Menegement For Oropitation
Menegement For Oropitation
Menegement For Oropitation
1
(d) Balance of Payments
(e) Inflation
4. Categories the following into stocks and flows (with brief justification):
(i) Capital (ii) Saving (iii) Gross domestic Product (iv) Wealth (v) Losses
(i) Capital: Capital is a stock variable because it is a quantity measured at a
particular period of time.
(ii) Saving: Saving is a flow variable because it is a quantity measured over a
specified period of time (If it is given as savings, then it will be considered a
stock concept which accumulates money at a particular point of time).
(iii) Gross domestic product: Gross domestic product is a flow variable
because it is a quantity measured over a specified period of time.
(iv) Wealth: Wealth is a stock variable because it is a quantity measured at a
particular period of time. It includes accumulated past savings and income not
spent.
(v) Losses: Losses is a flow because losses are always with reference to a time.
2
below.
Basis Closed economy Open economy
Socio- A closed economy has no An open economy has a socio-
economic socio-economic relation with economic relationship with the
relationships the world economy. rest of the world sector.
Economic The closed economy follows The open economy follows the
Guidance the guidelines of the plans of principles and guidelines of
the central government. the market economic system
Trade scope Only domestic output is It keeps trade association with
traded inside the country and many countries of the world
there is the complete absence economy.
of international trade.
Borrowing This economy neither This economy borrows and
and lending borrows nor lends. lends
Flexibility A closed economy is rigid. An open economy gives & take
foreign aids & loans.
Unit-2
1. What do you mean by GDP deflator?
2) What do you mean by Real GDP & Nominal GDP? Difference?
3) What is meant by circular flow of income in two sector and three Sector
economy?
4)Expenditure method of a calculation GDP.
1. What do you mean by GDP deflator?
GDP Deflator:-
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Real GPP =
𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥
100
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Or, GDP Deflator (Price Index) =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
100
Example:-
Nominal GDP (2023-CY) = 250 (₹)
Real GDP (Base year - 2015) = 200 (₹)
250
= × 100 = 125
200
↓
Price Index
125-100 = 25%
↓
Inflation
(It is a ratio of GDP at current price & GDP at constant price,
3
GDP deflator is measured of the level of prices of all new final goods & services
in an economy.
The deflator measures the change in prices that has occurred between
the base year and the current year. Since, GDP deflator is based on a
calculation involving all the goods produced in an economy, it is a widely based
Price index that is frequently used to measure Inflation.
Let us see how money flows from firms to households and from
households to firms. This can be show with the help of flow chart. There are
four factors that are required for productions i.e. land, labour, capital &
organization. The firms get these inputs from the members of households. For
example, owner of land gets rent in exchange from the firms. Supplier of labour
gets wage from the firm. Owner of capital gets interest & the organizer (owner)
of the firm gets profit. Thus, a flow of factors of production from households to
firm continues and in return a flow of money from firms to households
continues.
Again, firms produce commodities and sell them in the market and
households spend their money to purchase it. The expenditure of the
households is the income of the firms. There are flows from firms to household
& households to firm and it is called circular flow. This can be explained by
following flow chart:
How money flows in this circle is clear from above figure. Since the
starting point and the final point are the same, this is called a circular flow.
Households' expenditure on goods & services
4
Comparison between Nominal and Real GDP
Basis Nominal GDP Real GDP
Meaning Value of all the goods and Value of all the goods and
services produced by an services produced by an
economy at current market economy, its investments,
prices. government spendings and
exports.
GDP Data The value of the total product The value of the total product
is seen to be higher because it appears low because inflation
does not reduce inflation. is reduced in it.
Reliability Less reliable in comparison to More reliable in comparison to
Real GDP. Nominal GDP.
Worth High Low
Uses Compares different quarters of Compares two or more FY.
an FY
Financial Analyzing is difficult Analyzing is easy
Growth
Size of 2.93 trillion dollars (2019) Rs.1,40,77,586 Lakh Crores
India's (2018-19)
economy
India's Fifth-largest in the world. Data Unavailable
position in
the world
5
3) What is meant by circular flow of income in two sector and three Sector
economy?
It refers to cycle of generation of Income in the production process. It's
distribution among the factors of production and finally, it's circulation from
households to firms in the form of consumption expenditure on goods and
services produced by them:
1
Factor of production
2 Firm
Households
3
Flow of goods & Services
Household expenditure
on goods & services
6
THE THREE SECTOR MODEL: Introducing the Government Sector
In the two sector model, we have illustrated how goods, services, and
factors of production move between households and firms. Let us now
introduce the government sector into this flow. The government spends on the
purchase of goods and services and also provides subsidies, grants, and aids.
The government also employs factor services from the households and
makes payment for them. The salaries received by government servants are
part of it. In this model, the entire earning of the firms is not coming from the
sales in the household sector. A part of it is coming from the government as
payments from goods and services or subsidies or grants. Similarly for
households, the entire income earned by the sector does not come from the
firms as part of it is obtained from the government sector. Thus, the
expenditure made by the government sector can be seen as injection in the
circular flow as it is not coming from either the household sector or the firm
sector.
The government makes the expenditure from the revenue it earns from
taxes and other sources. It collects taxes from both firms and households.
Thus part of the income of the households is flowing to the government sector
instead of going to the firms as payments for goods and services. Similarly, a
part of the earnings of the firms is going to the government as taxes and not to
the households. Thus, this can be viewed as leakage from the system.
Factor services
7
terms of expenditure on purchase of final goods and services produced in the
economy during an accounting year.
Step 1:- Identification of Economic units which incur final Expenditure":""
- household sector.
- Firm Sector
- Govt. Sector
- Rest of the world
Step 2 :-
ii) classification of final expenses
a) Private final consumption Exp. (C)
↳ Food, Education, Health, cloth.
+
Non-profit organization.
Step4
Calculation of National Income.
𝑁𝑁𝑃𝐹𝐶 = 𝐺𝐷𝑃𝑀𝑃 -NIT – NFIA - Depreciation
8
viii) service produced for self-consumption = Not included.
Unit-5
1. What is inflationary gap? Diagrammatically explain the concept of inflationary
gap.
9
2.What do mean by natural rate of unemployment? Do you think that full
employment means zero unemployment? Explain the concept of frictional
unemployment.
3. Distinguished between Deemed – Pull and Cost – Push inflation. Briefly explain
the theory of Cost – Push inflation.
4. Explain the concept of High – Powered Money. Derive the money multiplier in
this context.
5. Distinguish between narrow money and board money.
6. (a) Explain the different concepts of inflation.
(b) Discuss the Different measures of controlling inflation.
7) Examine how far fiscal policy is more effective than monetary policy in
combatting a recessionary situation.
8) What do you mean by voluntary and involuntary unemployment?
9)Explain the concept of Frictional Unemployment.
O Q X Income/output/employment
10
AD rises AD to AD1 it denotes the situation of excess demand and the gap
between them is terms as inflationary gap.
What is Inflationary Gap?
According to Prof. Keynes, at full employment level of income, if the total demand for
commodity is greater than the total supply of commodity then that excess demand for
commodity is called inflationary gap i.e. inflationary gap is the difference between total demand
for commodity and total supply of commodity at full employment level of income.
According to Prof. Keynes equilibrium level of income is determined where total demand
in the country is equal to total supply of that country. Total supply of commodity of a country
is the total national income or total income (Y) of the country due to equality of national income
and national product. To determine the total demand of the country three sectors economic
system is considered. These three sectors are households who incur consumption expenditure
(C) i.e. make demand for consumption goods, firms or production units who make investment
(I) i.e. make demand for capital goods and the government sector which incur government
expenditure (G) i.e. make demand for consumption goods and capital goods. So here total
demand of the society or country is C+I+G. So it can be said that equilibrium level of income is
determined where
Total Supply = Total Demand
i.e. Y = C + I + G.
With the help of Figure inflationary gap is analyzed.
E
Consumption
Expenditure (C),
Investment
Expenditure (I), C+I+G
Government H C+I
Expenditure (G) A
C
11
to FH. So it is necessary that the equilibrium level of income should be OF amount. Here it is
assumed that maximum amount of income at full employment level of income is OD. This
means that in the society it is not possible to increase the total level of income more than the
amount OD i.e. even though total demand of the society is C+I+G but it is not possible to
increase the total level of income of the amount OF. Here OD is the full employment level of
income. At this OD level of income total demand of the society is DB and the total supply of the
society is DA. So here the amount of excess demand is (DB-DA) AB. This AB is called
inflationary gap.
Price level of the country increases continuously or inflation occurs due to this
inflationary gap of the amount AB. So long as this inflationary gap exist up to that, total
demand of the society is greater than total supply of the society and due to the effect of this
excess demand price level continue to increase or inflation continues i.e. inflation in the
country continue so long as this inflationary gap exist.
Inflationary gap will be removed and inflation will stop if C + I + G curve shifts in the
downward direction and passes through the point A.
2.What do mean by natural rate of unemployment? Do you think that full
employment means zero unemployment? Explain the concept of frictional
unemployment.
Natural rate of unemployment?
The natural rate of unemployment, or NAIRU, represents the level of
unemployment inherent in a healthy, functioning economy. It includes
structural and frictional unemployment, reflecting the time It takes for people
to find suitable jobs and adjustments in the economy. When the actual
unemployment rate aligns with the natural rate, the economy is considered at
full employment. Policymakers use this concept to understand the normal state
of the labour market and to avoid the Inflationary consequences associated
with pushing unemployment below the natural rate. The natural rate serves as
a crucial benchmark for economic analysis and policy formulation.
Full employment means zero unemployment?
No, full employment does not necessarily mean zero unemployment. Instead,
full employment is a state where the economy is operating at Its potential
output, and the unemployment rate is at its natural or equilibrium level. This
level of unemployment includes frictional and structural unemployment, which
are considered normal in a dynamic economy.
Frictional unemployment occurs as individuals transition between jobs or
enter the workforce, while structural unemployment arises due to shifts in the
economy's structure, rendering some skills obsolete. These types of
unemployment are generally unavoidable and do not imply economic
Inefficiency.
Therefore, full employment acknowledges the existence of some level of
unemployment that is consistent with a well-functioning, dynamic labour
market. It provides room for job turnover, voluntary transitions, and
adjustments within the economy while maintaining stable inflation and
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overall economic health.
Cost Push Theory of Inflation: If the price level of the country rises continuously as a result
of increase in cost of production due to increase in the prices of the factors of production then
that situation is called cost push inflation. Though cost of production increases due to increase
in the prices of factors of production but according to the modern economist price of labour i.e.
wage rate is most important among the prices of factors at production. According to them,
nowadays trade unions are so strong that they can increase the wage rate by giving pressure
upon the owner. If the wage rate increases at a greater rate due to trade unions pressure than
the rate of increase in productivity of labour then cost of production increases as a result of
13
increase in that wage rate. If price level rises continuously as a result of increase in cost of
production due to that wage increase then it is called cost push inflation. Fig. 5.4. is used to
explain cost inflation. །
In Fig. 5.4. amount of commodity is measured on the horizontal axis and price le is
measured on the vertical axis In the diagram OS is the amount of production at full
employment level. Here S1AS0 is the primary supply curve. The portion S1A of this supply
curve is upward rising, this is because before full employment supply of commodity increases
as price level increases. Further the portion AS0 of the supply curve S1AS0 is parallel to price
level axis, this is because at full employment level amount of production and supply of
commodity remain fixed (OS). As a result amount of production and supply of commodity
remain constant even though the price level increases after full employment. In the diagram
DD1 is the total demand curve of the society. From the diagram it is seen that total demand
curve of the society DD1, and total supply curve S1AS0 intersect each other at point E1. Here
the point E1 is the equilibrium point. Here the equilibrium price is OP 1 and the equilibrium
amount of commodity is OM1 which is less than the amount of commodity (OS) at full
employment level.
Price Level S0
A
D
E2
P2
P1 E1 D1
S2
S1
O M 2 M1 S Amount of Commodity
Fig. 5.4.
If the wage rate increases due to trade union pressure but the productivity of labourer
remain the same, then cost of production rises and the production unit claim higher price than
before for the same amount of commodity. As a result supply curve shifts to the left. From the
diagram it is seen that as a result of increase in cost of production due to trade union pressure
total supply curve shift to the left from S1AS0 to S2BS0. From the diagram it is seen that new
supply curve S2BS0 intersect the fixed demand curve DD1 at point E2. Here E2 is the new
equilibrium point and the equilibrium price level is OP 2 and the equilibrium amount of
commodity is OM2. So here equilibrium price level increases from OP1 to OP2 and the
equilibrium amount of supply decreases from OM21 to OM2. Cost of production trend to
increase as the wage rate increases due to trade union pressure. As a result total supply curve
continuously shift to the left. But due to unchanged total demand curve price level increases
continuously. This increase in price level is called cost push inflation. So it is seen that before
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full employment level, demand remain constant, due to wage increases, cost of production rises
and as a result price level increases which is the cost push inflation.
Here it may be mentioned that trade unions and the production units enjoy high power
to control market. For this they directed the wage rate and price level for their own interest. For
this cost inflation is called administered price inflation.
According to Prof. Samuelson, cost push inflation occurs by the admixture of price
increase. According to him at first price of the commodity increases, as a result trade unions
give pressure for wage increase. Ultimately cost inflation occurs as a result of increase in cost
of production due to wage increase.
There are some criticisms against this cost push theory of inflation. Main criticisms are:
(1) In this theory it is assumed that trade unions can increase wage rate i.e. in the labour
market perfect competition does not exist. But if perfect competition exist in the labour market
then wage rate can increase only when excess labour demand exist in the labour market. So
trade unions cannot increase wage rate if there is no excess demand in the labour market. So if
perfect competition exist in the labour market then only one inflation can exist, that is the
demand pull inflation and not cost push inflation.
(2) If the amount of money supply and government expenditure remain constant the price of
the commodity which is increased as a result of increase in cost of production due to wage
increase through trade unions pressure cannot be continued for a long time. If the amount of
money supply and government expenditure remain constant, the demand for commodity
decreases along with the increase in price level. As a result amount of production and supply
trend to reduce and the number of unemployment in the economy trend to increase. Increase
in wage rate and increase in price level will stop as a result of increase in number of
unemployment. So as a result of wage increase price level cannot increase without any
obstacles if the amount of money supply and government expenditure do not increase along
with the increase in wage rate. For this it is said that cost inflation cannot occur without the
support of the government.
4. Explain the concept of High – Powered Money. Derive the money multiplier in
this context.
High Powered Money - explanation.
Ans. There is two factors in the determination of money supply in the economy.
1) High Powered Money (H) → Denoted by H.
It consists →
• Cash reserves with the Commercial Banks.
• Currency held by the public.
• Required Reserves of the commercial Banks to be maintained with the
RBI.
H = C + RR + ER
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Derivation of Money Multiplier
A degree by which total quantity of money supply is changed as a result of
change in High Powered Money is called Money Multiplier.
𝑀
m=
𝐻
M = m. H
(i) ÷ (ii)
𝑀 𝐶+𝐷
= …………… (iii)
𝐻 𝐶+𝑅
𝐶+𝐷 𝐶
𝑀 𝐷 +1
= 𝐶+𝑅 = 𝐷
𝐶 𝑅 ….…..(iv)
𝐻 +
𝐷 𝐷
𝐷
𝐶
= cash deposit Ratio [K]
𝐷
𝑅
𝐷
= Reserve Deposit Ratio [r]
𝑀 𝑘+1
=
𝐻 𝑘+𝑟
𝑘+1
M = H.
𝑘+𝑟
M = H. m
m = Money Multiplier
1+𝑘
= 𝑟+𝑘
16
narrow money definition of money supply is a measure of valuable coin and notes in circulation
and other Mani equivalent that are easily. convertible into cash such a short term deposit in
the banking system".
■ Different Types of Inflation: Price of majority commodities of any country when increases
continuously then that situation is called inflation i.e. when general price level rises
continuously than the situation which is created is called inflation.
17
Inflation is of different types. Here we discuss important types of inflation:
18
If the price level of the country rises continuously at a rapid rate then that situation is called
galloping inflation or hyperinflation. But there is no hard and fast rule regarding the annual
rate of rise in price level to become treated it as galloping inflation or hipper inflation.
19
(2) Cost of production rises as a result of sellers' inflation due to increase in price of other
inputs along with wage rate. But necessary amount of employment and production do not rise
due to slow rate of economic growth.
Due to these reasons unemployment in factor of production, commodity deficit etc.
are seen in one side and on the other side price level rises regularly. This is the stagflation
which in now converted into malediction of the world. In India along with other countries of the
world this problem is acute.
(b)The different measures used for controlling inflation are explained below.
A: Monetary measures:
If the supply of money in the economy can be decreased, prices are expected to fall. The
quantity of money and the price level change in the same direction. Hence, if the quantity of
money decreases, the price level will fall. If we can reduce the rate of lending by banks, then we
can reduce the total supply of money significantly. The Central Bank of a country can reduce
the lending of commercial banks in different ways.
Quantitative credit control:
(a) Bank rate: The bank rate is that discount rate at which the Central Bank of any country
rediscounts any bill of exchange submitted by any commercial bank to take loans from
the Central Bank.
(b) Open market operations: This indicates the purchase and sale of Government securities
or treasury bills by the Central Bank At the time of inflation, the Central Bank sells
Government securities in the open market to pump out some amount of money from
circulation However, the open market sale has been pursued by the RBI to check
continuous expansion of liquidity with the banking sector. The success of this policy
instrument depends on an organized bill/security market.
(c) Cash reserve requirements: Every commercial bank has to keep a certain minimum
cash reserve with the Central Bank. The RBI increases this cash reserve requirement
during inflation With a rise in the cash reserve requirements, the amount of loanable
funds with the commercial banks declines. Thus, the process of credit creation by the
commercial banks is checked.
(d) Statutory Liquidity Ratio (SLR): In addition to the CRR, the commercial banks are often
required to maintain a given portion of their total liquid assets with the Central Bank. This is
known as SLR. The SLR is raised for combating the inflationary pressure.
B: Fiscal Measures:
An inflationary gap arises when aggregate demand exceeds the maximum potential supply in
an economy. To overcome this situation, the following types of fiscal measures can be
undertaken:
(a) A decrease in the Government expenditure, or.
(b) A decrease in the Government transfer and subsidy payments.
(c) An increase in taxes imposed by the Government, or
(d) A combination of all these measures.
These are regarded as contractionary fiscal policies. These contractionary fiscal policies reduce
the employment and income opportunities within the economy. For instance an increase in the
tax rate reduces the disposable income of the consumers. Hence, these policies restrict the
growing demand for goods and services within the economy, and help in contracting the
inflationary pressure.
7) Examine how far fiscal policy is more effective than monetary policy in
20
combatting a recessionary situation.
21
8) What do you mean by voluntary and involuntary unemployment?
Voluntary Unemployment and Involuntary Unemployment : Generally there are two types
of unemployment in every economy. One is voluntary unemployment and the other is
involuntary unemployment. A person is said to be voluntarily unemployed if he is not willing to
work at the existing wage rate even if he gets the job. On the other hand, a person is said to be
involuntarily unemployed if he fails to get a job at the prevailing wage rates. The main
problems of unemployment in an economy is the problem of involuntary unemployment.
Concept Note
22
1) Fiscal Policy:-
Those policies & roles which is made by govt. is called Fiscal Policy.
i) Decrease in gout spending : Govt. spends huge amount on its
infrastructural and administrative activities to control the situation of excess
demand.
Govt. should reduce its expenditure on maximum possible, extent which would
result reduce the level of AD in the com economy and help to correct
inflationary pressures in the economy,
ii) Increase in Taxes:- During excess Demand, Govt. increases the rate of
Taxes and even imposes some new taxes. It leads to decrease in the level
of Aggregate expenditure in the economy and helps to control the situation of
excess demand.
Before After
Tax Rale = 10%. Tax Rate = 20%
Income =10,000 Income = 10,000
2) Monetary Policy:
The RBI is empowered to regulate the money supply in the economy
through Monetary Policy.
i) qualitative Instrument:- These instruments aim to influence the
total volume of credit in circulation.
₹ ₹
Commercial
X Bank
Bank
Int. @10% Int. 18%
Open Market operations: It refers to sale and purchase of securities in the open
market by central Bank.
During excess demand, central Bank offers securities for Sale of
securities reduce the reserve of Commercial Bank. It adversely affects the
Bankers ability to create credit & decrease the level of AD.
Public
Central
Bank
Commercial
Bank
Legal Reserve Ralio:- Each commercial bank Kept a certain amount of money
from the deposit as a Reserve.
24
Legal Reserve Ratio
CRR SLR
• It refers to the minimum %
of net demand & time
• It is the minimum %
liability which commercial
of net demand & Time
banks are required to
liability, to be kept by
maintain with them- selves.
commercial bank with
the central bank.
25
when economy is suffering from excess demand, central Bank increases the
margin which restricts the credit creating power of Banks.
Loan (₹) Security (₹) Margin Requirements (₹)
case 1 1,00,000 1,50,000 50,000
Case 2 1,00,000 3,00,000 2,00,000
Discourage The Loan
Excess Demand are
controlled.
Moral suasion (Advising to discourage lending :-
Moral suasion = (Persuasion + pressure) by the central banks.
Loan
26
fluctuation. The measures which a govt usually takes include the monetary
and fiscal measures.
There are some benefits, of monetary measures, but it has certain
limitations also. For this reason modern economists have suggested some fiscal
measures which are fruitful, Prof. Keynes has suggested to apply fiscal policy
extensively to counter cyclical fluctuations. In present days, many more
economist also support such measures. The main reason of cyclical movement
of the economy is that the expenditure for consumer goods is either more or
less than the volume of saleable goods. Therefore cyclical movements of the
economy can be controlled if the deficit or surplus demand for consumer goods
can be checked.
Inflation:- Inflation is defined as a situation where there is a Continuous rise
in general price level of goods & services and I fall in the purchasing power of
money.
For instance, if a product which cost ₹100 costs ₹110 after a certain period of
time, the inflation for that period is 10%.
There are mainly two causes of inflation :-
a) Demand Side Factors (Demand Pull. Inflation)
b) supply side Factors (cost push Inflations)
27
D2
D1 S’
D
𝑃2 E2
𝑃1 E1
𝑃 E D’2
D’1
Price S D’
0 Q quantity
A co. producing smart phones at ₹5000 whose quantity demand is 200 per day
and production per day is 150 per day at full employment level. Therefore
demand creates inflation in the economy.
S0
Price D’1 D’2
Level
P2 E2
P1 E1 D2
D1
O S Amount of commodity
The amount of commodity is measured on the horizontal axis and Price Level is
measured on the vertical axis. In the diagram 550 is the total supply curve of
commodity at full employment This supply curve is parallel to price level axis
because amount of production and total supply of commodity remain constant
28
(OS) at full employment level. In the diagram it is seen that total demand curve
and total supply curve intersect each other, at point E [E = Equilibrium point].
Here Equilibrium Price level is OP, and the equilibrium amount of commodity
is OS. Total demand curve will move to the right if total demand of economy
increases. From the diagram it is seen that total demand curve shifts to the
right from DD1 to DD2 due to increase in total demand in economy. Demand
Curve DD2 intersect the unchanged supply curve SS0 at point E2. Here, E2 is
the new equilibrium level Point and the new equilibrium price level is OP2. But
at new equilibrium price level, the amount of commodity remain constant at
OS level. Here equilibrium price increase from OP1 to OP2 but production and
supply remain constant due to full employment. This increase in price level is
called demand Pull inflation. Thus it is seen that at full employment level total
supply remain constant, the price level which is increased due to increase in
demand is the demand Pull inflation.
29