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Chapter 1
Economics is the study of how society allocates scarce resources and
goods. Resources are the inputs that society uses to produce output, called goods.
Resources include inputs such as labor, capital, and land.
Goods include products such as food, clothing, and housing as well as services such as
those provided by barbers, doctors, and police officers.
These resources and goods are considered scarce because of society's tendency to
demand more resources and goods than are available.
Scarcity: Resources are finite, so decisions must be made as to how to allocate those
resources in the most efficient manner possible. Oil and petrol have rather become
scarce and hence the prices of such commodities continuously rise. In 1995 you could
get a liter of petrol of 20 Rs but the same today costs almost 80 Rs. So lets assume,
today if you have Rs 1000 would you want to go on a drive with your friends or use the
money to go to a close by restaurant.
The two fundamental facts of Economics is
(i) Human beings have unlimited wants; and
(ii) The means of satisfying these wants are relatively scarce form the subject matter of
Economics.
Adam Smith, the father of Economics, published The Nature and Causes of Wealth of
Nations in 1776. He defined Economics as An inquiry into the nature and causes of the
wealth of the nations.
J B Say defined economics as Science which deals with wealth
Alfred Marshals definition of economics: Economics is a study of mankind in the
ordinary business of life. It examines that part of individual and social action which is
most closely connected with the attainment and with the use of the material requisites
of well-being. Thus, it is on the one side a study of wealth and on the other and more
important side a part of the study of the man.
A C Pigou The range of our inquiry becomes restricted to that part of social welfare
that can be brought directly or indirectly into relation with the measuring rod of money
Prof. Lionel Robbins - book Nature and significance of Economics 1931 Economics is
the science which studies human behavior as a relationship between ends and scarce
means which have alternative uses.
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Classical Economics- was the first modern style of how people perceived economics. It
flourished in the 18th and 19th century.
Some famous Classical economists were Adam Smith, Jean-Baptiste Say, David
Ricardo, Thomas Malthus and John Stuart Mill.
Neo-classical Economics -Flourished during the late 19th century where economists
related supply and demand to an individual's rationality and his or her ability to
maximize utility or profit.
Paul A. Samuelson defined economics as Economics is the study of how men and society choose, with or without the use of
money, to employ scarce productive resources which could have alternative uses, to
produce various commodities over time and distribute them for consumption now and
in the future amongst various people and groups of society.
Prof Henry Smith - Economics, is the the study of how in a civilized society one obtains
the share of what other people have produced and of how the total product of society
changes and is determined.
'Laissez Faire' An economic theory from the 18th century that opposes governmental
regulation of or interference in commerce beyond the minimum necessary for a freeenterprise system to operate according to its own economic laws. The transactions
between private parties should be free from taxes, tariffs, and government subsidies.
The phrase laissez-faire is French and literally means "let them do as they will," It has a
few other assumptions:
(i)
(ii)
The economic market rises or falls based upon its own fluctuations with no
government input to stabilize it.
Literally to let things take their own course without interfering.
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Microeconomics- micro means small, it studies the markets on a small scale. It focuses on
how a market is impacted by decisions and choices made by small economic units such as
individual consumers, individual firms, or individual government agencies. It includes
(I) Product pricing
(II) Consumer behavior
(III) Factor pricing
Macro Economics Is a term derived from the Greek work Makros meaning large.
Macroeconomics considers the aggregate performance of all markets in the market system
and is concerned with the choices made by the larger subsectors of the economythe
household sector or consumers; the business sector, or firms; and the government sector or all
government
agencies.
It includes:
(I) National income and output
(ii) General Price level
(iii) Balance of trade and payments
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Inductive Method Facts are collected & analyzed & then conclusions are drawn
based on them.
Points A, B and C represent the points at which production of Good A and Good B is
most efficient. Point X demonstrates the point at which resources are not being used
efficiently in the production of both goods; point Y demonstrates an output that is not
attainable with the given inputs.
TYPES OF ECONOMIES
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Merits
De-merits
Income inequalities
Welfare is not protected
Economic instability
Huge amount spent on product promotion
Class conflict between employers & employees
Misuse of resources
Formation of monopolies
Insecure employment
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De-merits
Predominance of bureaucracy
No freedom
No right of private property
No incentive to work hard
Improper cost calculation
Extreme form not practicable
- Mixed Economy Public sector & private sector co-exist. It has the best
features of market economy & controlled economy
Characteristics
Co-existence of public & private sector
Better economic planning
Balanced regional development
Dual system of pricing
Merits
Merits of both capitalism & socialism
Protects individual freedom
Price mechanism operates
Reduced income inequalities
Stable economy
Balanced economic development for developing countries
De-merits
Difficult to operate
Excessive controls and heavy taxes
Red-tapism, nepotism, favoritism, officialdom exist
According to Schumpeter, advantages offered are temporary
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CHAPTER 2
Demand: Willingness & ability of consumers to purchase at various prices for a given
period of time.
Demand is effected by
1) Desire
2) Means to purchase
3) Willingness to purchase
Quantity demanded:
1) Always expressed for a given price
2) It is a flow
Determinants of demand:
1)
2)
3)
4)
5)
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4) Taste & preferences: Taste changes in favour of good, demand increases & vice
versa.
5) Other factors:
- Population: Population increases, demand increases
- Composition of population: Effected by the age group of people
- Income distribution: Less rich people & more of poor people Less demand
Law of demand:
Prof. Alfred Marshall - The greater the amount to be sold, the smaller must be the
price at which it is offered in order that it may find purchasers or in other words the
amount demanded increases with a fall in price and diminishes with a rise in price.
Law of demand states that, ceteris paribus, or other things remaining constant, people
will buy more at lower price and will buy less at higher price.
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Rationale for law of demand:
(Reason for the negative slope)
1) Law of diminishing marginal utility: As more of a good is consumed, the
satisfaction derived decreases. So consumer will only buy till the price it equalizes
their satisfaction.
2) Substitution effect: As the price of good increases, consumers replace the goods
with the substitutes.
3) Income effect: As price increases, the real income of the consumer decreases
and therefore quantity demanded falls & vice versa.
4) Arrival of new consumers: As price for a good fall, new consumers also move in
to buy them. This increases the demand at lower price.
5) Different uses: If price for commodities with multiple uses rises, consumer will limit
their use and this will decrease demand and vice versa.
5)
6)
7)
Giffen goods: These are the goods whose demand falls even if price falls. For
e.g. coarse grains like bajra, low quality rice etc.
Conspicuous necessities: These goods have become necessities due to their
constant usage. For e.g. television, coolers etc.
Future expectations about prices: If price of good increases and is expected to
increase even more in futures then consumers will buy them in present despite of
a price increase.
Ignorance: Due to poor knowledge and ignorance of consumers, impulsive
purchases are made without appropriate calculations.
Demand for necessities: The demand for necessities is not affected much by
price change.
Speculative goods: Speculative goods like stocks and shares, demand increases
with price.
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Shift in curve
1. Indicate change in demand due to
change in factors other than price.
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Elasticity of Demand
Perfectly inelastic
Unit elastic
Elastic
Inelastic
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E=
A little change in price causes infinite
change in quantity demanded.
E=0
Quantity demanded doesnt change with
price.
E=1
Change in quantity demanded is equal to
the change in price
> E > 1
Proportionate
change
in
quantity
demanded is more than change in price
0<E<1
Proportionate
change
in
quantity
demanded is less than change in price
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Total outlay method
ELASTICITY
PRICE
TOTAL EXPENDITURE
Increases
Decreases
Decreases
Increases
E = 1, Unitary elastic
100% increase
Unchanged
Increases
Increases
Decreases
Decreases
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Positive income elasticity: With increase in income, demand for goods increases &
vice versa. It happened for normal goods.
Negative income elasticity: With increase in income, demand for good falls & vice
versa. It happens for inferior goods, also known as Giffen goods.
Zero income elasticity: There is no change in the demand with the change in income.
It happens for necessities like salt etc.
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Demand distinctions:
1. Producer goods- Intermediate goods used for further production.
Consumer goods- Used for final consumption
2. Durable goods- Consumer goods which can be used more than once over a
period of time
Non-durable goods- Consumer goods which can be used just once.
3. Derived demand- Demand of these goods is consequence of purchasing
another good.
Autonomous demand- Demand of these goods is independent.
4. Industry demand- Total demand of a particular industry
Company demand- Demand by a particular individual company
5. Short run demand- Demand with its immediate reaction to changes in the
factors affecting demand
Long run demand- Demand with changes after allowing enough time to react.
Wants: Tastes, desires & motives of human beings.
Classification of wants:
1. Necessaries: Goods essential for living
2. Comforts: Not essential for living but are required for happy living
3. Luxury: Expensive goods which adds consumers efficiency.
Utility:
Satisfaction derived from the consumption of a commodity.
Total utility (Full Satiety): Sum of utility derived from consumption of different units of
commodity. It is sum total of marginal utilities.
Marginal utility (Marginal Satiety): Additional utility derived from the consumption of
one additional unit of a commodity.
MU = TUn TUn-1
Assumptions of Marginal Utility Analysis:
1. The Cardinal Measurability of Utility- It states that utility is measurable.
2. Constancy of the Marginal Utility of Money- While consumer is spending money
on commodity, the marginal utility of money remains the same.
3. The Hypothesis of Independent Utility- It states that the total utility is just the sum
total of different utilities of goods.
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The Law of Diminishing Marginal Utility
The additional benefit which a person derives from a given increase in stock of a thing
diminishes with every increase in the stock that he already has. Marshall
In simple words it states that as the more of a thing is consumed, the lesser marginal
utility it has. As the consumption of a good is increased the marginal utility starts falling
and after the point of saturation it becomes negative. Due to this the total utility also
falls
Assumptions of Law:
1. Units consumed should be homogeneous in nature
2. Units consumed should be measured in standard units.
3. Consumption should be continuous i.e. without any time gap.
4. Prestigious goods like gold, cash etc. are exemptions.
5. Presence of related goods affects the shape of utility curve.
Consumer Surplus
Consumer surplus as per Marshall-Excess of the price which a consumer would be
willing to pay rather than go without a thing over that which he actually does pay.
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Consumer surplus is the difference between what a consumer is willing to pay for one
unit of a commodity and what he actually pays for it.
Consumer surplus = Value of the product for consumer price paid by consumer for it
Consumer surplus declines as more of a commodity is consumed. This is because of
the law of diminishing marginal utility, which suggests that the first unit of a good or
service consumed generates much greater utility than the second, which generates
greater utility than subsequent units.
Limitations:
1. Cannot be measured precisely
2. In case of necessities, marginal utility varies infinitely for different units
3. It is affected by availability of substitutes.
4. Utility of prestigious goods like diamonds cannot be measured appropriately.
5. Consumer surplus assumes that marginal utility of money remains constant, which
is unrealistic.
6. It assumes utility is measurable in monetary terms.
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Indifference Curve
The indifference curve represents a set of possible consumption bundles between
which the individual is indifferent i.e. the consumer derives equal satisfaction for each
bundle.
Assumptions:
1. Consumer is rationale
2. Consumer has complete knowledge
3. Consumer can rank combination of goods according to the satisfaction derived
from them.
4. Consumer has consistent consumption pattern.
5. More is preferred to the less of any commodity.
In the figure below, consumer is indifferent at point A & B i.e. the combination of goods
at point A & point B gives consumer equal satisfaction.
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Indifference map:
It is a collection of many indifference curves.
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Budget Line
Budget line characterizes on a graph the maximum amounts of goods that the
consumer can afford with the given income and prices.
Consumer Equilibrium
Consumer is at equilibrium at the point where the budget line touches the highest
indifference curve on an indifference map.
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SUPPLY:
Supply is willingness and ability to offer to the market at various
prices during a period of time.
-It is the quantity that is offered for sale and not what is successfully sold.
- It is a flow
Determinants of supply
1. Price of good- Direct relation between price & supply. Price of the good
increases, quantity supplied increases & vice versa.
2. Price of related goods- If price for other goods increases then supply is shifted to
other goods.
3. Price of factors of production-Inverse relation between price of factors of
production & supply. Price of factors increases, supply decreases.
4. State of technology- If technology improves, supply increases
5. Government policy- Imposition of taxes supply decreases
Subsidies- supply increases
6. Other factors like governments industrial and foreign policies, goals of the firm,
infrastructural facilities, market structure, natural factors etc. also affects supply.
Law of Supply
Law of supply states that other things being constant equal, higher the price, the
greater is the quantity supplied & vice versa.
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Elasticity of Supply
Elasticity of supply measures responsiveness of the quantity supplied to the changes in
the price.
E=
A little change in price causes infinite change in quantity
supplied.
Perfectly inelastic
E=0
Quantity supplied doesnt change with price.
Unit elastic
E=1
Change in quantity supplied is equal to the change in price
Elastic
>E>1
Proportionate change in quantity supplied is more than
change in price
Inelastic
0<E<1
Proportionate change in quantity supplied is less than
change in price
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Es = (dq/dp) x (p/q)
2. Arc elasticity:
It is used to find elasticity between two points.
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Equilibrium price:
Price at which Quantity Demanded = Quantity Supplied
It is also called market clearing price.
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CHAPTER 3
Production
Production is the act of creating output, a good or service which has value and
contributes to the utility of individuals. It means creation or addition of utility.
Production is the organized activity of transforming resources into finished products in
the form of goods and services; and the objective of production is to satisfy the
demand of such transformed resources. - James Bates and J.R. Parkinson
Production process:
1. Change the form of natural resources Form utility
2. Change the place of the resources to a place where they have greater utility
Place utility
3. Making materials available when they are required Time utility
4. Using personal skills
Factors of Production
1. LAND
Economic definition - All free gifts of nature which would include besides the
land, in common parlance, natural resources, fertility of soil, water, air, natural
vegetation etc.
Characteristics:
Free gift of nature
Supply of land is fixed i.e. it is strictly limited in quantity
Land is fixed and cannot be shifted from one place to another
Properties of land cannot be destroyed
Land yields results only after human efforts
2. LABOUR
In economics labour means expenditure of physical or mental efforts for
production of goods & services.
Anything done out of love & affection or for pleasure is not a part of economic
activity.
Characteristics:
Connected with human efforts
It is highly perishable
Labour cannot be separated from the labourer
Labour power & skills differ from labourer to labourer
All labours are not productive
Labour has poor bargaining power
Labourer has to choose between hours of leisure & hours of labour
Labour is a mobile factor
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3. CAPITAL
It is a part of wealth which is used for further production of wealth. It is also termed
as produced means of production as they are already produced goods which are
used in production of goods & services.
Types of capital:
Fixed capital Exists in a durable shape and is available for a long period
Circulating capital Available for a single use
Real capital physical goods
Human capital human ability & skills
Tangible capital can be touched
Individual capital personal property
Social capital belongs to society
Capital formation:
It is a term used to describe net capital accumulation during an accounting period.
Capital formation refers to net additions of capital stock such as equipment, buildings
and other intermediate goods. It is also known as investment.
Stages of capital formation Savings The ability and willingness to save forms the base of the capital
formation. It is more for the higher income group or richer country.
Mobilization of savings It involves circulating the saved money to facilitate the
process of capital formation. It is done through banks & financial institutions.
Investment It involves converting the real savings into the real capital assets.
This is the final stage of capital formation.
4. ENTREPRENEUR
Entrepreneur mobilizes all the factors of production, combines them in right
proportion, initiates the process of production & bears the risk involved in it. They
are also called organiser, manager or risk taker.
Functions:
Initiating a business enterprise and resource co-ordination
Risk bearing or uncertainty bearing
Introduce innovations
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Production Function
The term production function is applied to the physical relationship between a firms
input of resources and its output of goods or services per unit of time leaving prices
aside -Richard H. Leftwich
Production function states the relationship between inputs and output i.e., the
maximum amount of output that can be produced with given quantities of inputs
under a given state of technical knowledge.
Equation of production function: q = f (a, b, c, d .n)
Q = rate of output of given commodity
a,b,c,d.n, are different factors (inputs) and services used per unit of time.
Short run production function: Capital remains constant where as other factors vary
during short run. It applies law of variable proportion.
Q = T (K, L)
Long run production function: All factors of production can be varied. It applies law of
returns to scale.
Assumptions:
It is related to a particular unit of time.
The technical knowledge during that period of time remains constant.
The factors of production are divisible into most viable units.
Best available technique is used.
Total product - Total quantity of output produced with the given quantity on inputs. If
one factor is kept constant then total product will vary with the quantity of variable
factor.
MP = TPn TPn-1
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If the variable factor of production is increased, there will come a point where extra unit
of input become less productive than previous ones. Therefore, these extra inputs will
have a lower marginal product.
Assumptions:
Technology remains same
One input is variable and others are fixed
Factors of production can be used in different proportions
Only physical inputs & outputs are considered
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STAGES
TOTAL PRODUCT
MARGINAL
PRODUCT
Initially reaches the
maximum point &
then starts falling.
AVERAGE PRODUCT
1ST stage
(MP > AP)
Law of increasing
returns
Initially increases at
an increasing rate.
Later at diminishing
rate
2nd stage
(MP < AP)
Law of diminishing
returns
Increases at a
diminishing rate &
reaches its
maximum point
Decreases &
become zero at
point M
3rd stage
(Beyond H)
Law of negative
returns
Begins to fall
Becomes negative
Stage of operation:
Inappropriate stages of production1. Stage 1 As MP is negative
2. Stage 2 Resources are underutilized and AP can be increased by increasing
variable factor
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Efficient stage of productionA rationale produced will produce in Stage 2 where MP & AP are falling. Resources
are efficiently utilized.
Returns to Scale
It studies the production in long run where all factors are variable. It studies the change
in output with the change in scale i.e. all the factors are increased (decreased) in same
proportion.
1. Constant Returns to Scale It states that with increase in the scale in some
proportion, output increases in same proportion. It is also called Linear
Homogenous Production Function.
2. Increasing Returns to Scale It states that with increase in the scale in some
proportion, output increases in higher proportion.
3. Decreasing Returns to Scale It states that with increase in the scale in some
proportion, output increases in lower proportion.
Managerial
ECONOMIES
(Reduces cost)
As production in increased
better utilization of capital
& machinery is possible.
Also there is greater degree
of division of labour or
specialisation
DISECONOMIES
(Increases cost)
After the maximum point of
efficient
utilization
of
resources further increase
will
make
things
unmanageable
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Commercial
Requirement
of
large After the optimum scale
amount
of
materials economies converts into
enables to place bulk diseconomies
orders & enjoy discounts.
Sales can be increased
with little extra cost
Financial
Risk bearing
Large
business
with After a point diversification
diversified
&
multi- can increase exposure to
production
capabilities economic disturbances
have better risk bearing
External diseconomies
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Cost Analysis
It is the study of the behaviour of in relation to or more production criteria like size of
output scale of operations, price of production factors.
7. Fixed costs Fixed costs do not vary with output and remains the same
irrespective of the level of output. These cannot be avoided. They are also
called inescapable or uncontrollable costs.
8. Variable costs- These costs vary with the level of output. These are a function of
output in the production period.
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Cost Function
It is the mathematical relationship between cost of a product and factors affecting the
cost.
C= f(Q, T, Pf, K)
C = total cost
Q = Output
T = Technology
Pf = factor price
K = Capital
TC = TVC + TFC
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Marginal cost Increase in total cost when one additional unit of output is produced.
MC = TCn TCn-1
It first declines, reaches its minimum & then begins to increase.
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In order to derive a long run average cost curve short run average cost curves for
different periods are considered and then long run cost curve is drawn as tangent to all
these short run average cost curves. It is NOT tangent to them at their minimum points.
Long run cost curve is Planning curve as firm produces any output in long run by
choosing a plant on the long run average cost curve corresponding to the given
output.
It is also called Envelope curve because it envelopes short run average cost curves
from below.
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CHAPTER 4
Elements of Market
(i) Buyers and sellers;
(ii) A product or service;
(iii) Bargaining for a price;
(iv) Knowledge about market conditions; and
(v) One price for a product or service at a given time.
Classification of Market
On basis of area
1. Local markets perishable goods are traded
2. Regional markets semi-durable goods are traded
3. National markets durable goods & industrial items are traded
4. International markets precious goods are traded
On basis of time
1. Very short period market perishable goods, fixed supply
2. Short period market supply can be increased by increasing variable factors
3. Long- period market supply can be increased by changing fixed factors
4. Very long period or secular period very long period in which there is
movement in factors like population size, supply of capital & raw material etc.
On basis of nature of transactions
1. Spot market goods are physically transacted on the spot
2. Future market involves future contracts
On basis of regulation
1. Regulated market - transactions are statutorily regulated
2. Unregulated market no restrictions
On basis of volume of business
1. Wholesale market commodities are bought & sold in bulk
2. Retail market commodities are sold in small quantities
On basis of competitions
1. Perfectly competitive market
2. Imperfect competition
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Types of Market Structure
Criteria
Perfect Comp.
Monopolistic
Oligopoly
Monopoly
No. of sellers
Many
Many
A few
One
Nature
product
of Homogeneous
Differentiated
Differentiated
Unique
Freedom
entry & exit
of Complete
freedom
Complete
freedom
Barriers to entry
Barriers to entry
Large
Small
Small
Some
Some
Very
considerable
Average revenue
Revenue per unit & is equal to price of the commodity
AR = TR / Q
TR = Total revenue
Q = Quantity sold
Marginal revenue
Increase in revenue due to sale of an extra unit
MR = TRn TRn-1
AR, MR, TR & Elasticity of demand
MR = AR [(e 1) / e]
Where, e = elasticity of demand
MR = 0, e = 1
MR > 0, e > 1
MR < 0, e < 1
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Behavioural Principles
1. Firm should produce till TR = TC or TR > TC
2. Production should be expanded if MR > MC till MR = MC
Determination of Prices
Price is fixed at the point where demand = supply
I.e. demand curve intersects supply curve
Changes in Demand
1. Increase in demandDemand increases demand curve shift rightwards price & quantity increases
2. Decrease in demandDemand decreases demand curve shift leftwards price & quantity falls
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3. Increase in supply
Supply increases supply curve shift rightwards quantity increases, price
decreases
4. Decrease in supply
Supply decreases supply curve shift leftwards quantity falls, price rises
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Perfect competition
Also called pure competition
1.
2.
3.
4.
5.
6.
Supply curve:
MC curve above AVC depicts firms supply curve
AVC > Price firms supply is zero
AVC > Price firms supply at point where MC = Price
Breakeven: AVC = Price
Normal profits: AR = ATC
Super normal profits: AR > ATC
Losses: In case of losses firm will try to produce where loss is minimized i.e. where it
covers its variable cost & a part of fixed cost.
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Short run marginal costs = Long run marginal costs
Monopoly
Features:
1.
2.
3.
4.
5.
Single seller
Strong barriers to entry
No close substitutes for the products sold
Price discrimination can be adopted
Firms are price maker & not price taker
As there is only one seller, the firms supply curve is also the markets supply curve &
firms demand curve is also the market demand curve.
Revenue curves:
1. AR & MR are negatively sloped
2. MR curve lies half-way between the AR curve and the Y axis
3. AR can never be zero but MR can be zero or even negative
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Profit: When firm charges price which is more than the equilibrium price of the firm.
Losses: Firm will suffer losses if ATC > AR. However, production is continued if firm can
cover AVC & a part of fixed cost.
Price discrimination
Price discrimination occurs when same commodity is sold at different prices to different
buyers by the same producer.
It is possible only if following conditions are satisfied1. Seller should have some control over supply
2. Market should be divisible into two or more sub markets
3. Price elasticity should be different in different markets
Price elasticity < 1, charge higher price
4. Buyers should not be able to resell the product at higher price.
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Degrees of price control1. 1st degree when the fixed price eliminates the entire consumer surplus
2. 2nd degree price takes away a part of consumer surplus
3. 3rd degree price vary according to location or customer segment
The discriminating monopolist will maximize his profits by producing the level
of output at which marginal cost curve MC intersects the aggregate
marginal revenue curve AMR.
This output will be divided between the sub markets in such a way that the
marginal revenues of the markets are equal.
The MC of the markets should also be equal
Prices will be decided according to the quantity that can be sold in the
different markets.
Equilibrium of firm
Conditions to be satisfied
1. MC = MR
2. MC cuts MR curve from below
Firms earn super normal profits during short run.
During long run, due to entry of new firms, firm earns only normal profits.
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Oligopoly
Features:
1. Few sellers
2. Homogeneous or differentiated products
Types:
1. Open oligopoly free entry in market
2. Closed oligopoly entry is restricted
3. Collusive oligopoly firms act in collusion with each other i.e. on basis of
understanding
4. Competitive oligopoly there is no understanding & firms compete with each
other
5. Partial oligopoly - one large firm dominate the market
6. Full oligopoly there is no leadership
7. Syndicated oligopoly products are sold through centralised syndicate
8. Organized oligopoly firms organise themselves into central association
Characteristics:
1.
2.
3.
4.
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Price & output decisions:
Change in price by any firm will result in reaction by other firms by changing prices.
Due to this the demand curve keep shifting & there is no specific demand curve, price
or output
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CHAPTER 5
Features of Underdeveloped economy
1. Agriculture is the main occupation
2. Wide spread poverty
3. High rate of population growth
4. Low standard of living
5. Low productivity of labour
6. Backward production techniques
7. High unemployment & underemployment
8. Low level of human well being
9. Widespread income inequalities
10. Low rate of capital formation
11. Low participation in foreign trade
12. Traditional social life
13. Weak infrastructure
Indias case:
1. Agriculture main occupation- population involved at the time of independence
72% and currently nearly 50%
2. 1/3rd of worlds poor live in India. Population in India below poverty line
1993-94 36%
1999-2000 26%
2004-05 22%
3. High population growth rate of 2%
4. The dependency rate i.e. percentage of people in non-working age group is
nearly 40%
5. Low per capita income - $1410 (2011)
6. Low gross capital formation
Gross domestic savings:
- 1990-91 23%
- 2010-11 32.3%
Domestic capital formation:
- 1990-91 26%
- 2010-11 35.1%
7. Backward techniques of production
8. High unemployment& underemployment Currently 6.6%
- 1999-2000: 7.31%
- 2004-05: 8.2%
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9. Low level of human well-being
Measured by Human Development Index (HDI) on the basis of longevity,
knowledge and standard of living.
2000 0.44
2010 0.519
2011 0.547
Relative global ranking (2010) 119 among 169 countries
Ranking in 2011 134 out of 187 countries
10. Highly unequal income distribution
Income inequalities are measured by GINI index:
- Zero index perfect equality
- One index perfect inequality
As per HDI, Indias GINI index
1994 0.297
2000-10 0.368
Agriculture
Industry
Service
1950-51 (%)
53.1
16.6
30.3
2011-12 (%)
13.9
27.0
59.0
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Increase in area under irrigation from 22.6 million hectares (1950-51) to 87.2
million-hectares (2007-08)
- Increase in literacy rate from 18.33% (1951) to 74% (2011).
- Improvement in medical field. No. of doctors has increased by more than 12
times & bed population ratio has increased to 1.03 per 1000
7. Development in banking & financial sector
-
Agriculture
Contribution
1. Provide employment
2. Share in National Income
Detail
50% of population (2010-11) is engaged in
agriculture sector
It contributes 12.3% of GDP (2010-11) &
13.9% of national income (2011-12)
3. Support industries
4.
5.
6.
7.
8.
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2. Increase in productivity
- Productivity increased at a rate of around 2.06% per annum during 1967-2003
- Productivity of food grains increased from 2.74% (1980-1990) to 2.91% (200012)
3. Diversified agriculture
- Share of non-crop sectors in agricultural output is increasing.
- Area under commercial crops & superior cereals is increasing
4. Modern agriculture
- Increased use of high yielding varieties of seeds, fertilizers, pesticides etc.
- Use of intensive cultivation, multiple cropping, scientific water management is
increasing
- Adoption of modern techniques by farmers which is resulting in improved
agricultural capacity.
- Better marketing of agricultural products
5. Improved agrarian system
- Abolition of zamindari system, the ryotwari system and the mahalwari system
& of exploitation of cultivators
- Introduction of tenancy reforms
Rents were fixed between 25-50% for different states
Legislations disallowing the ejectments of tenants were passed
Ceilings were imposed on agricultural holdings
2.18 million hectares of land has been distributed as surplus area
- Land holdings were reorganised
6. Other developments
- Inputs are provided at subsidised rates
- Provision of credit at low interest rate
- Minimum wage level is fixed
- Governments support in marketing & selling
- Special programmes to provide employment to rural people
- Special schemes passed to support production of various product
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Problems of agriculture sector
Problems
Backward techniques
Finance related
problems
Warehousing &
marketing problems
Details
1.
2.
3.
4.
Steps:
1. 14 banks were nationalised in 1969 & 6 in 1980
2. Regional Rural Banks (RRBs) were set up in 1975
3. National Bank for Agriculture and Rural Development
(NABARD) was set up in 1982 as apex bank
4. Kisan Credit Card scheme was started in 1998
5. Agricultural Debt Waiver and Debt Relief Scheme in
2008
6. Rehabilitation package was initiated
Problems:
1. Loans concentrated to limited regions
2. Nearly 40% of amount financed does not come back
to the society
3. Large & medium farmers enjoyed major benefits
4. Lack of proper staff in financial institutions
1. Improper storage facilities
2. Lack of organization among farmers
3. Existence of agents between farmers & buyers who
charge heave fees
4. Produces have to be sold in nearby markets at low
prices due to improper transport facilities
5. Existence of several malpractices
6. Improper knowledge of market
7. Low level grading & standardization
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Warehousing &
marketing problems
Industry
Role of Industry
1. Modernises & improves agricultural productivity
2. Generate employment opportunities. Currently employs 22% of labour force
(2009-10)
3. Share in GDP increased from 12% (1950-51) to 27% (2011-12)
4. Contributes to more than 2/3rd of export earnings.
5. Industrial development increases GNP per capita
6. Industrialization enhances self-sustaining economic growth
7. Industries helps in meeting high-income demands
8. It strengthens the economy
- Produce capital goods at low cost
- Helps in production of economic infrastructure
- Supports agricultural sector
- Makes country self-reliant in defence materials
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Pattern of Industrial Development
1.
2.
3.
4.
5.
6.
7.
8.
Important points
1. Based on Mahalanobis model, during 2nd plan, focus was shifted on
basic & capital goods & Three Steel Plants were set up in the public
sector at Bhilai, Rourkela and Durgapur. 1st 5 year plan in India started
in 1951.
2. Industrial sector has become broad-based and modernised
3. Massive increase in the size and diversification of public sector from 5
units (1951) to 242 units (2008)
4. Emergence of many big industries in Private Sector from 2 units (1951)
to 80 in present
5. Major expansion of infrastructural facilities
- Emergence of public financial institutions
- Improvement power generation, railway transport facilities,
telecommunications etc.
6. India ranks high in the world in respect of technological talent and
manpower and in development of information and communication
etc.
7. Since 1951 there has been the mammoth growth of small-scale
industrial units. They employ nearly 312 lakh people.
8. Classification of industries as per Micro, Small and Medium Enterprises
Development (MSMED) Act, 2006
In Manufacturing Sector- Investment up to Rs.25 lakh - micro enterprises
- Investment between Rs.25 lakh and Rs.5 crore small enterprises
- Investment between Rs.5 crore and Rs.10 crore medium
enterprises
In Service Sector
- Investment up to Rs.10 lakh - micro units
- Investment between Rs.10 lakh and Rs. 2 crore - small enterprises
- Investment between Rs. 2 crore and Rs.5 crore - medium
enterprises
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Services
Service sector includes:
1. Business & professional services
2. Communication services
3. Real estate & related services
4. Distributive services
5. Education services
6. Energy & environmental services
7. Financial services
8. Health services
9. Tourism
10. Transport
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2009-10 29%
3. Providing support to other sectors Support agriculture & industries
4. Contribution to exports
- Services accounted for about one third of total exports in India (2010-11)
- In 2006, India's share in world's total commercial services export was 2.7%
- There is a growth of 20% in Indias service exports (2004-11)
NATIONAL INCOME
National income is the money value of all the final goods and services produced by a
country during a period of one year.
Basic Concepts
1. Gross Domestic Product (GDP):Goods & services produced within the
domestic territory of a country during an accounting year
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2. GDP at Constant Prices & Current Prices:
- Current prices - estimated on the basis of the prevailing prices
- Constant prices - measured on the basis of some fixed prices i.e. some base
year prices
3. GDP at Factor Cost & at Market Price:
- At factor cost - estimated as the sum of net value added by the different
producing units and the consumption of fixed capital.
- At market price at price paid by consumers.
- GDPF.C = GDPM.P - IT + S.
IT = Indirect Tax
S = Subsidies
4. Net Domestic Product: GDP depreciation
5. Gross National Product (GNP):GDP + Net Factor Income from Abroad (NFIA)
NFIA = Difference between income received from abroad & income paid to
non-residents within domestic territory.
6. Net National Product (NNP):GNP Depreciation
NNP = NDP + NFIA
7. NNP at Factor Cost or National Income: Volume of commodities and services
produced during an accounting year, counted without duplication.
NNP at FC = National Income = FID + NFIA
FID = factor income earned in the domestic territory of a country
8. Personal Income: Sum of all incomes actually received by individuals during a
given year
PI = National income - social security contribution - corporate income taxes undistributed corporate profits + personal payments
9. Personal Disposable Income: Personal income personal taxes
Or
Consumption + Saving
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Care to be taken
- Sale of second hand items is to be excluded
- Non-monetary activities excluded
- Production for self-consumption included
- Commission of dealer of 2nd hand goods included
2. Income Method:
Factor income of all the factors of production is added.
NI = Compensation of employees + Net interest + Rental & royalty income + Profit
Care to be taken
- Income of primary factors only is to be included
- Transfer incomes excluded
- Labour income included
- Non-labour income excluded
- Illegal incomes, windfall incomes, death duties etc. excluded
- Sale proceeds of 2nd hand goods excluded
- Income of self-employed included
Note:
- If NI is calculated from data regarding incomes paid out by producers then
add NFIA
- If NI is calculated from incomes received by people then NFIA is not added
3. Expenditure Method:
It focuses on finding the total output of a nation by finding the total amount of
money spent.
NI = Expenditure on final goods & services + Net foreign investment
Items Included
Items Excluded
1. Fees paid to educational institutions 1. Expenditure on the repair of fixed capital asset
by students (payment for a service (intermediate consumption)
received)
2. Expenditure on electricity by
household (final consumption).
transfer
payments
like
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Gross national expenditure = Consumption expenditure + net domestic investment +
net foreign investment + replacement expenditure (i.e., expenditure on replacement
investment).
Important Points:
1. All measures of NI should give same result
2. Methods used by different sectors:
- Agricultural sector Net value added
- Small scale sector & service sector Income method
- Construction sector Expenditure method
3. Developed economies use income method
Problems in calculation NI
(1) Presence of a large non-monetized sector
(2) Lack of appropriate and reliable data
(3) Problem of double counting
(4) Problem of transfer payments
(5) Difficulties in classification of working population
(6) Unreported illegal income
Direct tax: Taxes which are not shifted. Income tax & Wealth tax are
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Merits of Direct Taxes:
Imposed according to persons ability to pay
Revenue is income elastic
Create better civic consciousness
Helps in transferring the income from rich to poor
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2. Excise Duties-
Levied on production
No connection with actual sale
Modified Value Added Tax (MODVAT) introduced in 1986-87 to remove
cascading problem
Under MODVAT a manufacturer got full reimbursement of excise duty paid on
the raw materials or components
Central Value-Added Tax (CENVAT) was introduced in 2000-01 which
consisted of only one basic excise duty.
3. Sales tax-
Multistage sales tax with credit for taxes paid on business purchases
Introduced in 1999
Implemented in April 2005 (only in some states)
At present, implemented in all states/ union territories.
5. Service Tax
-
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5. Cost of tax collection - more than Rs.6,500 crore (2010-11)
6. High evasion and tax avoidance
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CHAPTER 6
Population
All the inhabitants of a particular town, area, or country
Or
Total no. of people residing in a place
Population growth as an asset:
Population growth as a burden:
Provide work force
Lead to increased unemployment
Provides market for produced goods
Pressure on social overheads
Promote innovations
Pressure on means of subsistence
Promote labor specialization
Slow capital formation
Increase dependency
2. Rate of growth:
-
1901-11, the population growth rate 5.74% per decade & 0.56% per annum
1991-2001, the growth rate was 1.97% per annum.
2001-2011: 1.64% p.a.
1921 Year of Great Divide
Death rate
1951- 27.4
2010 7.2
Birth rate
1951- 39.9
2010- 22.1
Lowest birth rate Kerala
Highest birth rate Uttar Pradesh
Lowest death rate West Bengal
Highest death rate Orissa
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4. Density of Population:
-
5. Sex Ratio:
-
7. Literacy ratio:
-
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Causes of rapid growth of population
High Birth Rate:
India being agrarian economy considers
children as assets
Small urbanization
Spread of education
Reduction in famines
Lack of education
Joint family system encourages big families
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3.
4.
5.
6.
7.
Spread of education
Provision of Old age pension & Social security
Reduction in infant mortality through improved medical facilities
Introduction of incentives for people with small families
Encouragement of urbanization
POVERTY
Absolute Poverty:
-
Relative Poverty:
-
Poverty in India
1. Use concept of absolute poverty
2. Expert Group poverty lines are used in India which defines separate poverty
line for rural & urban thresholds.
3. Poverty ratio as per URP data 2004-05:
- Rural: 28.3
- Urban: 25.7
- Total: 27.5
4. Poverty ratio as per MRP data 2004-05:
- Rural: 21.8
- Urban: 21.7
- Total: 21.8
5. Per capita consumption expenditure reduced to 60.5 of population in 2004-05.
6. India has a poverty index of 0.296 with a rank of 119 (among 169) countries
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Causes of Poverty
Economic causes:
Rapidly growing population
Agriculture is main occupation
Low productivity
Underdeveloped economy
Income inequalities
Large level of unemployment
Inflation
Other causes:
Large family sizes
Poor education
Bonded labour
UNEMPLOYMENT
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Types of Unemployment:
1. Voluntary: People who are willingly unemployed
2. Frictional: Temporary unemployment due to change of jobs, strikes or lockouts
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3. Inappropriate technology
4. Inappropriate education system
5. Large scale rural-urban migration
Measurement of Unemployment:
1. Usual Status (US): Estimates the no. of people to are chronically unemployed
2. Current Weekly Status (CWS): Person is said to be unemployed even if he is
unemployed only for a day during the analysed week
3. Current Daily Status (CDS): Anyone who works for an hour or more during the day
is considered to be employed for half day. (6.6% during 2009-10)
(Number of persons per thousand of population 2009-10)
WPR
PU
LFPR
US
392
8
400
CWS
370
14
384
CDS
341
24
365
Demographic Dividend:
Properly utilised big labour force is Demographic Dividend
Eleventh planned aimed at utilizing demographic dividend
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NFRATRUCTURAL CHALLENGES
ENERGY
-
Electricity
-
Difficulties & problems related to energy- Demand for commercial energy has increased more than the supply.
- Increase in oil prices has led to rising general prices in India
- Indias oil import bills has increased from Rs.1100 crore (1973-74) to Rs.4,80,000
crore (2010-11)
- High transmission and distribution losses
- Many SEBs have been declared sick
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TRANSPORTATION
Railways
-
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Roads
-
Water Transport
-
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Air Transport
-
COMMUNICATION
Postal Services
-
Telecommunications
-
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-
HEALTH
-
Good health comes from (1) balanced and nutritional diet and (2) medical
care
Low health standard in India because 37% of population lives below poverty
line
Various health development programmes have been integrated with family
welfare and nutritional programmes
Focus is now on providing better health and medical care services to the
poor people
Efforts to provide hygienic conditions
There is a fall in the incidence of certain diseases like T.B, leprosy and polio
There is a rise in the incidence of certain diseases like AIDS, blindness, cancer
etc.
EDUCATION
-
India has the one of the largest education systems in the world
The National Policy on Education (NPE) was introduced in 1986 & modified in
1992 which emphasized on: universal access and enrolment; universal
retention of children up to 14 years of age and a substantial improvement in
the quality of education.
Target expenditure on NPE: 6% of GDP
Actual expenditure on NPE: 3.13% of GDP (2009-10)
Right of Children to Free and Compulsory Education Act (RTE Act) 2009 gave
children between age 6 to 14years a right to free education
Gross enrolment ration for age group 6 14 years increased to 96.7 in 2011
Sarva Shiksha Abhiyan (SSA) launched in 2001-02.
National Programme for Education of Girls at Elementary Level (NPEGEL) &
Education Guarantee Scheme and Alternative and Innovative Education
(EGS + AIE) are important parts of SSA
The number of secondary and higher education school has increased from
7416 in 1950-51 to about 1,72,000 in 2007-08
Rashtriya Madhyamik Shiksha Abhiyan was launched in 2009 to enhance the
access to secondary education
Technical education has improved significantly
National Literacy Mission (NLM) was launched in 1998 to impart functional
literacy to non-literates
Problems:
Deterioration of academic standards
Inadequate number of institutions
Large number of unemployed educated people
Large-scale migration of educated people
Lack of infrastructure
Neglect of primary education
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Regional disparities
Large number of dropouts
Steps to be taken:
Restrictions should be imposed on higher education
Education should be made job-oriented
Expansion should be properly planned
There should be emphasis on rural areas
Brain drain should be stopped
The standard of education should be raised
Drop out ratio should be controlled
INFLATION
Persistent upward movement in the general price level which results in fall in purchasing
power
Demand-pull inflation Occurs when the aggregate demand in the economy is more
than the aggregate supply. This pushes up the overall price level.
Cost Push inflation - Caused by substantial increases in the cost of important goods or
services where no suitable alternative is available. As the cost of production increases,
the market prices of goods and services are increased.
Stagflation - Situation where an inflation rate is high, the economic growth rate slows
down, and unemployment remains steadily high.
Deflation Prices falls & purchasing power increases
Consumer Price Index It measures changes in the price level of consumer goods
and services purchased by households
-
Public expenditure has risen from 18.6% of GDP (1961) to around 27% (201112)
Deficit financing
Erratic agricultural growth
Price support to the agriculturists
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2006-07: 3.3%
2007-08: 2.5%
2008-09: 6%
2009-10: 6.5%
2010-11: 4.8%
Reasons for increase in budget deficit during 2008 to 2010
Increase in the plan expenditure
Reduction in indirect taxes
Sector specific measures
Debt relief package for farmers
BALANCE OF PAYMENTS
Balance of payments is systematic record of all economic transactions between the
residents of one country and the residents of the rest of the world in a year.
Balance of Trade = Value of goods sold to foreigners by the residents of country - value
of goods purchased by them from foreigners
Balance of trade equilibrium: Exports of goods = Import of goods
Balance of trade deficit: Exports < Imports
Surplus balance of trade: Exports > Imports
Balance of Current Account Balance of trade + Balance of services + Balance of
unilateral transfers
It could be positive, negative or zero depending upon the values of these balances
Balance of Payment on capital account includes balances of private direct
investments, private portfolio investments and government loans to foreign
governments
Balance of Payments = Balance of current account + Balance of capital account
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EXTERNAL DEBT
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CHAPTER 7
Background:
-
Crisis in 1991
2. Privatization of industries:
-
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3. Automatic clearance for import of capital goods was given if
-
4. Government approval was not required for industries in area with population
more than 1 million
5. Mandatory convertibility clause was removed for term loans for new projects
6. Phased manufacturing programmes were approved
7. New broad banding facility was provided
Foreign Investment
-
MRTP Act
MRTP act was abolished under New Economic Policy,1991
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Fiscal Reforms
Policy relating to public revenue and public expenditure
Tax Reforms:
1.
-
2.
-
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Impact of Economic Reforms on Indian Economy
-
Hurdles:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Liberalisation
Relaxation of previous government restrictions
Privatisation
Transfer of assets or service functions from public to private ownership
Ways: franchising, leasing, contracting and divesture
Preconditions required-
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Arguments against privatisation
-
Disinvestment
Disposal of public sectors units equity in the market
Methods of Disinvestment
1.
2.
3.
4.
Issue of equity
Issuance of the Global Depository Receipts (GDRs)
Crossholding - government sells part of its shares in one PSU to other PSUs
Warehousing - governments own financial institutions buy governments stake &
holds them till 3rd buyer emerges
5. Retaining golden share - retaining governments stake up to 26% in the PSU
6. Strategic Sale method - government sells a major portion of its stake to a
strategic buyer & also transfers management
Progress of Disinvestment
-
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GLOBALISATION
Integrating the domestic economy with the world economy
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2. World Bank
- The International Bank for Reconstruction and Development (IBRD)
- Formed at Bretton Woods in 1945
- 187 member countries
- Objectives
Investing for peoples basic health & education
Focus on social development
Protect environment
Support and encourage private business development
Create a stable macro-economic environment
- Functions
Provide long term loans for reconstruction and development
Encourage private foreign investment
Promote long- term balanced growth
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3. World Trade Organization
-
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CHAPTER 8
Money:
1. Served as medium of exchange
2. Served as common measure of value
3. Served as store of value
Functions of Money
1. Act as medium of exchange
2. Common measure of value
3. Standard of deferred payments
4. Store of value
Dynamic functions:
1. Directs economic trends
2. Encourage division of labour
3. Smoothens transformation of savings into investments
M1 = Currency with the public i.e., coins and currency notes + Demand
deposits of the public known as narrow money.
M2 = M1 + Post office saving deposits.
M3 = M1 + Time deposits of the pubic with banks called broad money.
M4 = M3 + Total post office deposits
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After it has been redefined:
COMMERCIAL BANKS
Role of Commercial Banks
1.
2.
3.
4.
Functions of a Bank
1. Receive deposits: Current deposits, Saving deposits, Time deposits
2. Lend money: Cash credits, overdrafts, loans and advances, or discounting of bills
of exchange
3. Agency services: Collection of bills, dividends, interest, premiums etc.
4. General services:
- Issue of letters of credit, travellers cheques, bank drafts, circular notes; etc
- Safe deposit vaults service
- Supply trade information &surveys
- Underwriting share issues
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4. Commercial banks violated norms
5. Private banks earned large profits by indulging in speculative activities
6. Export, small-scale industries etc. were also completely neglected
Objectives:
1. Removal of control by few
2. Providing facilities to agricultural sector
3. Better management
4. Encourage new entrepreneurs
5. Better staff service
Measures required
1.
2.
3.
4.
5.
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Meaning & Functions of Central Bank
It constitutes the apex of the monetary and banking structure of a country
Central Bank of India: Reserve Bank of India (RBI)
Regulation of currency
Perform general banking & agency services for state
Custody of cash reserve
Manages international currency reserve
Grants collateral advances to commercial banks, bill brokers & dealers
Clearance arrangements amongst banks
Control of credit as per monetary policy
COMMERCIAL BANK
Mobilises savings
Role of RBI
1. Apex monetary institution of India
2. Strengthens, develop and diversify the countrys economic and financial
structure
3. Maintain economic stability
4. Assist economic growth
5. Control monetary policy
6. Advisor to government
7. Represent country in International economic forums
8. Guide commercial banks
9. Develop adequate & sound banking system
10. Control inflation
11. Protect market for government securities
12. Channelize credit in desired direction
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Functions of RBI
1. Issue of currency
2. Banker to government
- transacts all the general banking business of government
- manages public debt
- sells T-bills on behalf of government
- makes advances to government
- act as adviser to government
3. Bankers bank
- Commercial banks maintain CRR with RBI
- Provides financial assistance
- Inspect commercial banks
4. Custodian of Foreign Exchange Reserves
5. Control credit through quantitative & qualitative methods
6. Promote banking habits & mobilises savings
7. Collection & compilation of statistical data
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3. Variable Reserve Requirements:
- Cash Reserve Ratio (CRR) proportion of total deposits to be kept with
central bank by commercial banks
- Statutory Liquidity Ratio (SLR) proportion of total deposits to be maintained
as liquid assets by commercial banks
- To control inflation Increase Reserve Ratios
- To control deflation Decrease reserve Ratios
- Current CRR is 6% & SLR is 24% (May,2011)
4. Repo rate & Reserve rate:
- Repo rate Rate of borrowing rupees from RBI
- Reserve Repo rate rate at which RBI borrows money from banks
- To control inflation Increase repo rate & reserve repo rate
- To control deflation Decrease repo rate & reserve repo rate
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