JOMO KENYATTA UNIVERSITY

OF
AGRICULTURE AND TECHNOLOGY

DEPARTMENT OF ELECTRICAL & ELECTRONIC ENGINEERING

P.O. BOX 62000 - 00200, NAIROBI

TEL: (067) - 52181-4, 52711 FAX: (067) 52220
Email: eee@eng.jkuat.ac.ke

TITLE : ASSIGNMENT

UNIT

UNIT CODE :HRD GENERAL ECONOMICS

LECTURER :

NAME: REG NO.

HENRY KABOGO ENED211-0316/2016

 General Economics

1.0 Criticize the following definitions of economics:

i. Adam Smith: Economics as an inquiry into the nature and cause of wealth of nations.
According to Adam Smith, the acquisition of wealth is the main objective of human activity.
Therefore it is necessary to study how wealth is produced. This is the subject matter of
Economics.

1. This definition is much too materialistic. Apparently it makes wealth more important than man
for whose use wealth is produced. Narrow meaning of wealth: Adam smith considered that
economics is the science of wealth and wealth includes only material goods. This is the narrow
sense of defining wealth. In practice, wealth includes both material and non- material goods. The
human wants can be fulfilled by using non material goods of services also.
2. Too much importance to wealth: Adam smith gave more importance to wealth than man. He
had given first place for wealth and secondary place for human beings. But according to
Marshall, wealth is only a means of satisfying human needs. Thus, economics must emphasize
the study of man much more than the study of wealth.
3. No meaning of human welfare: this definition gave any importance to the welfare of society.
According to Marshall, the main aim of economics is to increase the welfare of human beings
not to obtain wealth only.
4. Wrong assumption of economic man: According to Adam smith, Economic man is one who is
involved in earning wealth and this economic man is only the subject matter of economics. But
no man can be limited only with earning wealth. Because man is equally influenced by moral
and spiritual thoughts like love, self-esteem, sympathy, friendship, etc.
5. Labour is not only the source of wealth: According to Adam smith, main source of wealth is
employed labour. In real, labour alone cannot produce anything. In production process, there are
other factors of production like land, capital, and organization including labour. Adam smith has
ignored these aspects.
ii. Alfred Marshall: As a study of mans activities in the ordinary business of life(welfare
definition)

In 1890, Alfred Marshall suggested a new definition which shifted the emphasis from wealth to
man. Economics is a study of mans, actions in the ordinary business of life. It enquires
how he gets his income and how he spends it.

Thus, according to Marshall, Economics is a study of a part of mans actions. It is concerned

with only those activities which relate to the earning and spending of income. By such activities
men acquire the material requisites of well-being. Economics is, therefore, on the one side,
a study of wealth and on the other and more important side, a part of the study of man.

Following are the main criticisms of the welfare definition:

a) Neoclassical economics is sometimes criticized for having a normative bias. In this view, it does
not focus on explaining actual economies.
b) The focus on individuals in the economy may obscure analysis of wider long term issues, such as
whether the economic system is desirable and stable on a finite planet of limited natural capital.
c) Large corporations might perhaps come closer to the neoclassical ideal of profit maximization,
but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider
social issues.
d) Problems with making the neoclassical general equilibrium theory compatible with an economy
that develops over time and includes capital goods.
e) In the opinion of some, these developments have found critical weaknesses in neoclassical
economics. Economists, however, have continued to use highly mathematical models, and many
equate neoclassical economics with economics, unqualified.
f) The basic theory of a downward sloping aggregate demand curve is criticized for its allegedly
strong assumptions.
g) In general, allegedly overly unrealistic assumptions are one of the most common criticisms
towards neoclassical economics.
h) The basic theory of production in neoclassical economics is criticized for incorrect assumptions
about the rationales of producers.
 i) Often at individual levels, variables such as supply and demand, which are independent, are
assumed to be independent also at aggregate level. This criticism has been applied to many
central theories of neoclassical economics.

iii. (Scarcity definition):Leonel Robbin : as a relationship between scarce resources which have
alternative use

Criticisms of Scarcity Definition

Following are the main criticisms of the scarcity definition:

a) Economics is not only a value theory. According to this definition given by Robbins,
economics has been concerned to the theory of value but the scope of economics is very big. It
also includes the study of national income and employment also.
b) Not use social aspects of economic activities. This definition is wrong when it holds that the
activities of those who live outside the society also from the part of economics.
c) Not obey the concept of wealth. This definition does not use the concept of wealth. It is only
concerned with that to allocation of resources in such a manner by which we get maximum
satisfaction. Not tell about the goods, which are required to satisfy our wants.
d) Economics is not only a positive science. According to this definition economics is only a
positive science which deals with satisfactions of our wants. Bu} economics is also a normative
science.
e) Economics is not only micro analysis. According to this definition economics is concerned
with the satisfaction of individual unlimited wants with scare resources.
2.0 Differentiate between microeconomics and macroeconomics

The main difference between the Microeconomics and Macroeconomics are as follows:

Microeconomics Macroeconomics

1. It is the study of individual economic units of It is the study of economy as a whole and its
an economy aggregates.

2. It deals with individual income, individual It deals with aggregates like national income,
prices and individual output, etc. general price level and national output, etc.

3. Its Central problem is price determination and Its central problem is determination of level of
allocation of resources. income and employment.

4. Its main tools are demand and suply of a Its main tools are aggregate demand and
particular commodity/factor. aggregate supply of economy as a whole.

5. It helps to solve the central problem of what, It helps to solve the central problem of full
how and for whom to produce in the economy employment of resources in the economy.

It is concerned with the determination of

6. It discusses how equilibrium of a consumer, a
equilibrium level of incoem and employment
producer or an industry is attained.
of the economy.

7. Price is the main determinant of Income is the major determinant of

microeconomic problems. macroeconomic problems.

Examples are: National income, national

8. Examples are: individual income, individual
savings, general price level, aggregate
savings, price determination of a commodity,
demand, aggregate supply, poverty,
individual firm's output, consumer's equilibrium.
unemployment etc.
 3.0 Explain the meaning of economic systems and types of markets under economic
systems and outline the advantages of each
3.1 What is an economic system?

An economic system is the system the government of a country uses to manage its economy.An
economic system decides what goods and services are produced and consumed in an
economy and how many goods and services are produced and consumed. An economic system
will also decide how goods and services are distributed to the population.

3.2 What are the different types?

Free market economy This is system where all economic activity is directed by private
individuals and organisation and there is no, or little, intervention from the government.

Advantages of Free market economies

i. A free market economy is driven by individual innovation and the notion that hard work and
ingenuity will be rewarded by success.
ii. Competition between firms should lead to firms wanting to produce as efficiently as possible
because they want prices to be as low as possible so that consumers will want to buy from them;
this drive towards efficiency should mean that resources are not wasted.
iii. Goods, which are being demanded by consumers i.e. consumer wants will be produced, and
those that are not in demand will be dropped.
iv. More choice for the consumer in terms of what they buy.
v. Profit rewards those who are successful for the risks that they take; they can then reinvest profit
to make more!

Command/centrally planned economy This is a system where the economy is controlled by

the government and it decides what and how things are produced and how goods and services are
allocated to the population.
 Advantages of Commands economy

i. it enables the government to overcome market failure, inequality and create a society that
maximises social welfare rather than maximises profit.
ii. Command economies can prevent abuse of monopoly power.
iii. Command economies can prevent mass unemployment, often a feature of capitalist economies.
iv. Command economies could produce goods which benefit society and ensure everyone has access
to basic necessities.

Mixed economy This is the most common type of economic system. It is a mixture of a
command and free market economy. There will be areas of the economy that are controlled by
the government but there will be also areas that are left to private individuals and organisations.

Advantages of mixed economy

a) The market gives producers an incentive to produce goods that consumers want.
b) The market provides an incentive to acquire useful skills.
c) The price system encourages producers and consumers to conserve scarce resources.
d) Competition pushes businesses to be efficient: keeping costs down and production high.
e) The market system involves a high degree of economic freedom.

Transitional economy This is when the economic system in a country is moving from one
type to another. For example, the government may decide to free up some areas of the economy
so they are produced by private individuals and firms rather than the state.

Advantages

i. Economies that transition to a world market economy provide an additional benefit to its
citizens. They are allowed to travel and practice professionally in a different country.
ii. Economies transitioning from a centralised or socialist economic system like that of Cuba to an
open-market system have the advantage of international trade agreements.
iii. Foreign capital investments at steady interest rates finance imports while land resources and
skilled human labour serve as exports.
iv. Gradual market relinquishment by the government has provided pricing stability of Chinese
goods, according to the Asian Development Bank.
v. Further competitive marketing helps countries pay for technology, capital-generating equipment
and improvements in public roads and general infrastructure.
 4.0 We have four market structures, differentiate as in the table below
The major market forms are:

Perfect Competition
Monopolistic Competition
Oligopoly
Duopoly
Monopoly
Monopsony

While Perfect competition form of market rarely exists the imperfectly competitive market forms
are real market situations where some monopolistic competitors, monopolists, oligopolists, and
duopolists exist and dominate the market conditions. The table below shows a summary of
market structures , comparing them along with their characteristics:

Perfect Monopolistic
Characteristic Oligopoly Monopoly
Competition Competition

Number of firms Very Many Many Few One

Only product of
Homogeneous / its kind
Type of Product Homogeneous Differentiated
Differentiated (no close
substitute)

Ease of entry Very easy Relatively easy Not Easy Impossible

Price Setting Nil Absolute

Somewhat Limited
power (Price taker) (Price Maker)

Considerable for a
Non Price
None Considerable differentiated Somewhat
Competition
oligopoly

Productive
Highly efficient Less Efficient Less Efficient Inefficient
efficiency
Long run profits 0 0 Positive High

Small town
Doesn't Exist; Fast Food, retails Cars, Steel, soft
Examples newspaper, rural
agriculture close stores, cosmetics drinks, cereals
gas station

5.0 What the meaning of public finance

Public finance is the study of the role of the government in the economy. It is the branch of
economics which assesses the government revenue and government expenditure of the public
authorities and the adjustment of one or the other to achieve desirable effects and avoid
undesirable ones.

It can also be defined as the study of income and expenditure of government at the central,state
and local levels.

5.1 State the difference between public sector and private sector

The Private Sector

The private sector is usually composed of organizations that are privately owned and not part of
the government. These usually includes corporations (both profit and non-profit) and
partnerships.

An easier way to think of the private sector is by thinking of organizations that are not owned or
operated by the government. For example, retail stores, credit unions, and local businesses will
operate in the private sector.

The Public Sector

The public sector is usually composed of organizations that are owned and operated by the
government. This includes federal, provincial, state, or municipal governments, depending on
where you live. Privacy legislation usually calls organizations in the public sector a public body
or a public authority.
Some examples of public bodies in Kenya are educational bodies, health care bodies, police and
prison services, and local and central government bodies and their departments.

Basis for
Public Sector Private Sector
Comparison

The section of a nation's economy, which is

The section of a nation's economy, which
under the control of government, whether it
Meaning owned and controlled by private individuals
is central, state or local, is known as the
or companies is known as Private Sector.
Public Sector.

Basic
To serve the citizens of the country. Earning Profit
objective

Raises money Issuing shares and debentures or by taking

Public Revenue like tax, duty, penalty etc.
from loan

Police, Army, Mining, Health, Finance, Information Technology, Mining,

Manufacturing, Electricity, Education, Transport, Education, Telecommunication,
Areas
Transport, Telecommunication, Manufacturing, Banking, Construction,
Agriculture, Banking, Insurance, etc. Pharmaceuticals etc.

Benefits of Job security, Retirement benefits, Good salary package, Competitive

working Allowances, Perquisites etc. environment, Incentives etc.

Basis of
Seniority Merit
Promotion

Job Stability Yes No

5.3 What are the roles of public finance in developing countries

 6.0 State the nature and kinds of public expenditures

Classification / Types of Public Expenditure

Classification of public expenditure refers to the systematic arrangement of different items on which
the government incurs expenditure. Public expenditure can be classified as follows:

a) PUBLIC EXPENDITURE

Capital and Revenue

Productive and Non-productive
Transfer and Non-Transfer
Plan and Non-plan

1) Capital And Revenue Expenditure

Capital Expenditure of the government refers to that expenditure which results in creation of fixed assets.
They are in the form of investment. They add to the net productive assets of the economy. Capital
Expenditure is also known as development expenditure as it increases the productive capacity of the
economy. It is investment expenditure and a non-recurring type of expenditure. For Eg. Expenditure - on
agricultural and industrial development, irrigation dams, public -enterprises etc, are all capital
expenditures
Revenue expenditures are current or consumption expenditures incurred on civil administration, defence
forces, public health and, education, maintenance of government machinery etc. This type of
"expenditure is of recurrent type which is incurred year after year.

2) Development and Non - Developmental Expenditure / Productive and Non - Productive

Expenditure:-
Expenditure on infrastructure development, public enterprises or development of agriculture increase
productive capacity in the economy and bring income to the government. Thus they are classified as
productive expenditure. All expenditures that promote economic growth development are termed as
development expenditure.
Unproductive (non - development) expenditure refers to those expenditures which do not yield any
income. Expenditure such as interest payments, expenditure on law and order, public administration, do
not create any productive asset which brings income to government such expenses are classified as
unproductive expenditures.

3) Transfer And Non - Transfer Expenditure:-

Transfer expenditure refers to those kind of expenditures against there is no corresponding transfer of
real resources i.e., goods or services. Such expenditure includes public expenditure on :- National Old
pension Scheme, Interest payments, subsidies, unemployment allowances, welfare benefits to weaker
sections etc. By incurring such expenditure, the government does not get anything in return, but it adds
to the welfare of the people, especially to weaker sections of society. Such expenditure results in
redistribution of money incomes within the society.
The non - transfer expenditure relates to that expenditure which results in creation of income or
output The non - transfer expenditure includes development as well as non - development
expenditure that results in creation of output directly or indirectly. Economic infrastructure (Power,
Transport, Irrigation etc.), Social infrastructure (Education, Health and Family welfare), Internal law
and order and defence, public administration etc. By incurring such expenditure, government creates
a healthy environment for economic activities.

4) Plan and Non - Plan Expenditure

The plan expenditure is incurred on development activities outlined in ongoing five year plan. In 2009-
10, the plan expenditure of Central Government was 5.3% of GDP. Plan expenditure is incurred on
Transport, rural development, communication, agriculture, energy, social services, etc.
The non - plan expenditure is incurred on those activities, which are not included in five-year plan. It
includes development and non - development expenditure. It includes :-Defence, subsidies, interest
payments, maintenance etc.

5) Other Classification (Mrs. Hicks)

Mrs. Hicks classified Public Expenditure on the basis of duties of government. It is as follows :-

i. Defence Expenditure :-
It is expenditure on defence equipments, wages and salaries of armed forces, navy and airforce etc. It
is incurred by government to provide security to citizens of country from external aggression.
 ii. Civil Expenditure :-
Government/incurs this expenditure to maintain law and order and administration of justice.

iii. Development Expenditure :-

It is expenditure on development of agriculture, industry, trade and commerce, transport and
communication etc.

6.1 Give the principles of a good budget

Responsible fiscal management. Minnesotas financial standing (including the states

bond ratings) depends on adequate reserves. A strong level of reserves also enables
policymakers to respond to economic downturns strategically and with thoughtful
deliberation, avoiding quick and drastic decisions. The long-term fiscal health of the state
would be aided by procedures that ensure a sufficient level of reserves.
Clear lines of accountability. Minnesotans should be able to hold policymakers
accountable for the decisions they make. This is only possible if elected officials maintain
decision-making authority, with minimal use of statutes or constitutional amendments
that preempt their ability to make budget choices.
Flexibility to respond to short-term challenges and plan for a long-term vision. A
healthy decision-making process recognizes that the circumstances facing Minnesota will
change, and public officials should have the flexibility to make the fiscal choices
necessary to both anticipate and react to those changes.
Good financial information. The states policymakers and the public both require
comprehensive and understandable information about the states fiscal circumstances that
can guide the decision-making process.
Stability in the decision-making process. Just as good financial management values
stability in the states revenue sources, there is also great value to ensuring consistency in
the procedures that guide the decision-making process. Encoding best budget practices in
law guarantees Minnesota citizens that policymakers will follow these procedures every
session.
6.2 State types of budgets

The public budgets are different from other forms of budgets in many ways; here the voters
delegate the power of spending their money to the politicians or the elected representatives. Now
having understood the concept of budget in the last article, let us understand the different
kinds of budget that are there in the public financial management:

1. Balanced Budget: As suggested by the name a balanced budget is that which has no
deficit or surplus. The revenues coming are equal to the expenditures.
2. Revenue Budget: It is just the details of the revenue received by the government through
taxes and other sources and the expenditure that is met through it.
3. Performance Budget: This type of budget is mostly used by the organizations and
ministries involved in the developmental activities. This process of budgeting, takes into
account the end result or the performance of the developmental program thus insuring
cost effective and efficient planning. With the increasing developmental challenges and
awareness regarding the usage of tax payers money, new methods of budgeting are
required of which the performance based budgeting has emerged as a transparent and
accountable method.

It relies on three aspects of understanding of the final outcome, the strategies formulated
to reach those final outcomes and the specific activities that were carried out to achieve
those outcomes. With a very detailed and objective analysis, this budgeting process is
very result oriented in its approach.

4. Zero based budget: Zero based budgeting has its clear advantage when the limited
resources are to be allotted carefully and objectively. It is quite flexible in nature and
relies on rational methods, systematic evaluation to reallocate resources and justify the
usage of funds. It starts from a zero base unlike traditional budgets where incremental
approach is used. Here, the needs and costs of every function of the organization are
taken into consideration for the next years budget. So the budget is futuristic and may or
may not be equal or more from the last years budget as traditionally calculated.
7.0 Differentiate between Central and commercial bank

There are certain basic differences between a central bank and a commercial bank. They are:

(i) The central bank is the apex monetary institution, which has been specially empowered to
exercise control over the banking system of the country. The commercial bank, on the contrary,
is a constituent unit of the banking system.

(ii) The central bank does not operate with a profit motive. The primary aim of the central bank
is to achieve the objectives of the economic policy of the government and maximise the public
welfare through monetary measures. The commercial banks, on the other hand, have profit
earning as their primary objective.

(iii) The central bank is generally a state-owned institution, while the commercial banks are
normally privately owned institutions.

(jv) The central bank does not deal directly with the Public. The commercial banks, on the
contrary, directly deal with the public.

(v) The central bank does not compete with the commercial banks. Rather it helps them by acting
as the lender of the last resort.

(vi) The central bank has the monopoly of note-issue, whereas the commercial banks do not
enjoy such right.

(vii) The central bank is the custodian of the foreign exchange reserves of the country. The
commercial banks are only the dealers in foreign exchange.

(viii) The central bank acts as the banker to the government, the commercial banks act as bankers
to the general public.

(ix) The central bank acts as the bankers' bank while The commercial banks are required to keep
a certain proportion of their reserves with central bank; (b) the central bank helps them at the
time of emergency; and (c) the central bank acts as the clearing house for the commercial banks.
But, the Commercial banks perform no such function.

7.1 State the functions and roles of each

The roles and functions of Commercial banks

i. Issue notes and coins and ensure people have faith in notes which are printed, e.g. protect
against forgery.
ii. Target low inflation, e.g. the Bank of England have an inflation target of 2% +/- 1. Low
inflation helps to create greater economic stability and preserves the value of money and
savings.
iii. Growth and Unemployment. As well as low inflation a Central Bank will consider other
macro economic objectives such as economic growth and unemployment. For example,
in a period of temporary cost push inflation, the Central Bank may accept a higher rate of
inflation because it doesnt want to push the economy into a recession.
iv. Set interest rates to target low inflation and maintain economic growth Every month the
MPC will meet and evaluate whether inflationary pressures in the economy justify a rate
increase. To make a judgement on inflationary pressures they will examine every aspect
of the economic situation and look at a variety of economic statistics to get a picture of
the whole economy.
v. Use other monetary instruments to achieve macro economic targets. For example, in a
liquidity trap, lower interest rates may be insufficient to boost spending and economic
growth. In this situation, the Central Bank may resort to more unconventional monetary
policies such as quantitative easing. This involves creating money and using this money
to buy bonds; the aim of quantitative easing is to reduce interest rates and boost bank
lending.
vi. Ensure stability of financial system, e.g. regulate bank lending and financial derivatives
vii. Lender of Last Resort to Commercial banks. If banks get into liquidity shortages then the
Central Bank is able to lend the commercial bank sufficient funds to avoid the bank
running short. This is a very important function as it helps maintain confidence in the
 banking system. If a bank ran out of money, people would lose confidence and want to
withdraw their money from the bank. Having a lender of last resort means that we dont
expect a liquidity crisis with our banks, therefore people have high confidence in keeping
our savings in banks. For example, the US Federal Reserve was created in 1907 after a
bank panic was averted by intervention from J.P.Morgan; this led to the creation of a
Central Bank who would have this function.
viii. Lender of Last Resort to Government. Government borrowing is financed by selling
bonds on the open market. There may be some months where the government fails to sell
sufficient bonds and so has a shortfall. This would cause panic amongst bond investors
and they would be more likely to sell their government bonds and demand higher interest
rates. However, if the Bank of England intervene and buy some government bonds then
they can avoid these liquidity shortages. This gives bond investors more confidence and
helps the government to borrow at lower interest rates.

The roles and functions of Commercial banks

a. Accepting Deposits:

The most important function of commercial banks is to accept deposits from the public. Various
sections of society, according to their needs and economic condition, deposit their savings with
the banks.

For example, fixed and low income group people deposit their savings in small amounts from the
points of view of security, income and saving promotion. On the other hand, traders and
businessmen deposit their savings in the banks for the convenience of payment.

b. Giving Loans:

The second important function of commercial banks is to advance loans to its customers. Banks
charge interest from the borrowers and this is the main source of their income.
 c. Over-Draft:

Banks advance loans to its customers upto a certain amount through over-drafts, if there are no
deposits in the current account. For this banks demand a security from the customers and charge
very high rate of interest.

d. Discounting of Bills of Exchange:

This is the most prevalent and important method of advancing loans to the traders for short-term
purposes. Under this system, banks advance loans to the traders and business firms by
discounting their bills. In this way, businessmen get loans on the basis of their bills of exchange
before the time of their maturity.

e. Investment of Funds:

The banks invest their surplus funds in three types of securitiesGovernment securities, other
approved securities and other securities. Government securities include both, central and state
governments, such as treasury bills, national savings certificate etc.

7.2 Characteristics of good money

Following are the qualities or characteristics which good money should possess:

i. General Acceptability: Good money is accepted by all because it serves as a medium of

exchange. Metallic money is acceptable due to its utility and value. Gold and silver coins
had general acceptability. The holder can use it as money or as metal. He does not lose
value in both cases.
 ii. Malleable: A good money material must be malleable. A metal is melted and then coins
are minted. The proper designs are made on it. The money material, which can be melted,
is fit for making coins. The malleable materials have impression on its face and back for
recognition.
iii. Elastic: The good material has the quality of elasticity. The business needs from season
to season. Paper money possess the quality of expansion and contraction of money
supply.
iv. Recognizable: Good money is recognized either by sight or touch. The printing of notes
is secret. The imitation is not possible, because the process of coloring and the quality of
paper are always in the hands of central bank. The general public is familiar with the
various kinds of notes.
v. Durable: Money should be durable. The money must not lose its value with the passage
of time. Metals are most durable as compared to other forms of money. The gold and
silver do not wear out quickly but it can be treated as durable due to replacement by the
bank.
vi. Portable: Good money must be portable easily. It should have more value in small
quantity. The passenger must feel easy while taking money with them.
vii. Storable: A good money material is storable for for meeting the future demand. The
minimum space and lowest storing expenses are necessary for keeping the money
material. The rupee notes and coins have this quality. .
viii. Standardized: The good money material is of standardized nature and quality of its
material does not undergo great change.
ix. Stable: Money must have stable value because it serve as a standard for measuring the
value of other things. A change in its value brings change in the prices of goods and
services. The public confidence is developed if value of money is stable. The money
having ever-changing value is not liked by the people.
x. Divisible: The money is always divisible without losing its value. The small units of
money are needed for making the smallest payments. The metallic money is to make
nominal payments in paisa. Public confidence develops due to this quality of money.
xi. Difficult to duplicate: Good money is one which is difficult to duplicate. There should
be no danger of fake issuance of money.
 xii. Scarce: The scarcity is the quality of good money material. Good money is always
scarce. Money must be limited in supply as compare to demand for it. This quality
induces the people to have more and more money for meeting their basic necessities of
life.
xiii. Homogenous: Good money must be of the same quality and quantity. The unit of money
must be of the respects otherwise there will be confusion in buying and selling of goods
and services. The color and size of money material help the people to deal in the market.
xiv. Economical: The good money material has economical quality. The cost of printing
currency notes and minting coins must be lower. The money system cannot last for a
longer period if it is too much costly.
xv. High Value: The money material should possess high value in small bulk, so that it can
be conveniently carried and handled.
xvi. Effective Supervision: The good money is one that can be effectively supervised by a
central monetary authority. It is of such a nature that central authority is able to keep
records of the amount of money in circulation and the pattern of its distribution.
xvii. Government Support: The good money material must be supported by the government.
The people accept even fiat money (money issued without keeping any metallic reserves)
due to the government support. The government's backing to money creates a sense of
confidence.Differentiate between money markets and financial markets
7.3 Differentiate between money markets and financial markets

Financial market can either be a Money Market where extremely liquid financial instruments
are traded or a Capital Market where buying and selling in securities are done to raise long-
term funds for the entity. These two terms are very complicated to understand, and that is why
people use them interchangeably which is wrong. So come on, lets first understand the meaning
and difference between Money Market and Capital Market.

Comparison Chart
Basis for
Money Market Capital Market
Comparison

A segment of the financial market where

A section of financial market where long
Meaning lending and borrowing of short term
term securities are issued and traded.
securities are done.

Nature of
Informal Formal
Market

Shares, Debentures, Bonds, Retained

Financial Treasury Bills, Commercial Papers,
Earnings, Asset Securitization, Euro
instruments Certificate of Deposit, Trade Credit etc.
Issues etc.

Risk Factor Low Comparatively High

Basis for
Money Market Capital Market
Comparison

Time Horizon Within a year More than a year

Merit Increases liquidity of funds in the economy. Mobilization of Savings in the economy.

Return on
Less Comparatively High
Investment

8.0 What is the meaning of national income

National income measures the monetary value of the flow of output of goods and services
produced in an economy over a period of time.

8.1 What are the importance of national income

Reason # 1. Economic Policy:

National income figures are an important tool of macroeconomic analysis and policy.

National income estimates are the most comprehensive measures of aggregate economic activity
in an economy.

It is through such estimates that we know the aggregate yield of the economy and can lay down
future economic policy for development.

Reason # 2. Economic Planning:

National income statistics are the most important tools for long-term and short-term economic
planning. A country cannot possibly frame a plan without having a prior knowledge of the trends
in national income. The Planning Commission in India also kept in view the national income
estimates before formulating the five-year plans.

Reason # 3. Economys Structure:

National income statistics enable us to have clear idea about the structure of the economy. It
enables us to know the relative importance of the various sectors of the economy and their
contribution towards national income. From these studies we learn how income is produced, how
it is distributed, how much is spent, saved or taxed.

Reason # 4. Inflationary and Deflationary Gaps:

National income and national product figures enable us to have an idea of the inflationary and
deflationary gaps. For accurate and timely anti- inflationary and deflationary policies, we need
regular estimates of national income.

Reason # 5. Budgetary Policies:

Modern governments try to prepare their budgets within the framework of national income data
and try to formulate anti-cyclical policies according to the facts revealed by the national income
estimates. Even the taxation and borrowing policies are so framed as to avoid fluctuations in
national income.

Reason # 6. National Expenditure:

National income studies show how national expenditure is divided between consumption
expenditure and investment expenditure. It enables us to provide for reasonable depreciation to
maintain the capital stock of a community. Too liberal allowance of depreciation may prove
harmful as it may unnecessarily lead to a reduction in consumption.

Reason # 7. Distribution of Grants-in-aid

National income estimates help a fair distribution of grants-in-aid by the federal governments to
the state governments and other constituent units.
Reason # 8. Standard of Living Comparison:

National income studies help us to compare the standards of living of people in different
countries and of people living in the same country at different times.

Reason # 9. International Sphere:

National income studies are important even in the international sphere as these estimates not only
help us to fix the burden of international payments equitably amongst different nations but also
enable us to determine the subscriptions and quotas of different countries to international
organisations like the UNO, IMF, IBRD. etc.

Reason # 10. Defence and Development:

National income estimates help us to divide the national product between defence and
development purposes. From such figures we can easily know how much can be spared for war
by the civilian population.

Reason # 11. Public Sector

National income figures enable us to know the relative roles of public and private sectors in the
economy. If most of the activities are performed by the state, we can easily conclude that public
sector is playing a dominant role.

8.2 State the measurements of national income

Measurement of National Income (3 Methods) and their Uses
Methods:

Since factor incomes arise from production of goods and services, and since incomes are
expended on goods and services produced, three alternative methods of measuring national
income are possible:

(i) Output Method:

The output method is also called the production method.

It consists of three stages:

First, we estimate the gross value of domestic output in the various sectors of production; then
we determine the cost of materials used and of services rendered to these sectors by other sectors
of production and also the annual value of the physical depreciation of the plants and equipment
used in these sectors; and then we deduct these costs and depreciation value from the gross value
of production to derive the net value of domestic output.

The figure so obtained has to be adjusted with net income from abroad. The net value thus
arrived at represents the sum total of the income produced originating in different sectors of the
economy like agriculture, manufacturing industry and services, including government. This gives
us the net domestic product at factor cost classified by industrial origin.

(ii) Income Method:

In the first method, i.e. the output method, we arrive at the net output estimates. But these
estimates can be regarded as the equivalent of the value of sales of the output yielding income to
the producers and receipts of the factor suppliers. This income comprises wages earned by the
workers and salaries of the staff. In the labour income, we also include social security
contributions by the employers, bonus, etc.

Then, there are the earnings of the self-employed persons, dividends of the shareholders and
undistributed corporate profits, rent of land, factories and business premises, interest on capital
and earnings of public enterprises. The income so estimated under the various heads are then
added together to arrive at an estimate of the total national income.

(iii) Expenditure Method:

Under this method, we estimate the disposal of income on the purchase of final goods and
services.

It includes:

(a) Personal consumption expenditure of households;

(b) The gross private domestic investment, i.e. business spending on capital goods;

(c) The net foreign investment, i.e. net spending by foreign nationals, firms and governments for
the countrys goods and services, and,

(d) Government purchases of goods and services.

The three methods give the same result. What is remarkable is that in estimating of national
income by the above three methods, we arrive at the same figure. This is so because we are only
looking at the same thing (i.e. final goods and services) from three angles, viz., the output,
income resulting from the output and the disposal of the income, i.e. expenditure on the purchase
of the goods and services.