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Introduction
Economics?
Economics is the social science that studies
economic activity to gain an understanding
of the processes that govern the production,
distribution and consumption of goods and
services in an economy.
Positive vs. Normative
Branches- Micro, Macro..
Types of Economies (factors of production)
Closed & Open economy
Basic Problems
Basic Problems of economy
Problem of choice
What, How & For Whom (Production,
Allocation, Distribution)
Opportunity Cost
Best possible trade-off
PPF
PPF
Points on the curve- Productive
Efficiency
Points inside the curve- Productive
inefficiency
Allocative Efficiency- is a type of
economic efficiency in which
economy/producers produce only
those types of goods and services
that are more desirable in the society
and also in high demand.
Micro
Microeconomics deals with individual
economic agents/ variables and their
interaction.
Consumption (Marginal Utility)
Demand Side
Equilibrium
Markets (Types)
Elasticity
Responsiveness of one variable to
changes in the other variable.
Price elasticity
Income elasticity.......
Euilibrium
Macro
Macroeconomics deals with aggregate
economic variables and their
interlinkages
Study of aggregates (Y, P, M)
Goals (Price Stability, Full Employment,
Economic Growth & Development, Self
Reliance)
Tools ( Fiscal, Monetary and Trade Policy)
Contd..
Post 1930
Emergence of Macro
Great Depression
It was realized that Y may not be at Yf
Resources may be idle- UN
Problem not of allocation but of Utilization
of resources
Yf is one of the many possible levels of Y
that can be there.
Level of Y determined by AD
Goods
Consumption goods
Capital goods
Services
Firms
Households:
Households:
Own
Own the
the factors
factors of
of production,
production,
sell/rent
sell/rent them
them to
to firms
firms for
for
income
income
Buy
Buy and
and consume
consume goods
goods &
&
services
services
Household
s
Firms:
Firms:
Buy/hire
Buy/hire factors
factors of
of
production,
production,
use
use them
them to
to produce
produce
goods
goods and
and services
services
Sell
Sell goods
goods &
& services
services
Factor services
FIRMS
HOUSEHOLDS
Goods
Taxes
Savin
gs
Imp
ort
s
Government
Financial markets
Personal consumption
Other countries
en t
m
n
r
e
Gov nding
Spe
ent
m
t
s
e
v
In
rts
Expo
Measurement
Total value of
goods &
services
produced
(Product
Method or
Value Added
Method)
Total
Expenditure
on goods &
services
(Expenditure
Method)
Total factor
income
(Income
Method)
Measurement
Value Added Method
GVA = (cost of goods produced)-(cost of
intermediate goods used in production)
GVA = GDP
(at Market Price)
MP
Income Method
Y = w+r+i+p = C + S ( Income received is either
consumed or saved)
Measurement
Expenditure Method- Exclusions
Intermediate goods
Expenditure pertaining to other periods
Transfer Payments
Depreciation
MP
Income Method
Current period
For goods and services produced
Excludes Capital receipts and Transfer payment
receipts
GNP
at
mar
ket
price
Government
Expenditure on Indirect Taxes
Goods &
Services (G)
Gross Private
Investment (I) NNP at factor
cost
Private
Consumption
(C)
or
The National
Income
(NY)
Direct Taxes
Net Business
Savings
Transfer
Payments
DY
PI & PDI
Personal Income (PI):
This measures all of the income that is received by individuals, but not
necessarily earned. Examples of this include social security benefits,
unemployment compensation, welfare payments, benefits for veterans,
and food stamps. Individuals also contribute income which they do not
receive. This includes corporate profits that are undistributed, indirect
business taxes, and the contribution of employers to Social Security.
PI = NI + income received but not earned - income earned but
not received.
Personal Disposable Income (PDI) = PI - Personal Income Taxes
Contd.
Demand Side
AD
MV = PY (QTM)
V, Y given
PM
Given M, MV is given => DD is Unitary Elastic
P is determined
Equilibrium level of Y
Intersection of AD & AS
AS
P
AD
Yf
Contd.
Classical model for r
Savings is a direct function of r
r is seen as a return for foregoing present
consumption and saving
Keynesian Model
Supply side
Wages and prices are rigid downwards
Perfectly elastic or upward sloping AS
curve upto Yf level then becomes
Inelastic
Demand side
Y dependent on AD
AD = C + I + G + (X-M) = C + S
Keynesian Model
Consumption function
Equilibrium
Multipliers
AS
Wages
are rigid downward
Prices and quantities
are both relatively flexible.
When AD shifts,
both prices and
quantities adjust
AD
Income and Output Y
AS
AD
Income and Output
Y
Money
Money
Medium of exchange
Unit of account
Store of value
Measures of Money
M0 (Reserve Money or High Powered
Money H): Currency in circulation +
Bankers deposits with the RBI + Other
deposits with the RBI
= Net RBI credit to the Government + RBI
credit to the commercial sector + RBIs
claims on banks + RBIs net foreign assets +
Governments currency liabilities to the
public RBIs net non-monetary liabilities.
M1 (Narrow Money): Currency with the
public + Deposit money of the public
(Demand deposits with the banking system +
Other deposits with the RBI)
Measures of Money
M2: M1 + Savings deposits with Post office savings
banks.
M3 (Broad Money OR Aggregate Monetary
Resources AMR):
M1+ Time deposits with the
banking system
= Net bank credit to the Government + Bank credit
to the commercial sector + Net foreign exchange
assets of the banking sector + Governments currency
liabilities to the public Net non-monetary liabilities of
the banking sector (Other than Time Deposits).
M4:
M3 + All deposits with post office savings
banks (excluding National Savings Certificates)
Assets (sources)
Gold
i) Held By Public
Forex
Loan to GoI
ASSETS
3. Net foreign
exchange assets
4. Net RBI credit
to government
5. Credit to
commercial sector
High powered money is 3+4+5-2
BANKING SYSTEMs
CONSOLIDATED
B-SHEET
LIABILITIES
1. Monetary
liabilities
2. Net nonmonetary
liabilities
ASSETS
3. Net foreign
exchange assets
of banks
4. Net bank credit
to government
5. Commercial
Broad Money is the monetary
credit liability of
banking system
H=C+R
M=C+D
D = DD + TD
c= C/DD => C = cDD
t= TD/DD => TD = tDD
r= R/D => R = rD = r(DD + TD) =
r(1+t)DD
Money Supply (M) = m.H
m= M/H = (1+c+t)DD/[c+r(1+t)DD]
Money Market
Keynesian Theory
Demand
Transaction Demand
Directly related to Income (Y)
Mt = k (PY) OR Mt/P = k (Y) OR mt = k. Y
Speculative
Inversely related to rate of interest (r)
If (r) increases, bond prices to fall
msp = h(r)
md = mt + msp
Supply
Ms Total stock of money in circulation among public at a
particular point in time
IS- LM
Simultaneous equilibrium of
Goods Market
Points of equilibrium in Goods market lie on
the IS curve
IS f (r, Y)
Money Market
All points of equilibrium in Money Market lie
along the LM curve
LM g (r, Y)
S > I Y will
fall
ms > md r
will fall
LM
I > S Y will
rise
ms > md r
will fall
I > S Y will
rise
md > ms r
will rise
IS
Inflation
Demand Pull
Cost Push
Philips curve
Demand Pull
Inflation
Cost push
inflation
Business Cycles
Inflationary Gap and Deflationary
Gap
BoP
Record of International transactions
of a country with RoW over a given
period of time
Double entry book keeping
Equilibrium?
BoP
Credits
R
s
Debits
1 Exports of goods
Import of goods
2 Exports of services
(shipping, tourism,
banking, insurance, etc.)
Import of services
(shipping, tourism,
banking, insurance, etc.)
Unrequited payments
(gifts, remittances,
grants etc. to foreigners)
4 Capital receipts
(borrowings from, capital
repayments by, sale of
assets to, foreigners)
Capital payments
(lending to, capital
repayments to, purchase
of assets from,
foreigners)
TOTAL RECEIPTS
TOTAL PAYMENTS
4 is basically import of capital (brings forex)
8 is export of capital (outgo of forex)
R
s
BoP
A
Balance of Trade
1-5
Balance of services
2-6
3-7
A+B+C
4-8
BALANCE OF PAYMENTS
D+E
Does it Balance?
Exchange Rate
Fixed
Floating
Devaluation?
Depreciation?
RER