Principles of Economics and Management

Chapter: 4 Basic economic problems

4.1 Poverty-meaning, absolute & relative poverty, causes, measures to

Basic
reduce poverty
economic
4.2 Unemployment: meaning, types, causes, remedies
problems
4.3 Inflation; meaning, types, causes, measures to control

Poverty

Basic
Economic
Problems

Inflation Unemployment

4.1 Poverty

Meaning: Poverty is about not having enough money to meet basic needs including
food, clothing, and shelter.

Poverty is a state or condition in which a person or community lacks the financial

resources and essentials for a minimum standard of living. Poverty means that the
income level from employment is so low that basic human needs can't be met. Poverty-
stricken people and families might go without proper housing, clean water, healthy
food, and medical attention. Each nation may have its own threshold that determines
how many of its people are living in poverty.

Concept of Poverty:

1. Absolute Poverty
2. Relative Poverty

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1. Absolute Poverty: Absolute poverty refers to a condition where a person does not
have the minimum amount of income needed to meet the minimum requirements for
one or more basic living needs over an extended period of time. This includes things like
 Food
 Safe drinking water
 Sanitation facilities
 Health
 Shelter
 Education
 Living in absolute poverty is harmful and can endanger your life.
 The standards set for absolute poverty are the same across countries.
 When it was established in 1990, the World Bank set the global absolute poverty line
as living on less than $1 a day.
 Absolute Poverty in India:
 Earlier, India used to define the poverty line based on a method defined by a task
force in 1979.
 It was based on expenditure for buying food worth 2,400 calories in rural areas,
and 2,100 calories in urban areas.
 In 2011, the Suresh Tendulkar Committee defined the poverty line on the basis
of monthly spending on food, education, health, electricity and transport.
 According to this estimate, a person who spends less than Rs. 27.2 in rural areas
and Rs. 33.3 in urban areas a day are defined as living below the poverty line.
 This has been criticized for fixing the poverty line too low.
 According to a committee headed by former Reserve Bank governor C
Rangarajan, people living on less than Rs. 32 a day in rural areas and Rs. 47 a day
in urban areas is poor.

2. Relative Poverty: Relative poverty is the condition in which people lack the
minimum amount of income needed in order to maintain the average standard of living
in the society in which they live.

 Relative poverty is considered the easiest way to measure the level of poverty in an
individual country.

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 Relative poverty is defined relative to the members of a society and, therefore,

differs across countries.
 People are said to be impoverished if they cannot keep up with standard of living as
determined by society.
 Relative poverty also changes over time.
 As the wealth of a society increases, so does the amount of income and resources
that the society considers necessary for proper conditions of living.
 Example
Person Income
A 5000
B 10000
C 15000
D 20000

 It is obvious that A is poorest person while D is richest person.

 However, Relative poverty may be assessed on the basis of some standard level of
income.
 If Rs. 20000 P.M. is consider as standard level of income then A, B, & C are
considered relatively poor.
 If Rs. 10000 P.M. is consider as standard level of income then only A is considered
relatively poor.

4.1.1 Causes of Poverty

1. Low rate of economic growth:

 Poor economic growth rate generates lower income.
 The low income restrict from availing even basic necessities of life like food, shelter
and clothing
2. Economic inequalities:
 It is uneven distribution of income and consumption.
 Due to this rich becomes richer and poor becomes poorer.
 According to one survey the top 3 percent of the rural households account for about
26 percent of the land area, while bottom 55 percent hold just 10 percent of the total
land area.

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3. Benefits of public investment have accrued more to the upper section of the
society:
 It has been found that the fruits of public investment undertaken during the last five
decades have accrued more to the upper section of the society than to the middle
and lower income groups.
 Subsidies in modern technique of irrigation will benefitted more to rich farmer than
poor one.
4. Unemployment and underemployment:
 Lack of employment will promote poverty.
 Due to less work or no work people is not getting income and they are not able to
full fill their basic need.
5. Inflationary price rice:
 Due to inflation price of the product rise and hence poor people cannot buy their
necessary product which leads to poverty.
 Indian economy all throughout the planning period, save for a few exceptional years
has been witnessing a spiral of inflationary price rise in spites of our avowed
objective of growth with stability.
6. Faster population growth amongst the poor:
 Poverty is also related with population growth.
 It is observes that population growth is large among the poor people.
 Population growth among poor is more due to lack of awareness about family
planning and education will limit their thinking.
7. Low level of literacy amongst the poor:
 Poverty and illiteracy are inter related factors.
 Illiterate people will have limited job opportunities.
 Illiterate people will get job only at bottom of the organization so their income is
also low.
8. Inadequacies of anti-poverty programs:
 Generally anti-poverty programs are inadequate and inefficiently implemented.
 It is right to say that poor designing, poorer identification and the poorest
implementation have almost paralyzed poverty alleviation program in India.

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9. Corruption:
 Corruption is very big problem of any economy.
 In an economy if corruption is there than what benefits are decided by government
will not reach to right people for which it is allotted.
 Corruption will restrict better steps taken to reduce poverty.
10. Natural calamity:
 It is universal problem and we don’t know in advance when, where, how, and size of
problem.
 It natural disaster activity like flood, earthquake etc.
 It is due to change in environmental condition that some time generated by men by
means of pollution.

4.1.2 Measures to Reduce Poverty

1. Rapid economic growth:

 As we know low economic growth is one cause of poverty.

 Rapid economic growth will help us to solve this problem.
 In India economic growth rate is slow that is one of the reason that we are having
still poverty.

2. Reducing economic inequalities:

 Reducing in inequality of income is another kingpin of poverty eradication.

 By providing opportunity to people to do work we can help them to overcome from
poverty.
 Develop small agricultural business and cattle farming illiterate people can also earn
money. So focus on such business.
 Help poor people collect tax from reach people based on income.
 Do not collect tax on necessary product like salt, weat etc. and collect more tax on
comfort product like air conditioner, car etc.
 Example - Progressive Income Tax

3. Employment oriented planning:

 Do planning in such a way that all people will get employment and able to full fill
their need.

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 Develop small scale business or house hold business which gives opportunities to
people to earn money.
 Promote in-house business like cloth designing, food packet preparation etc.
 Pattern of investment should be such that it provide gain gull employment to people
and not infrastructure centric.
 Example - Make in India

4. Adoption of appropriate pattern of production:

 The pattern of production has to be so designed as to cater to the needs of the poor
and weaker sections of the society.
 It is necessary to give a high priority to agriculture and industries, producing
essential articles of mass consumption.
 Distribution will also be have to be evolved so that the essential articles are supplied
to the vulnerable sections of the society in adequate quantities and at reasonable
prices.
 Example - Drop Irrigation

5. Control of inflation and price stability:

 No program of removal of poverty can success till inflation is continuous increasing.

 Expansion of employment will not reduce poverty if continuous price rise is there.
 It is essential that suitable monetary, fiscal and other measures are adopted to
control inflation and stabilize price.
 It essential to make such a policy so that essential things are reached to the poor
people at reasonable price.
 Example - Reduction of import duty on essential commodities

6. Removal of illiteracy:

 There is close relation between poverty and illiteracy.

 Removal of illiteracy is integral part of poverty eradication program.
 Generally poverty and illiteracy go together.
 Literate people can able to do many type of job while illiterate people cannot. So
removal of illiteracy will help to reduce poverty.

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 Government is taking some steps for the same.

 Example - Right to free primary education

7. Population control:

 Generally large family size is big problem for poor people.

 If they get small work then they cannot fulfil need of large family.
 Example - Family planning

8. Special program of poverty eradication:

 Self-Employment program
 These programs aim at providing the poor households with productive assets
financed by subsidies and credit.
 Example - Gram Rozgar Yojana
 Wage-Employment program
 These programs provide direct wage-employment to the poor and the process
create productive assets.
 Example - Mahatma Gandhi NREGA
 Social security program
 These programs are launched to provide social security to the weakest among
the poor.
 Example - Aam Aadmi Bima Yojana

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4.2 Unemployment

Definition: Unemployment refers to a situation in which a person is jobless though

 He/ She is able to work.
 He/ She is willing to work.
 He/ She is ready to accept the current wage rate. &
 He/ She is in search of job.
Meaning of Unemployment
 Unemployment is a concept which is connected with only active labour force
in the country.
 Active labour force includes age group 15-60 year. Above and below this age
limit is not considered in active labour force.
 Housewives, physically handicapped, old person, and children etc. are not
considered in active labour force.
 There are two possible divisions in unemployment:
1. Voluntarily Unemployed:
 Voluntary unemployment refers to a situation when Person choose not to work
because their expected salary is higher than the usual salary.
 In other words, unemployed of their own will.
 Such persons are not included in labour force of the country.
 Sometimes people reject employment opportunities if they do not receive desired
wages or if they are not offered the kind of work they wish to do.
2. Involuntarily Unemployed:
 An involuntary unemployment means a situation in which all able persons who are
willing to work at the prevailing wage rate do not get work.
 Such people are (i) physically and mentally fit to work and are also (ii) willing to
work at the going rate but are out of Job.
 This type of unemployment is due to deficiency of aggregate demand sufficient to
ensure full employment.
 It indicates excess supply of labour which the rigid wage-rate has failed to eliminate.
 In short, if involuntary unemployment exists, the economy cannot be said to be at
the level of full employment equilibrium.

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 It will indicate under-employment equilibrium in the economy.

 All calculation include involuntarily unemployed person only voluntarily
unemployed person are not considered in unemployment problem.

Dimensions of Unemployment

 Economic
 It indicates unutilized or underutilized manpower.
 We cannot get desired increases in production and national income.
 Social
 He starts support to any activity to overthrow the existing economic and social
system.
 Psychological
 Cannot live life with self-respect.
 Become mentally frustrated.

4.2.1 Types of Unemployment

1. Cyclical Unemployment:
 Cyclical unemployment is the fluctuating rate of unemployment resulting from
swings in the business cycle. Arises due to ups & downs in economic activity.
 This type of unemployment increases during a recession and decreases during an
expansion.
 Businesses are unwilling to spend money on wages when they believe consumers
are not buying their products.
 It is short-term or long-term phenomenon.
 For example, an auto worker may be laid off during a recession, when people are
buying fewer cars. When people buy fewer cars, the auto makers don't need as many
employees to meet the consumer demand. So as the demand for cars decreases, so
does the demand for auto workers.
 As the economy strengthens, and consumers start to spend more money on goods
(like cars), the unemployed auto worker will probably be rehired.

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2. Frictional Unemployment:
 It is always presence in the economy, resulting from temporary transitions made by
workers and employers.
 It is caused because; unemployed workers may not always take the first job offer
they receive because of the wages and necessary skills.
 This type of unemployment is also caused by failing firms, poor job performance, or
outdated skills.
 This may also be caused by workers who will quit their jobs in order to move to
different parts of the country.
 Frictional unemployment can be seen as a transaction cost of trying to find a new
job.
 It is the result of not having perfect information of available jobs.
3. Structural unemployment:
 The Structural Unemployment is the situation when the jobs are available, and also
the workers are willing to work, but they don’t have the required job skills suitable
for the vacant positions.
 It occurs due to the change in the demand for specific types of worker because of the
fundamental shifts in the economy.
 Advances in technology and changes in market conditions often turn many skills
outdated.
 For e.g. with the rise of computers, many jobs in manual book keeping have been
replaced by highly efficient software users.
 Workers need to acquire new skills in order to obtain such jobs.

4. Seasonal unemployment:
 Worker of seasonal business will get employment in season only and in off season
they are unemployed.
 Example – workers of mango farm.

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4.2.2 Causes of Unemployment

1. Slow rate of economic growth:

 The overall economic growth rate during last five decades of planning has been
about 4 to 5 percent.

 This growth rate in the context of rising population has been found to be too slow.
 Due to slow economic growth rate expansion of employment opportunity is very
low.
2. Preference to capital centric techniques of production:
 The growth of employment depends on the volume and pattern of investment in the
economy.

 Most of the investment has gone into capital intensive techniques and areas of
production.
 It is easy to work with capital centric technique than human being so most of the
business follows that only.
 Example-Buying new technique machine instead of increasing labour.
3. Defective system of education:

 System of education is going to affect unemployment a lot.

 As we know that today person having education but still unemployed because skill
require working in industry is lacking.
 It is needed to reform the education system and make it such a that it can give
output as student who can directly work in industry.
 Example- Not giving industry ready students.
4. Absence of skill development opportunities:
 There is very less opportunity available in India for skill development.
 Due to this person cannot able to work in many places where skill is needed.
 Example- Training program is very less.

5. Lack of man-power planning:

 Proper man-power planning is highly needed.

 Lack of man power planning will leads to more employee available in one sector and
less in other sector.

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 Due to this some jobs are available but unemployment person cannot do that job
and owner cannot get right person for work.
 Example- Imbalance in skill and requirement.
6. Immobility of labour:

 One of the reason of unemployment is limited mobility of labour, both geographical

and occupational.
 Many a times, people are not willing go too far off places in the country even if work
is available there.

 They prefer jobs only at their residential places or nearby areas.

 Example- Home-sickness.
7. Rapid growth of population:
 Fast growth of population will directly affect unemployment.
 As population increases we need to increase employment but we have limited
resources so it is very difficult to generate new jobs.
 So population growth is big problem against any developing economy.

4.2.3 Remedies of Unemployment

1. Accelerating economic growth rate:

 Economic growth rate affect unemployment directly.

 Various steps taken for economic growth will expand overall output of economy
which result into increase in employment.
 Planned development by accelerating industrialization, removing the deficiency of
demand, stabilizing the rate of domestic investment and consumer demand can
fight the problem of unemployment.
2. Change in pattern of investment:
 Both the organized and un-organized sectors must adopt labor-intensive
technology if sufficient employment opportunities are to be generated in both the
rural and urban sectors of the economy.
 The decline in employment elasticity of output growth is primarily due to the
increasing trend in capital intensity in the organized industrial sector as well as in
agriculture.

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 Increasing mechanization of agriculture in various states has lowered the

employment elasticity of growth of agricultural output.
 Of course, the use of labor-intensive techniques with lower productivity of
workers in the industry and agriculture may lower the growth of output.
3. Employment oriented planning:
 For solving unemployment problem in the urban areas, the organized industrial
sector must also absorb a sufficient number of workers.
 The failure of the organized industrial sector to generate enough employment
opportunities is due to the use of capital-intensive technologies imported from
abroad.
 The tendency to use the higher capital-intensive technology by the Indian
industries in the post reform period has been intensified because they are trying
to improve competitiveness to face competition from imported commodities.
 Capital has become relatively cheap due to various fiscal concessions such as
liberal depreciation and investment allowance and low interest rates on borrowed
funds for investment.
 Consequent to the use of high capital-intensive technologies in our industries the
labour productivity has been increasing while employment has been growing at a
snail pace.
 Therefore, to encourage the use of relatively more labor-intensive technologies
and thereby to generate more employment opportunities, fiscal and monetary
concessions mentioned above on use of capital must be withdrawn.
4. Role of employment exchange:

 More employment exchanges should be opened.

 Information regarding employment opportunities should be given to people. So
that people can take advantage of that information and develop them self for that
area.
5. Appropriate labour policy:
 We need flexible labour law access of finance to small enterprise and removal of
inspector raj.
 The Employment Assurance Scheme (EAS) was designed to provide employment
in the form of manual work in the lean agricultural season.

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6. Encouragement to self-employment:

 Most people in India are self-employed.

 They are engaged in agriculture, trade, cottage and small scale industries etc.
 These persons should be helped financially, providing raw materials and technical
training.
 Also motivate people to do small scale and household business so that they can
earn and for that various help should be provided from government.
 Arranging various financial help, credit granting, and markets for selling their
products.
 The government has also launched some programs namely Training for Rural
Youth for Self-Employment (TRYSEM) and Jawahar Rozgar Yojana.
 Prime Minister’s Rozgar Yojana was introduced in August 1993 to provide self-
employment opportunities to the educated urban youths.
7. Reform of education system:
 Educational pattern should be completely changed.
 Students who have liking for higher studies should be admitted in colleges and
universities.
 Emphasis should be given on vocational education.
 Qualified engineers should start their own small units.
 Other people should be provided with industrial education so that they can work in
that industry.
 Different industrial training centers must be open based on area and business type
in that area so that people of that area will be capable to work in that industries.
8. Control of population growth:
 The growth of population should be checked in order to solve unemployment,
problem.
 Family planning program should be implemented widely and effectively.

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4.3 Inflation

Definition: Inflation is defined as a sustained increase in the general level of prices for
goods and services.

 It is measured as an annual percentage increase.

 As inflation rises, every rupee you own buys a smaller percentage of a good or
service.
 The value of a rupee does not stay constant when there is inflation.
 The value of a rupee is observed in terms of purchasing power.
 Real, tangible goods that money can buy.
 When inflation goes up, there is a decline in the purchasing power of money.
 For example, if the inflation rate is 10% annually, then theoretically a RS 100
pack of gum will cost RS 110 in a year.

4.3.1 Types of Inflation - On the Basis of Causes

1. Demand-pull inflation:

 Demand-pull inflation results from strong consumer demand. Many individuals

purchasing the same good will cause the price to increase. And when such an
event happens to a whole economy for all types of goods, it is called demand-pull
inflation.

 Demand-pull inflation is used by Keynesian economics to describe what happens

when price levels rise because of an imbalance in the aggregate supply and
demand.
 When the aggregate demand in an economy strongly outweighs the aggregate
supply, prices go up.
 Economists describe demand-pull inflation as a result of too many dollars chasing
too few goods.

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Causes of demand-pull inflation

 Growing economy.
 Expectation of inflation.
 Overexpansion of the money supply.
 Strong brand.
 Technological innovation.

2. Cost-push inflation:
 Cost push inflation is inflation caused by an increase in prices of inputs like labour,
raw material, etc.
 The increased price of the factors of production leads to a decreased supply of
these goods.
 While the demand remains constant, the prices of commodities increase causing a
rise in the overall price level. This is known as cost push inflation.

Causes of cost-push inflation

 Companies that achieve a monopoly over an industry.
 Salary increases.
 Natural disasters.
 Government regulation and taxation.
 Shift in exchange rates.

3. Currency inflation:
 This type of inflation is caused by the printing of currency notes.
 A situation in which more money becomes available without an increase in
production and services, causing prices to rise.

4. Credit inflation:
 Being profit-making institutions, commercial banks sanction more loans and
advances to the public than what the economy needs.

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 There are many cases in which an increase in the supply of credit will lead to an
increase in the supply of money.
 For example, most bank loans result in the creation of new deposit currency.
 To be more specific, when a bank makes a loan it doesn't transfer part of its existing
deposit base to the borrower rather, it creates new money "out of thin air" and thus
alters the value of all existing currency units.
 Such credit expansion leads to a rise in price level.

5. Deficit-induced inflation:

 The budget of the government reflects a deficit when expenditure exceeds revenue.
 To meet this gap, the government may ask the central bank to print additional
money.
 Due to pumping of additional money price rise this is called the deficit-induced
inflation.

4.3.2 Types of Inflation Based - on Degree of Rise in Price

1. Creeping inflation:

 Circumstance where the inflation of a nation increases gradually, but continually,

over time.
 This tends to be a typically pattern for many nations.
 Although the increase is relatively small (less than 3%) in the short-term, as it
continues over time the effect will become greater and greater.

2. Walking/Moderate inflation:

 When prices rise moderately and the annual inflation rate is a single digit (3% -
10%), it is called walking or trotting inflation.
 Inflation at this rate is a warning signal for the government to control it before it
turns into running inflation.

3. Running inflation:

 When prices rise rapidly like the running horse at a rate of 10% - 20% per annum, it
is called running inflation.

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 Its control requires strong monetary and fiscal measures, otherwise it leads to
hyperinflation.

4. Hyper/ Galloping inflation:

 When prices rises 20% to 100% per annum or even more, it is called galloping or
hyperinflation.
 Such a situation brings a total collapse of the monetary system because of the
continuous fall in the purchasing power of money.

4.3.3 Causes of Inflation

1. Demand Side Factors:
 Increase in money supply will leads to increase in demand and hence inflation.
 Increase in government spending through deficit financing money supply in
economy will increase which leads to inflation.
 Expansionary monetary policy will increase money supply.
 Buoyant economy and expansion of private sector capital projects.
 Existence of parallel black money economy.
 Repayment of public debt.
 Income from exports.
2. Supply Side Factors:
 Shortage of factor of production (inputs).
 Labour instability.
 Priorities set by producers in such a way that they can earn more profit and
hence basic product may not produce in sufficient amount.
 Price rise in the international inputs.
 Natural calamities.
 Artificial scarcity will leads to storage of necessary and selling slowly at higher price.
3. Perceptual Factors:
 Expected salary rise will increases current consumption and price rise.
 Due to expectation of getting higher price in future supplier will restrict the
supply.
 Due to expectation of rise in price in future producer will buy more row material.

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4.3.4 Measures to Control Inflation

1. Monetary measures:
 Credit Control will limit money supply in the market and hence inflation will
reduce.
 Issue of New Currency must be stopped or limited so that further inflation will
not rise.
 Increase in Bank Rate will restrict other banks to take money from RBI and
hence money supply in market will reduce.
 Increase in Cash Reserve Ratio (CRR) will restrict bank to supply money in the
market as they need to keep more money with RBI.
 Increase in Statutory Liquidity Ratio (SLR) will restrict money flow in market as
bank have to maintain more money with them.
 Withdraw liquid funds from economy through Open Market Operations (OMO).
By selling government property money can be reduce from economy.

2. Fiscal Measures:
 Reduction in public Expenditure will reduce deficit-financing and less money will
supply in economy.
 Increased taxation will collect more money from economy and hence reduce
demand.
 Tex incentives on savings and investments. Various schemes of investment and
saving must be introduce which provide relaxation in tax so that people are more
attracted towards that.
 Extension of repayment of public debt.

3. Other Measures:
 Price control strategy must be introduced so that common man can fulfil their
need.
 Rationing is the way by which government provide basic product at low price so
that everyone can survive.
 Increase Production will meet demand of economy and leads to price fall so it
will stabilize price and reduce inflation.

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