest rate rises.
- Friedman's restatement: money is one asset among many; demand depends on permanent income and the returns on other assets, and is stable.
Topic 4
Supply of money
The money supply is the total stock of money held by the public. RBI measures: M1 (currency with the public + demand deposits + other deposits with RBI — narrow money) and M3 (M1 + time deposits — broad money). Money supply is influenced by the RBI (high-powered money) and by banks through credit creation (money multiplier = 1/required reserve ratio).
Key terms
- GDP
- Value of final goods and services produced within a country
- National income
- NNP at factor cost
- Liquidity preference
- Keynes's theory of the demand for money
- M3 (broad money)
- M1 plus time deposits
- Money multiplier
- The extent to which banks expand money supply
Quick revision
- GNP = GDP + net factor income from abroad; NNP = GNP − depreciation.
- Methods: product, income, expenditure.
- Functions: exchange, measure, store, deferred payments.
- Fisher MV = PT; Keynes: transactions, precautionary, speculative motives.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define national income.
- Q2.Differentiate between GDP and GNP.
- Q3.List the functions of money.
- Q4.State Fisher's quantity theory equation.
- Q5.What are Keynes's three motives for holding money?
Long-answer questions
- Q1.Explain the methods of measuring national income and the difficulties involved.
- Q2.Explain the nature, functions and types of money.
- Q3.Compare the classical and Keynesian theories of the demand for money.
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