MN 304- Business Economics and Financial Accounting

Recognization of Macroeconomic Variables

and Resent Trends in Sri lanka.

Group Members:
040218K R.T.Liyanage EE

050036J H.M.S.L.G.Bandara EE

050246D L.H.L.Lilantha EE

050249N S.K.Liyanagama EE

050424X M.R.K.C.Senevirathna EE
 Theoretical Report
Macroeconomics is a one of the major part of Economics. It is deals with the
behavior, performance and structure of the economy. Macroeconomics is primarily focused
on the determination of prices and the role of prices in allocating scarce resources.
Macroeconomics is a broad field of study. Basically there are two areas of research that are
the attempt to understand the causes and consequences of short-run fluctuations in national
income and the attempt to understand the determinants of long-run economic growth. In
macroeconomics there are most important macroeconomics variables such as national income,
unemployment, inflation, investment and international trade.

National Income.

We can define national income as "The sum of all incomes which arise as a
result of economic activity that is from the production of goods and services". Basically the
national income shows the economic position of a nation. To achieve the economic progress
of a country they must coordinate natural resources, human resources, capital and technology
more efficiently. The national income will help to assess and compare the progress achieved
by a country over a period of time. And also the study of national income is so much
importance due to many reasons. That are to estimate economic development, to know how
far development objectives were achieved, to know the contribution of various sectors to
national income. Economic activity is directly related to production, income and expenditure.
Based on above three factors there are three methods are used for calculating national income.
They are production method, income method and expenditure method.
The national income consists of two entities. The economic activity
within the country (GDP) and economic flows from abroad. Production of a country is one
major factor of the national economy. Continuous increase in production can be considered as
an index of progress that an economy has achieved. This increase in production will naturally
promote the growth of National Income. All production units are classified into primary,
secondary and tertiary sectors (Graph-1).
Then we can identify the various units that come under these sectors. And also we can
estimate the goods and services produced in each of these sectors. The sum total of products
produced in these three sectors is the total output of the nation. After find out the value of
these products in terms of money, the money sent by citizens working abroad is also added to
this. The total sum is the gross national income (GNI).
 GNI = (Money value of total goods and services) + (Income from abroad)

Agriculture and allied

activities.
Forest
Fishing
Mining
Productive
Registered industries
Sectors Non registered industries
Electricity
Trade
Manufacturing

Graph-1

Calculating the national income serves several purposes. Namely:

• Standard of living in a country (national income per head)
• Compare with the wealth with different countries
• It is possible to measure the improvement deterioration in national wealth and
the standard of living
• Assists central government in its economic planning

Inflation is a particular problem in using national income as a measure of a national

wealth. Price inflation increases the money value of national income. This is not to be
interpreted as a meaning that there are more economic activities going on the economy. All
that has happened as the price of the things that are measured have been increased.

To see if there has any real change in the level of the activity that must be deducted
any influence due to inflation. The standard method for turning money GDP or GNP in to real
measures is to use what is called the GDP deflator in order to take inflation out of the figure.
 Unemployment

Unemployment statistics measure the condition and extent of joblessness within an

economy of a country. Unemployment is the condition of willing workers lacking jobs or
"gainful employment". The measuring of unemployment rate is important to get an idea about
the unemployment of a country. Unemployment rate is obtained by the number of
unemployed workers divided by the total civilian labor force.

Not having a job when a person needs one can make it difficult to meet financial
obligations such as purchasing food to feed oneself and one's family, and paying one's bills;
failure to make mortgage payments or to pay rent may lead to homelessness through
foreclosure or eviction. Being unemployed, and the financial difficulties and loss of health
insurance benefits that come with it, may cause malnutrition and illness, and are major
sources of mental stress and loss of self-esteem which may lead to depression, which may
have a further negative impact on health. And also the rising of unemployment increases the
crime rate, the suicide rate, and causes a decline in healthiness. However in some counties
unemployment rates exceeded 20% but the crime rate did not increase. The unemployment
often ends up with welfare programs such as Food Stamps. Higher government transfer
payments in the form of welfare and food stamps decrease spending on productive economic
goods, decreasing GDP.

There is several type of unemployment. Those are can be listed as Frictional,

Structural, Cyclical, Technological, Classical (real-wage), Marxian, and Seasonal.

• Frictional: When moving from one job to another, the unemployment temporarily
experienced when looking for a new job.
• Structural: Caused by a mismatch between the location of jobs and the location of job-
seekers. "Location" may be geographical, or in terms of skills. The mismatch comes
because unemployed are unwilling or unable to change geography or skills.
• Cyclical: Also called as demand deficient unemployment. When there is not enough
aggregate demand for the labor. Caused by a business cycle recession.
• Technological: Caused by the replacement of workers by machines or other advanced
technology.
• Classical (real-wage): When real wages for a job are set above the market-clearing level,
commonly government as with the minimum wage or unions.
• Marxian: When unemployment is needed to motivate workers to work hard and to keep
wages down.
• Seasonal: When an occupation is not in demand at certain seasons. In situations like
construction workers in winter.

The consequences of unemployment are as follows.

• Loss of output
• Social cost
• Loss of human capital
• Increasing inequalities in the distribution of income
• Increased Burdon of welfare payments

Boosting demand increased the level of employment can caused a higher rate of
inflation. However growth in unemployment can also be associated in the rising rate of
inflation.

Inflation.

Inflation refers to a continual rise in the general price level measured against a
standard level of purchasing power. Due to Inflation is the name given to and increases in
price level generally. It is also manifest in the decline in the purchasing power of money.
Higher rate of inflation are harmful to an economy. Inflation redistributes income and wealth.
Uncertainty about the value of money makes business planning more difficult. Constantly
changing price imposes extra cost.

An economy policy objective which now has a central place in the policy
approaches of the governments of many developed countries is that of stable prices. Inflation
leads to a redistribution of income and wealth in ways which may be undesirable.
Redistribution of wealth might take place from creditors to debtors. This is because debts lose
‘real’ value with inflation. If a country has a higher rate of inflation than its major trading
partner, its exports will become relatively expensive and imports relatively cheap. As a result,
the balance of trade will suffer, affecting employment in exporting industries and in industries
producing import-substitutes. Eventually, the exchange rate will be affected.
 If the rate of inflation is imperfectly anticipated, no one has certain knowledge
of the true rate of inflation. As a result, no one has certain knowledge of the value of money
or of the real meaning of prices. If the rate of inflation becomes excessive, and there is
‘hyperinflation’, this problem becomes so exaggerated that money become worthless, so that
people are unwilling to use it and are forced to resort to barter. In less extreme circumstances,
the results are less dramatic, but the same problem exists. As prices convey less information,
the process of resource allocation is less efficient and rational decision-making is almost
impossible. A fourth reason to aim for stable prices is the resources cost of friendly changing
prices. In times of high inflation substantial labour time is spent on planning and
implementing price changes customers may also have to spend more time making price
comparison if they seek to buy from the lowest cost source.

Some of the common measures of inflation as below:

• Consumer price indices (CPIs) measure the price of a selection of goods purchased by
a "typical consumer".
• Producer price indices (PPIs) measure the price received by a producer. This differs
from the CPI in that price subsidization, profits, and taxes may cause the amount
received by the producer to differ from what the consumer paid. This could be "passed
on" as consumer inflation, by increasing the productivity or could be absorbed by
profits.
• Wholesale price indices measure the change in price of a selection of goods. These are
very similar to the Producer Price Indexes.
• Commodity price indices measure the change in price of a selection of commodities.
In the present commodity price indexes are weighted by the relative importance of the
components to the "all in" cost of an employee.

There are three major types of inflation, namely;

• Demand-pull inflation: inflation caused by increases in aggregate demand due to

increased private and government spending.
• Cost-push inflation: Also termed as "supply shock inflation" caused by drops in
aggregate supply due to increased prices of inputs. As an example when instance a
sudden decrease in the supply of oil. It would increase oil prices.
• Built-in inflation: It involves workers trying to keep their wages up with prices and then
employers passing higher costs on to consumers as higher prices.
If inflation is high in an economy there are three main problems it can cause:

• People on a fixed income like students will be worse off in real terms due to higher
prices and equal income as before will lead to a reduction in the purchasing power of
their income.
• Rising inflation can encourage trade unions to demand higher wages. If these strikes
occur in an important industry which has a comparative advantage the nation may see a
decrease in productivity and suffer.
• If inflation is relatively higher in one country then the country maintains fixed exchange
rates with other countries. Therefore the country's exports will become more expensive
for other countries to purchase, creating a deficit on its current account.

To Control inflation there are a number of methods although a 0% inflation

rate has never been achieved over any sustained period of time in the past. High interest
rates, slow growth of the money supply and monetary policy are some of the traditional ways
to prevent inflation. And also by reducing demand in general often through fiscal policy. By
using increased taxation or reduced government spending to reduce demand as well as by
using monetary policy. Supply-side economists advocate fighting inflation by fixing the
exchange rate between the currency and some reference currency such as gold. All of these
policies are achieved in practice through a process of open market operations.

Analytical Report.
Sri Lanka’s economic growth remains uneven to adverse shocks like the ethnic
conflict and the devastating tsunami. However, the relatively strong growth record has proved
inadequate to substantially reduce poverty beyond the urban areas. Rapid growth in the
 services and industry sectors has concentrated in urban areas, while stagnation in agriculture
has adversely impacted the rural economy where most of the poor live.

Behavior of Income over last 3 years

OUTPUT 2004 2005 2006

GDP at current market prices (Rs. 2,029 2,366 2,802

billion)

GNP at current market prices (Rs. 2,016 2,354 2,790

billion)

Per capita GDP at market prices (Rs.) 104,273 120,276 140,894

Per capita GNP at market prices (Rs.) 103,570 119,688 140,302

REAL OUTPUT (percentage 20 20 20

change) 04 05 06

GNP 5. 5.6 7.0

3

GDP 5. 6.0 7.4

4

Per capita GDP at market prices (Rs.)

GDP at current market prices (Rs. billion)
160,000
140,000
3,000
120,000
2,500
100,000
Per Capita GDP

2,000
80,000
GDP

1,500
60,000
1,000
40,000
500
20,000
0 0
2004 2005 2006
2004 2005 2006
Year
Year

Gross Domestic Product (GDP) at current market prices achieved a nominal growth of
16.6 % in the year 2005 and continued its growth in 2006 by achieving a growth of 18.4% in
the year 2006. The GDP per capita experienced an increase of 15.3 % in 2005 and continued
that increase by achieving 17.1% growth in 2006.
 The macro-economic variables in Sri Lanka for the last three years, as the central bank
reports suggest, are in favor of the development of the country. The National income and GDP
growth have risen. The unemployment percentage of the population has decreased. The Gross
National Product (GNP) defined as GDP adjusted for net factor income from abroad (NFIA)
grew by 7.0 %, a lower rate than GDP growth, The NFIA remained negative and deteriorated
further by 31.1 per cent in 2006.

REAL OUTPUT (% change) 2004 2005 2006

GNP 5.3 5.6 7.0

GDP 5.4 6.0 7.4

Contribution of three sectors Agriculture, Industry and Service to the growth of GDP
 Sectoral classification of GDP 2 2 2
-(%) change 004 005 000
6

Agriculture -0.3 1.9 4.7

Industry 5.2 8.3 7.2

Services 7.6 6.2 8.3

The main factor contributing to the National income of the country is

the Service sector. But throughout the last 3 years the percentages of contribution has
changed.
Sector classification of GDP (%)
9
8
7
6 Agriculture
5 Industry
%

4 Services
3 GDP
2 GNP
1
0
-1 2004 2005 2006
year

• Healthy developments in the Services and Industry sectors contributed to economic growth
in 2004. In 2004 the Agriculture sector faced a setback due to adverse weather conditions.
Post harvest losses in agriculture, especially in perishable crops, continue to remain high.

• All major sectors of the economy grew at a healthy pace in 2005. The Agriculture sector
grew by 1.5 per cent, the Industrial sector by 8.3 per cent and the Services sector by 6.4 per
cent. The three sectors contributed 4.4 per cent, 36.3 per cent and 59.3 per cent,
 respectively, to the GDP growth in 2005. The Agriculture sector rebounded from the
setback in 2004. In 2005, both paddy and tea production reached new record levels.

• In 2006 the Agriculture sector grew by 4.7 per cent contributing 11.1 per cent to the
overall growth while the Industry sector grew by 7.2 per cent contributing to 27 per cent to
the overall growth. Contribution from the Services sector was the highest at 62.6 per cent
as the sector grew by 8.3 per cent during the year. The agriculture sector continued its
recovery in 2006, benefiting from strengthening partnership between public and private
sectors together with favorable weather.

GDP distribution among provinces

It’s also interesting to find that the provincial wise contribution of GDP in Sri
Lanka is not at all distributed throughout the country

Unemployment Total Male Female

2004 8.3 6 12.8

2005 7.7 5.5 11.9

2006 6.6 5 9.5

Behavior of Unemployment over last 3 years

 • [Please note that in 2004, Mullativu and Killinochchi districts were not surveyed. In
2006, the North and East provinces were neglected.]

The expansion in economic activity impacted positively on the labour market. The
unemployment rate, which was 7.3 per cent in 2005 dropped to 6.5 per cent in 2006.
Unemployment

14
12
10
8 Male
Female
%

6
Total
4
2
0
2004 2005 2006
year

According to the QLFS, the number of employed persons increased by 4.7 to 7.1 million
in 2006 from 6.8 million in August 2005.

Unemployment has historically been a very sensitive issue in Sri Lanka. This is mainly
due to that the high levels of unemployment have predominantly been concentrated among
educated youth. An even more serious aspect of the problem is that unemployment rate
increases with the level of education. What does this depend on - is it because they are young,
because they are more educated or because they benefit from family support to perform an
extended job search.

It is found that there are mainly three determinants of unemployment. The first is age; the
probability of being unemployed is highest among the youth, and it declines with age. The
second is education. Studies indicate that unemployment rate increases with the level of
education. The final determinant is benefit from family support. The probability of being out
of job is higher among individuals who live with their parents.

Behavior of Inflation over last 3 years

Inflation, which is the rate of change of the Colombo Consumer price index, has risen 7.6% in
2004, and then 11.6% in 2005 and 13.7% in 2006. But the National Income has risen 16.17%
in 2005 and 18.15% in 2006 with respect to the previous year. One should note that this is not
GDP. GDP growth rate is 6% and 7.4% respectively.
Inflation
16
14
12

2 10
8

%
Year 2004 005 2006 6
4
Inflation 7.6 11.6 13.7
2
0
The sharp increase in the general price level2004
in 2006 over the
2005price level of2006
2005 was a
year
result of the combination of both demand pull and cost push factors. Consumer prices in Sri
Lanka exhibit distinct seasonal patterns, which are clearly reflected in the movements of the
CPIs. Furthermore it is important to realize that the inflation is a cause of the government
having an expenditure of more than the National income (which has been increasing over the
last years). Therefore this relationship between National income and inflation stringently
stresses the excessive money being printed without proper income sources.

By reducing unemployment the National income has risen respectively. But the
increase in National income has not been enough to prevent inflation from soaring high. With
the increase of government sector jobs it can be seen that the unemployment level has
decreased but due to the payment of wages and/or other expenditures, it can be seen that the
inflation has risen. Therefore in the perspective of the government it is important to realize the
productivity per person has to increase for the National income to be adequate to prevent
inflation.

High dependency on fuel and lack of policies for its efficient use has made domestic
prices more vulnerable to international price fluctuations. Continuation of upward
adjustments in nominal wages to compensate the negative effects of inflation has resulted in
increasing real wages without commensurate improvements in the productivity, particularly in
the public sector. The incidence of high rates of unemployment among the educated youth
while some sectors of the economy are suffering from the lack of skilled labour, highlights the
deficiencies in the education system. The increase in National income shows the potential
economic growth that has been projected from previous years. The increase in inflation on the
other hand, is due to trade in-balance and the printing of money through out the respective
year. Therefore it is observed that the economy is in fact deteriorating even though the
presence of a GDP growth of 5.4%, 6% and 7% is present.

Furthermore it is important to realize that the inflation is a cause of the government having an
expenditure of more than the National income (which has been increasing over the last years).
Therefore this relationship between National income and inflation stringently stresses the
excessive money being printed without proper income sources.

REFERENCES: “www.wikipedia.com”,“www.education.kerala.gov.in/chapter11.pdf .com”,

Text book: BPP study text – CIMA (Economics for Business)
Sri lanka Central Bank Annual Report -2004, 2005, 2006