DEMAND

Definition- Demand for a commodity refers to the number of units of a good or service that consumers are willing and
able to purchase during a specified period at different prices.

It can be individual or market, autonomous or derived, ex-ante or ex-post, joint and rival/composite.

Determinants of individual demand are-

 Its price- inversely related- Law of Demand, with other things/factors being equal i.e. ceteris paribus
 Price of related goods- substitute goods directly & complementary goods inversely related
 Disposable income- necessary goods rises and tapers, comfort & luxury goods rises,
inferior goods rises and later falls
 Taste/preference/choices- relate to habits, customs, fashion, climate etc.

Besides these, Market demand is influenced by population, advertising, expected change in prices, credit facilities etc.

Downward slope/Price effect of demand curve is due to Income effect + Substitution effect

Exceptions to Law of Demand-

 Giffen goods/paradox- demand of inferior goods directly related to price

 Conspicuous necessities- fashion and prestige goods
 Conspicuous consumption- by the rich
 Emergencies

Shift in demand-

 Change in quantity demanded- depends on price- can be expansion or contraction

 Change in demand- depends on variables other than price- can increase or decrease

Consumer’s Equilibrium- A situation where a household has allocated its resources such that
there is no incentive to change

Utility- is the want satisfying power of a commodity; depends on the intensity of want, is subjective and relative

 Total Utility- is the sum of all utilities derived from the total number of units of a commodity consumed
 Marginal Utility- is the utility derived from the additional unit of a commodity consumed

Total utility is maximum when Marginal utility is zero

Law of Diminishing Marginal Utility- Alfred Marshall- The additional benefit a person derives from a given increase of
his stock diminishes with every increase in the stock that he already has.

Point of satiety or saturation is achieved when marginal utility falls to zero

Law of Equi-Marginal Utility- Paul A Samuelson- The consumer will spend his money/income on different goods in such
a way that marginal utility of each good is proportional to its price.

Assumptions of Laws of Utility- consumption is in defined units, all units of the commodity are identical, consumption is
continuous, consumer is rational, utility is quantifiable

Ordinal Utility- postulates that utility is not measurable, hence uses indifference curves to determine consumer’s
equilibrium
Indifference curve represents the combinations of two commodities that give the same satisfaction to the consumer.
Defined, it is the locus of points i.e. particular combinations or baskets of two commodities, which yield the same level
of satisfaction/utility to the consumer, so that the consumer is indifferent to the particular combination he consumes. A
set of Indifference curves representing different level of satisfaction is called an Indifference map.

Indifference curves have a negative slope, are convex to the origin and do not intersect

Marginal rate of substitution of X for Y is defined as the number of units of commodity Y that must be given up in
exchange for an extra unit of commodity X to maintain same level of satisfaction for the consumer

Budget line identifies a set of attainable combinations of two commodities, given their market prices and income
constraints. It is tangent to the indifference curve.

Conditions for Consumer’s Equilibrium-

 Marginal rate of substitution should be equal to the ratio of commodity prices

 At the point of equilibrium the marginal rate of substitution must be declining i.e. indifference curve should be
convex to the origin

Elasticity of Demand- measures the responsiveness of quantity demanded of a commodity to a change in any one of the
determinants of demand e.g. price, income etc.

 Perfectly elastic demand- at the same price different quantities of a commodity are demanded
 Perfectly inelastic demand- quantity demanded of a commodity remains the same at different prices

Price elasticity of Demand depends on-

 Substitutes- more the substitutes, higher the elasticity

 Complementary goods- show less elasticity
 Uses of a commodity- single use, less elasticity; multiple use, more price elastic
 Demand for Necessities less elastic; Luxuries more elastic
 Non-durable low priced goods, inelastic; High priced durable goods, high elasticity of demand

Types of income elasticity of demand-

 Negative- demand falls as income rises e.g. inferior goods

 Zero- demand does not change with income e.g. necessities
 Zero to 1- demand rises less in proportion to income e.g. sugar
 One- Demand rises in same proportion as income e.g. clothes
 >1- demand rises more than the proportion of rise in income e.g. consumer durables

Cross elasticity of demand- measures the responsiveness of quantity demanded of a commodity to change in the price
of another quantity. It can be-

 Infinity- commodity X is a perfect substitute of commodity Y

 Zero- commodities X and Y are not related
 Negative- commodities X and Y are complementary
SUPPLY

Definition- quantity of a commodity offered for sale by a producer at different prices during a given period.
It can be Intended or Actual, Individual or Market, Joint or Composite

Stock of a commodity refers to the total quantity of a commodity available with a seller at a given time i.e. is a potential
supply without any time dimension and depending upon the production & procurement price of the commodity.

Determinants of supply or Supply functions-

 Price of the commodity- Law of Supply- Supply α Price with other factors remaining the same
(exceptions- agricultural goods, perishable goods, goods having social status)
 Price of related goods especially substitute goods
 Prices of factors of production
 Goals of producers- profit or prestige
 State of technology

Besides these, Market Supply depends on- climate/nature for agricultural commodities, means of transportation,
taxation policy, expectation of price rise

Elasticity of Supply- measure of the degree of responsiveness of the quantity supplied to changes in the product’s own
price i.e. %age change in quantity supplied/%age change in price. Normally it is positive.

Es = (ΔQ/ΔP) x (P/Q); P-price, Q-quantity, Δ-change

Factors determining Elasticity of Supply- Cost of production, Change in future price, Nature of commodity, Time,
Scale of production, Technology of production, Size of firm, Natural factors, Mobility of factors

Types of Elasticity of Supply- Elasticity Coefficient-Es

 Perfectly inelastic- Es=0- no change in quantity supplied with change in price e.g. rare books or stamps-
supply curve is vertical- seen over a very short run/time period
 Less than unit elastic- Es<1- %age change in quantity supplied < %age change in price-
supply curve originates on X axis and is steep upward- seen over a short run
 Unit elastic- Es=1- %age change in quantity supplied = %age change in price- supply curve originates at O
 More than unit elastic- Es>1- %age change in quantity supplied > %age change in price-
supply curve originates on Y axis- seen over a long run
 Perfectly elastic- Es∞- supply can change irrespective of the change in price-
supply curve is horizontal- seen over a very long run

Shift in Supply Curve-

 Expansion or Contraction, due to change in price (increase or decrease)

 Increase-rightward shift or Decrease-leftward shift, due to change in factors other than price
like technology, input prices, price of other goods, taxes & subsidies, number of sellers etc.

MARKET EQUILIBRIUM

 Equilibrium price is the price at which quantity demanded is equal to the quantity supplied.
When Market price > Equilibrium price- Demand falls, Supply rises and vice versa
 Over short time periods, equilibrium price is more affected by demand while
over long time periods, equilibrium price is more affected by supply
 Price ceiling by the Government, results in shortage and black marketing while
Setting of floor price by Government, results in surplus of the commodity
PRODUCTION- means transformation of one set of goods into another.
The factors of production are called factor inputs including land, labor, capital and enterprise.
Input factors can be Fixed e.g. machinery, top management, security or Variable e.g. raw materials, labor, power.
Production Function- is the relationship between physical inputs and outputs of a firm.
In the short run at least one factor is fixed while in the long run all factor inputs can vary.
The output produced jointly is called product/good which can be material or non-material/services.

Total product- Total number of units of output produced in a specified period of time
Average product- Total product divided by amount of variable input used to produce the product
Marginal product- the addition to total product attributable to the addition of one unit of the variable input to the
production process with the fixed inputs remaining unchanged

Law of Variable Proportions-

As more units of a variable factor are applied to the given quantity of a fixed factor, the total product may initially
increase at an increasing rate but eventually it will increase at a diminishing rate i.e. the marginal product of the variable
input will eventually decline.

Three stages of Production-

 Stage I- extends from zero input of variable factor till the average product is maximum and is equal to the
marginal product. Throughout Stage I fixed factors are underutilized and efficiency can be improved by
increasing variable input.
 Stage II- from end of Stage I to the point where marginal product is zero and total product is maximum.
During this Stage both fixed and variable factors are optimally utilized hence is called the Stage of Operation.
 Stage III- beyond Stage II where variable factor is excessive, marginal product is negative and total output falls.

Cost of Production- Expenses incurred on the factor inputs used in the production of a commodity.
It includes- Explicit cost-monetary , Implicit cost-owner inputs and Opportunity cost/Normal profit.

Costs can be-

 Explicit/Accounting or Implicit/Opportunity
 Money-objective or Real-subjective
 Private or Social-positive or negative
 Fixed- constant, unavoidable, overhead or Variable- avoidable, increase with rise in output,
 direct

Total cost = Total fixed cost + Total variable cost

TC & TVC curves initially increase slowly, increase at a constant rate in intermediate stage and
ultimately increase at an increasing rate.

Short-term cost of production per unit (TQ- total quantity produced)-

 Average fixed cost- TFC/TQ- falls as output increases, never zero, curve is rectangular hyperbola
 Average variable cost- TVC/TQ- initially falls but finally rises with rising output, curve is U-shaped
 Average cost- TC/TQ- AFC+AVC- initially falls but finally rises, curve is U-shaped
Optimum level of output corresponds to the lowest point on the AC curve.
 Marginal cost- The addition to the total cost for one more unit of output- MC N = ΔTC/ΔTQ = TVCN – TVCN-1-
Marginal cost is determined by variable cost only;
with rising output it initially falls, later becomes constant and finally rises giving a U-shaped curve

Long-term cost-
 Long run total cost- always positive, curve rises initially slowly and finally fast
 Long run average cost- U-shaped curve
 Long run marginal cost- U-shaped curve (LMC curve intersects LAC curve at its lowest)
REVENUE- receipts from sale of output in a given period

 Total- Q-quantity x P-price

 Average- TR/Q = P
 Marginal- addition to TR from sale of an additional unit of a commodity- MRN = TRN-TRN-1 = ΔTR/ΔQ

Behavior of revenue-

 With perfectly elastic demand curve i.e. firm can sell as much as it likes at a given price- Perfect competition-
TR increases constantly, AR remains same, MR remains same & equals AR
 With downward sloping demand curve i.e. firm will have to reduce price to sell more- Imperfect competition-
TR rises then falls, AR falls continuously, MR falls continuously at a greater rate & may become negative later

E-elasticity coefficient = AR/(AR-MR) or AR = MR x E/(E-1) or MR = AR x (E-1)/E

On the AR curve-

 E >1- MR is always positive

 E=1- MR is zero
 E<1- MR is always negative

MARKET- A mechanism by which buyers and sellers of a commodity are able to contact each other and strike a deal
about the price and quantity to be bought and sold.

Classification of Markets-

 Perfect competition- numerous sellers & buyers of a homogenous product- fresh vegetables/meat
 Monopoly- single seller- electricity supply
 Duopoly- two sellers of a product- commercial aircrafts Boeing or Airbus
 Oligopoly- few large suppliers of a pure or differentiated product- Cars, TV programmes
 Monopolistic competition-many smaller sellers delight in slightly differentiated products- PCs, software

Equilibrium of a firm- Producer’s Equilibrium- when profits earned are maximum

 TR-TC approach- TR should exceed TVC, vertical distance between TR & TC is maximum
 MR-MC approach- AR ≥ AVC/TR ≥ TVC, MR = MC, MC should be rising

Perfect Competition- features-

 Large number of buyers and sellers in the market

 Free entry & exit and mobility with no transportation cost
 Homogenous product, sold at the same price throughout the market
 Transparent complete knowledge of product & price for both buyers and sellers
 Price of a commodity determined by total demand and total supply
 Industry is the price maker and a firm is the price taker, individuals do not have a role in determining price
 Resources are used most efficiently to produce goods at the minimum price and
the consumers purchase the commodity at the lowest possible price

Price-Output determination in a Perfectly Competitive Market-

 Should a firm produce?- Yes, till AR ≥ AVC

 How much should it produce?- Maximum profit i.e. short-run equilibrium achieved when
MR = MC & MC cuts MR curve from below

 In the short run- Shut down point when AR = AVC and Break even point when TR = TC or AR = AC
 In the long run, at equilibrium all firms break even when MC = MR = AR = AC = Price
Other market forms-

MONOPOLY- single seller of a good, individual or cartel, with no substitute. Sources of monopoly are
ownership of scarce resources, patents, trademarks, copyrights, licensing and exclusive franchise
(Monopsony- market with single buyer and many sellers e.g. single sugar factory in an area producing sugarcane)

Monopolistic Competition- most common form of market structure characterized by-

 Large number of smaller firms

 Each firm selling differentiated product
 Free entry and exit
 Each firm takes decisions independently
 Increased selling cost through advertising, sales promotion, retailer incentive etc.
 Demand curve is downward sloping

OLIGOPOLY- >2 producers, with a homogenous e.g. LPG or differentiated e.g. motorcycles product.
It is the most common form of market structure in the manufacturing sector of modern economics.
Characterized by-

 Interdependence of firms in the industry

 Indeterminate demand curve
 Selling costs play an important role in pricing and sales
 Price rigidity
 Industries exhibit economics of scale
 Group behavior to protect interest of all firms

AGGREGATE DEMAND- total demand or total expenditure for goods and services in an economy in a year or total
proceeds/revenue which all entrepreneurs in an economy expect to receive from the sale of their products in a year.
It can be ex-ante/notional/planned or ex-post/effective/actual and can be for consumption or investment.

 Aggregate consumption expenditure depends on the income

 Aggregate investment (autonomous, not induced) is independent of the level of income

Aggregate demand includes- Household consumption expenditure + Government consumption expenditure +

Private & Public investment expenditure + Net exports

AGGREGATE SUPPLY- money value of all goods and services produced in a country in a year or the minimum price at
which all the entrepreneurs are willing to sell their products at a given level of employment.
It refers to the national income or domestic product of a country including consumption and savings.

Propensity to consume-

 Average propensity to consume- ratio between consumption and income- APC = C-consumption/Y-income
 Marginal propensity to consume- the rate at which consumption changes with change in income- MPC = ΔC/ΔY

Consumption curve- between income and consumption expenditure is a straight line at 45 0 if C = Y

Algebraic equation of linear consumption function is C = a + b.Y where
a = consumption a zero level of income & b = marginal propensity to consume

 With increase in ‘a’, Y intercept shifts upwards & consumption curve too shifts parallel upwards and vice versa
 With increase in ‘b’, Y intercept remains unchanged & consumption curve shifts upwards and vice versa

Propensity to save-

 Average propensity to save—ratio between saving and income- APS = S/Y

 Marginal propensity to save- rate at which savings change with change in income- MPS = ΔS/ΔY
Saving curve- starts from negative quadrant and then slopes upwards- savings increase with the income
Algebraic equation of saving function is S = -a + (1-b).Y where -a = saving at zero income & b = propensity to consume

 APC + APS = 1 & MPC + MPS = 1

 Consumption & Saving are dependent upon income, wealth, credit, consumer expectation and taxation

EMPLOYMENT- A situation when a person, able and willing to take up a job, gets a job
It can be Full employment, Under employment or Unemployment
Unemployment can be voluntary, involuntary, cyclical, technological, frictional, structural, disguised

Determination of Equilibrium Output-

 Aggregate demand & Aggregate supply approach- In equilibrium AD = AS, primarily affected by AD
 If AD > AS- additional investment made to increase output
 If AD < AS- employment and production is decreased

 Saving & Investment approach- In equilibrium Ip = S, where Ip is planned investment

 If Ip > S- production & employment is raised to increase income and hence savings
 If Ip < S- production & employment is reduced to decrease income and hence savings

INVESTMENT- Expenditure incurred on the purchase of NEW stock of capital/capital goods including
plants & machinery, construction and stocks. Types of Investment are-

 Induced- taken up by the private sector, influenced by rate of interest, income elastic
 Autonomous- taken up by public sector, not influenced by rate of interest, income inelastic

Multiplier- ratio of change in income to change in investment- K = ΔY/ΔI- determines the rate of growth of economy
Determinants of the size of Multiplier are-

 Marginal propensity to consume- MPC- K = 1/(1-MPC) = 1/(1-ΔC/ΔY)- directly proportional to multiplier

 Marginal propensity to save- MPS- K = 1/MPS = 1/(ΔS/ΔY)- inversely proportional to multiplier

Trade cycles in terms of change in Aggregate Demand-

 Prosperity/Boom- rise in investment, output, employment, income, prices hence rising demand
 Recession- cut in investment, employment, fall in incomes, purchasing power hence prices fall
 Depression/Slump- output, employment, income, prices hence demand at the lowest
 Recovery- investment, employment, output, income, prices move upwards spurring demand

Excess Demand- Excess of anticipated expenditure over available output at constant prices- INFLATIONARY gap

Deficient Demand- Excess of available aggregate output over anticipated expenditure- DEFLATIONARY gap

Causes of excess demand- government expenditure > government revenue, increase in autonomous investment,
surplus of balance of payments, increase in capital formation (vice versa for deficient demand)

Measures to correct excess demand-

 Fiscal policy- reduce budget deficit by raising tax rates & reducing government spending
 Monetary policy- raise interest rates, increase reserve ratios, sell government securities
 Enlarge trade deficit- increase imports over exports financed by
gold or foreign exchange reserves, foreign exchange grants & foreign loans
 Avoid wage increase- decreases disposable income
 Increase output- through better utilization of existing production capacities
(vice versa for correcting deficient demand)
MONEY & BANKING

Money- A measure and store of value acceptable as a means of exchange

Functions of money-

 Primary- medium of exchange, standard of value/unit of account

 Secondary- store of value, transfer of value, standard of deferred payment
 Contingent- equalization of marginal utilities of spending, distribution of national income, basis of credit,
liquidity & uniformity of wealth, bearer of option

RBI measures of Money supply-

 M1- Currency with public + Demand deposits with banks + Other deposits with RBI
 M2- M1 + Savings deposits of post office
 M3- M2 + Time deposits with banks
 M4- M3 + All deposits with post offices (excluding NSC)

Bank- a financial intermediary that accepts deposits from public for lending/investment repayable on demand and
withdrawable through cheque/DD

Types- Central, Commercial, Savings, Exchange, Industrial, Agricultural Development, Cooperative, International

Functions of a Commercial bank-

 Receive deposits- Savings, Demand/Current Account, Fixed

 Extend loans & advances- Cash credit, Overdraft, Demand loans, Short term loans
 Transfer funds- Demand draft, Cheques, Mail transfer, Travellers cheque, Online transfer-NEFT/RTGS
 General utility services- Collection & payment of cheques, Trustees & attorney for customers,
Provide locker facility for safekeeping valuables

Role of Commercial Bank in economy-

 Accelerate the rate of capital formation

 Provision of finance and credit
 Redistribution of funds among people & regions
 Extension of market size
 Developing entrepreneurs
 Growth of priority sectors

Central Bank- RBI- Apex institution in the banking structure of a country regulating currency and credit in the economy;
owned & governed by Government only, no profit motive, does not directly deal with public,
has monopoly over issuing notes/currency (unlike commercial banks)

Functions-

 Formulates monetary policy (Repo rate, Reverse Repo rate, SLR, CRR, OMO)
 Issue notes/currency
 Banker, agent and financial advisor to State
 Banker to the Banks
 Custodian of Foreign Exchange reserves
 Lender of last resort
 Bank of Central clearance, settlement and transfer
 Controller of Credit
Monetary Policy- decided by a 6 member MPC established by Finance Act, 2016, an amendment to RBI Act, 1934
6 members include 3 from RBI and 3 external members appointed by the GoI with a term of 4 years each
Decisions are by consensus or by majority, with RBI Governor having a casting vote in case of a tie
Mandated with keeping inflation rate at 4±2%

FOREIGN EXCHANGE- currencies of other countries

can be hard-acceptable throughout the world e.g. US dollar, Pound, Euro, Yen or soft e.g. Indian rupee

 Demand for FX- import of goods & services, outbound tourism, repayment of interest & loans,
remittance by foreigners working in India/multinationals/FIIs
 Supply of FX- export of goods & services, inbound tourism, remittances by Indians living abroad, FDI & FII
 Graph for demand of FX is downward sloping & for supply of FX is upward sloping

Rate of Exchange- purchasing power of a currency in terms of other currencies; can be fixed or floating

Foreign exchange market- facilitates transactions between buyers and sellers of foreign exchange;

 Can be spot-exchange effected instantaneously at prevailing rate of exchange or

forward-payment & delivery done on a specified future date
 Was fixed exchange rate from 1946-1971 and is flexible/market i.e. demand & supply linked since 1972

Functions of foreign exchange market- Transfer, Credit, Hedging

Equilibrium rate of exchange- the price at which market demand & market supply of FX are equal

 Depreciation of currency- fall in value of domestic currency w.r.t. foreign currency in flexible FX rate market
 Appreciation of currency- rise in value of domestic currency w.r.t. foreign currency in flexible FX rate market
 Devaluation of currency- reduction in value of domestic currency w.r.t. foreign currency
by the government under fixed FX rate system
 Revaluation of currency- raise in value of domestic currency w.r.t. foreign currency
by the government under fixed FX rate system

BALANCE OF PAYMENTS- an annual statement of accounts of monetary transactions, credit & debit, of a country

Components of BoP- includes goods, services and capital

 On current account- records earnings & expenditure of FX by a country on gods and services during a year as
exports-credit or imports-debit;
it may be in surplus if exports > imports, deficit if exports < imports or balance if exports = imports
Current Account Deficit- Exports < Imports- financed by gold or FX reserves & loans,
deposits or investment in FX
 On capital account- includes FDI, FPI, loans-assistance or commercial borrowing, NRI deposits

Overall BoP of a country = BoP on current account + BoP on capital account = 0

If Capital account surplus > Current account deficit then country’s FX reserves will increase and vice versa

Disequilibrium in BoP-

 Can be surplus or deficit

 Causes- economic, political, social
 Correction of deficit- depreciation of currency (makes exports cheaper & imports costlier),
deflation, raising interest rates, higher import duties, export incentives/subsidies
FISCAL/BUDGETARY POLICY- concerned with revenue and expenditure of the Government
Its instruments are- public revenue, public expenditure, public debt

PUBLIC REVENUE- sum of money mobilized/total income of the Government. Its sources are-

 Current/Revenue receipts- do not create any liability of repayment on the Government, include-
 Tax revenue- generated through GST, income tax, corporate tax
 Non-tax revenue- generated through
 Commercial revenue- prices paid for Government supplied commodities and services
e.g. railways, post, electricity
 Administrative revenue- various fees, licence fees, fines and penalties, forfeitures
 Dividends- from PSUs out of the surplus generated by their activities
 Grants or donations from abroad
 Capital receipts- involve either a liability for repayment for the Government or a reduction in assets of the
Government; include loans & borrowings, recovery of loans, disinvestment

Revenue sources for the State Governments in India-

 Tax revenue- from tax on income, property, commodities and services

 Non-tax revenue- includes court fees, income from undertakings or property owned by State Government,
royalty from mines or forest, Grant-in-aid from Central Government
 Resource transfer from Central to State Governments- means are
 Share in taxes collected by the Central Government- 42% per 14th & 15th Finance Commission
 Grants-in-aid
 Loans
 Others- assistance for externally aided projects, share of small savings collection,
grant or loan in case of natural disasters etc.

TAX- a compulsory payment from a person to the Government to defray the expenses incurred in the common interest
of all without reference to special benefits conferred. It can be-

 Direct tax- levied on the income of an individual, responsibility/impact and burden/incidence of the tax are on
the same person e.g. income tax, corporation tax
 Advantages- equity, certainty, elasticity with income, simplicity, civic consciousness, reduce inequality
 Disadvantages- arbitrary, tax evasion, inconvenient, high cost of collection, disincentive to earn
 Indirect tax- levied on expenditure, impact and incidence of tax are on different persons e.g. GST, import duty
 Advantages- convenient to collect, difficult to evade, elasticity with consumption, equity, social benefit
 Disadvantages- inequitable, uncertain, inflationary

Classification of taxes on the basis of rate of taxation-

 Progressive taxation- rate of tax increases as tax base increases

 Proportional taxation- rate of tax remains the same at different tax base/income of taxpayers
 Regressive taxation- rate of tax falls as the tax base increases
 Degressive taxation- rate of increase in taxation does not increase proportionate to rise in incomes
PUBLIC EXPENDITURE- expenditure incurred by the Government for collective needs and welfare of its citizens
It increases economic growth & investment, promotes economic welfare, checks unemployment, reduces inequalities
It includes defence, administrative, economic and social expenditures
It can be developmental or non-developmental and plan or non-plan expenditure

 Revenue/Consumption expenditure- does not create any capital asset in the economy and does not cause any
reduction in the liability of the Government e.g. subsidies, interest on Government loans,
public administration, defence expenditure
 Capital expenditure- leads to creation of assets in the economy or reduction in Government liabilities e.g.
creation of infrastructure, repayment of loans

Main heads of Public Expenditure by GoI-

Central scheme, Central assistance to States, Interest payments, Defence, Public administration and Services

PUBLIC DEBT- debt owed by the GoI to citizens or to other governments

It is needed to meet budgetary deficit, finance War, check recession, accelerate development, meet contingencies

Methods of repayment/redemption of Public Debt- Repudiation i.e. refusal to repay, Conversion of loans/debt,
Serial repayment, Sinking fund, Capital levy/tax, Use FX

BUDGET- annual financial statement of the Government detailing total revenue and expenditure for a year
It includes revenue budget and capital budget & can be balanced, surplus or deficit budget
Changes in Budget from 2017- Presented on 1st February, includes Railway budget, no distinction in Plan & Non-Plan

Importance of Budget- Mobilisation of resources, Acceleration of economic growth, Balance regional growth,
Reduce inequalities of income & wealth, Price stability, Creation of employment opportunities

Revenue deficit- Revenue expenditure > Revenue receipts, can be reduced by raising taxes or reducing expenditure

Budgetary deficit- (Revenue+Capital) expenditure > (Revenue+Capital) receipts, financed by printing new currency

Fiscal deficit- (Revenue+Capital) expenditure – (Revenue receipts+Recovered loans+Non-debt creating Capital receipts)
It is a barometer of financial health of the Government, a small Fiscal deficit is good for economic growth
Fiscal deficit = Primary deficit + Interest payment = Borrowing by the Government
Its adverse effects are- Rise of interest rates, Reduction in private investment, Increase in public debt, Inflation
It is financed by raising capital receipts through loans or borrowing from RBI that prints new currency

Deficit financing- done by printing new currency (a practice of the past)

Excess expenditure by the Government-Increases money supply-Spurs demand- Investment-Increase in employment &
income-More consumption & saving-Economy back on a growth path
Limits of deficit financing by printing new currency- Inflation

Circular flow of income- Flow of payments and receipts for goods, services & factor services-land, labor, capital,
enterprise- between different sectors-households, firms, government, rest of the world- of the economy

Models-

 Two sector model- Households & Firms- without & with savings- The output or real flow from seller to buyer
creates the income or money flow from buyer to seller- Leakage-Savings & Injection-Investment
 Three sector model- Households, Firms & Government-
Leakage-Savings+Taxes & Injection-Investment+Government expenditure
 Four sector model- Households, Firms, Government & Rest of the World- Leakage-Savings+Taxes+Imports &
Injection-Investment+Government expenditure+Exports

Intermediate goods- used as raw materials to produce other goods, are commonly resold, can undergo value addition,
not ready for use by final customer, not included in computing National Income (unlike Final Goods)
NATIONAL INCOME- sum total of money value of all final goods and services produced in an economy in a year
It can be Nominal/national income at current prices or Real/national income at constant prices

Gross Domestic Product- GDP- value of final goods and services produced by the residents of a country within the
country in a year. It is commonly an index of welfare.
Situations where rise in GDP does not increase welfare- Rapid population growth, Uneven distribution of income,
Production of luxury goods, High rate of inflation, Unreliable data

Basic concepts in National Income analysis-

 Stock variable- a quantity measurable at a given point of time, has no time dimension
 Flow variable- a quantity measurable over a period of time, has a time dimension
 Closed economy- does not maintain economic relations with the rest of the world
 Open economy- maintains economic relations with the rest of the world
 Productive activity- contributes to the flow of goods and services in an economy
 Non-productive activity- does not contribute to the flow of goods and services in an economy, does not
generate any factor income, results in only transfer of income from one person to another
 Domestic territory- includes political frontiers, territorial waters, ships & aircrafts,
fishing vessels & oil rigs operating in international waters,
embassies, consulates, high commissions & military establishments in other countries
 Resident- a person who resides in a country and whose centre of economic interests lie in that country
 Domestic product- value of all final goods and services produced by all enterprises located within domestic
territory of a country during a year
 National product- value of all final goods and services produced by normal residents of a country operating
within domestic territory of a country or outside
 National product of India = Domestic product of India + Income earned by Indian nationals abroad –
Income earned by foreign nationals in India
 Investment- part or stock of man-made goods used for further production to increase the stock of capital
 Gross investment includes Fixed investment + Inventory investment
 Net investment = Gross investment – Depreciation (expenditure on replacement of damaged fixed assets)
 Product at market price = Product at factor cost + Net indirect taxes (Indirect taxes – Subsidies)

Concepts of National Income-

(G-gross, N-net & national, MP-market prices, FC-factor cost-rent+wages+income+profits)

 GDPMP- sum total of market value of all final goods and services produced within the domestic territory of a
country during a year (GDPMP = NI + Net indirect taxes + Depreciation – NFIA)
 GNPMP- aggregate market value of all final goods and services produced by normal residents of a country during
a year (GNPMP = GDPMP + NFIA)
 NDPMP- market value of net output of all final goods and services produced in the domestic territory of a country
by its normal residents and non-residents in an accounting year (NDPMP = GDPMP – Depreciation)
 NNPMP- market value of net output of all final goods and services produced by an economy during an accounting
year with net factor income from abroad (NNPMP = NDPMP + NFIA = GNPMP – Depreciation)
 NDPFC- sum of net values added by all the producers in the domestic territory of a country during an accounting
year (NDPFC = NDPMP – Indirect taxes + Subsidies = NDPMP – Net indirect taxes)
 NNPFC- factor income accruing to the residents of a country during a year (NNPFC = NDPFC + NFIA)-
NATIONAL INCOME
 GNPFC- sum of factor cost of the gross product attributable to the factors of production supplied by the normal
residents of the country during a year with net factor income from abroad (GNP FC = NNPFC + Depreciation)
 GDPFC- sum of net value added by all the producers in the domestic territory of the country and the consumption
of fixed capital during an accounting year (GDPFC = NDPFC + Depreciation = GNPFC – NFIA)

GDP excludes sale & purchase of 2nd hand goods, smuggling and transfer payments
Transfer payments- income and payments not related to any production activity, may be voluntary or compulsory and
include-

 Current transfers- paid from current income of the payer and added to the current income of the recipient for
consumption expenditure, can be-
 Within the country- direct taxes, donations, scholarships, pensions, interest on national debt
 Between countries- gifts & donations during natural calamities, transfer of gifts, transfer of military equipment
 Capital transfer- made in cash or kind out of wealth or saving of the payer for gross capital formation or long-
term expenditure of the recipient
 Within the country- capital gains tax, lump sum payment to households for demolition/acquisition
 Between countries- compensation for war damages, economic aid

Disposable income = Factor income + Net current transfers, can be

 Private- pretax income of private sector

 Personal- represents purchasing power in the hands of the people used for consumption and saving

 Net National Disposable Income = NNPFC + Net indirect taxes + Net capital transfers from rest of the world
 Gross National Disposable Income = Net National Disposable Income + Consumption of fixed capital

 GVAMP = Value of gross output – Value of intermediate goods

 NVAMP = GVAMP – Depreciation
 NVAFC = NVAMP – Net indirect taxes = NVAMP – Indirect taxes + Subsidies

Measurement of National Income-

 Product or Value added method- preferable for an underdeveloped economy & with inadequate data,
NNPFC = NDPFC + NFIA = NDPMP – Net indirect taxes = GDPMP - Depreciation
 Income method- preferable for a developed economy led by 20 & 30 sectors,
NNPFC = Employee compensation + Operating surplus + Mixed income + NFIA = NDPFC + NFIA,
where Operating surplus = Rent + Interest + Royalty + Profit + Dividend
 Expenditure method- NNPFC = GDPMP + NFIA – Net indirect taxes – Depreciation,
where GDPMP = Private consumption expenditure + Government consumption expenditure +
Gross domestic capital formation + Net exports

While calculating National Income following are excluded-

 Sale and purchase of 2nd hand goods

 Transfer income like old age pension, scholarships, unemployment allowance
 Sale of bonds and shares
 Income from illegal activities like smuggling, gambling
 Income from windfall sources like lottery

Difficulties in measuring National Income are-

 Price instability
 Non-availability of data
 Danger of double counting
 Production for self consumption