Principles of Macroeconomics

Course Code:
BAEC2204

Specialization:
Common Course

Department:
Business Studies

https://www.pngfuel.com/free-png/rruuo
 CHAPTER - 1

INTRODUCTION TO MACROECONOMICS

Image (Source): https://jooinn.com/economy-graph-indicates-micro-economics-and-charts.html

Economics and Macroeconomics:
• Economics is the study of how humans make Problem of choice in
decisions in the face of scarcity. These can be economics is related with:
individual decisions, family decisions, business
decisions or societal decisions. If you look
around carefully, you will see that scarcity is a
fact of life. Scarcity means that human wants
for goods, services and resources exceed what
is available.
• Macroeconomics is the study of the entire
economy in terms of the total amount of
goods and services produced, total income
earned, the level of employment of productive
resources, and the general behavior of prices.
 Image (Source): https://fotomelia.com/?download=bonhomme-
blanc-3d-choix-direction

The THREE central economic

problems are regarding the
allocation of the resources.
Image (Source): http://economicsunit34.weebly.com/the-economic-problem.html
Macroeconomics definition: (Refer page number 91-93, topic no. 13)

Macroeconomics is the study

of the entire economy in
terms of:
1.the total amount of goods
and services produced,
2.total income earned,
3.the level of employment of
productive resources, and
4.the general behavior of
prices.

https://www.dreamstime.com/illustration/inflation-money.html
Difference between Microeconomics and
Macroeconomics

Image (Source): https://www.linkedin.com/pulse/understanding-micro-macro-economics-juhi-khan

Micro and Macroeconomics are the two broad branches of economic theory.
•Microeconomics deals with a small part of the economy. It studies the economic
behavior of individual unit, an individual, or a firm. Microeconomics studies
product and factor pricing and also theory of economic welfare. It is sometimes
referred to as price theory, because it mainly spins around the prices of different
variable.
• Macroeconomics, on the other
hand, deals with the aggregates
of the whole economy.
• It is a study of economic system
as a whole.
• It deals with aggregates such as
total income and employment,
general price level, total
production, consumption and
investment etc.
• Macroeconomics, therefore,
studies theories related to
income, output, employment,
and growth.
Source: http://susanecon.weebly.com/circular-flow.html
Source: https://marketbusinessnews.com/financial-glossary/macroeconomics-definition-meaning/
Nature and scope of Macroeconomics:
Nature of macroeconomics:- Macroeconomics is basically known as theory of income. It
is concerned with the problems of economic fluctuations, unemployment, inflation or
deflation and economic growth. It deals with the aggregates of all quantities not with
individual price levels or outputs but with national output.
According to G. Ackley, Macroeconomics concerns with below mentioned variables −
1. Aggregate volume of the output of an economy
2. Extent to which resources are employed
3. Size of the national income
4. General price level and control over inflation
5. Economic policies and economic governance

Source: http://clipart-library.com-cliparts.html
Scope of Macro-Economics:
Macroeconomics is adheres its application in economy with theoretical and practical
importance. The boundaries of study of macroeconomics is limitless as global economic changes
has created many development in the file of study. Technological changes, demographic, social,
lifestyle, consumer purchase behavior and many more have created big impact on the area of
macroeconomic study. Following are the points covered under the scope of macroeconomics.
(a) Working of the Economy:- The study of macroeconomics is crucial to understand the working
of an economy. Economic problems are mainly related to the employment, behavior of total
income and general price in the economy. Macroeconomics help in making the elimination
process more understandable.
(b) Economy Policies:- Macroeconomics is
very useful in an economic policy.
Underdeveloped economies face
innumerable problems related to
inflation, demographic changes, balance Source:
https://www.goodreads.com/book/show/435274
of payments and balance of trade etc. The 73-the-ideal-economic-policy
main responsibilities of government are to
make the fiscal policies, monetary
policies, and foreign trade policies
(c) Understanding the behavior of economy:-
Each economy is different from the others
and the economic behavior may tends
differently according to the various
macroeconomic factor like, population,
natural resources, labor market,
productivity and other demographic
factors. Economic policies have to made in
such a way which is most suitable to the
economic growth and development.
https://www.wikirating.org/wiki/List_of_countries_by_credit_rating
Importance of study of Macroeconomics
1.It helps us understand the functioning of a complicated modern economic
system. It describes how the economy as a whole functions and how the level
of national income and employment is determined on the basis of aggregate
demand and aggregate supply.
2.It helps to achieve the goal of economic growth, a higher GDP level, and higher
level of employment.
3.It helps to bring stability in price level and analyses fluctuations in business
activities.
4.It explains factors which determine balance of payments. At the same time, it
identifies causes of deficit in balance of payments and suggests remedial
measures.
5.It helps to solve economic problems like poverty, unemployment, inflation,
deflation etc.
 CHAPTER -2
NATIONAL INCOME & RELATED
AGGREGATES
National Income concept: (Refer page number 94-114, Topic no 14)

National income means the value of goods and services produced by a

country during a financial year.
Thus, it is the net result of all economic activities of any country during a
period of one year and is valued in terms of money.
National income is an uncertain term and is often used interchangeably
with the national dividend, national output, and national expenditure.
We can understand this concept by understanding the national income
definition.
NATIONAL INCOME AT CURRENT AND CONSTANT PRICES

• National income at current

prices is the money value of
all goods and services
produced in a country
estimated at the prevailing
prices.

• National income at
constant prices is the
national income estimated
at a base year, which is an
earlier year to the current
year.
National income at current prices can be converted into
national income at constant prices when comparison is
required, by using the following formula:
As per the previous table National income at current
price is740 and at constant price is 600, using the above
formula:-

600=740/Price index*100
Price index= 740/600*100, =123.24
So inflation rate=123.24-100=23.24%
Circular flow of income:
• Circular flow of income is defined as the flow of payments and
receipts for goods and services and factor services between
different sectors of the economy.
• There are two types of flows money flows and real flows. Money
flow is the flow of income/payments in terms of money. Real flow
refers to the flow of goods and services.
• National income is both a flow of goods and services and flow of
money income
• National income is the aggregate factor income (earnings of labor
and property) which arises from the current production of goods
and services by the factors of production.
Circular flow of income in Open Economy:
• Open economic model of circular flow of income is more realistic as
comparison to the simple economic model
• In open economic model three new sectors are added as Financial institutions,
foreign market, and government intervention.

Source: https://saylordotorg.github.io/text_macroeconomics-theory-through-applications/s20-16-the-circular-flow-of-income.html
Circular flow of income in simple economy
(Closed economy)
Economy with two sectors only,
households and firms. Households
are basically consumer units and
they own factors of production.
Firms produce goods while
households provide services of the
factors of production to these firms.
Factors of production receive
incomes for rendering their services.
The sales value of net production
must equal the sum total of
payments made by the firms to the
factors of production in the form of
wages, rents, interest and profits.
Source: https://en.wikipedia.org/wiki/Circular_flow_of_income
Leakages (withdrawal) and Injections into
the circular flow of income
Leakages:-
•Saving of income in non productive
manner
•Paid taxes to the government
•Spent on foreign-made goods and I+T+S E+G+I
services, i.e. imports (M)
Injections:-
•Investment expenditure or private
investment
I+T+S E+G+I
•Government expenditure
•Exports
Assumptions for circular flow of income in
simple economy:
• The economy is closed economy. That is, there is no foreign
sector;
• Households do not produce but provide factors of production;
• Firms or business sector is the only producing sector;
• Whatever is produced by firms is sold and there is no
accumulation of inventories;
• Consumers or household sector do not save their income but
spend all their income;
• There is absence of taxes, government expenditure on goods and
services etc.
Factors of circular flow of income:
• Household
• Firms/market/industry
• Financial institution
• Foreign trade policy
• Government
Factor of production and factor income
in circular flow of income

Factor of
production
•Land
•Labor
•Capital

Source: http://clipart-library.com-cliparts.html
Leakages (Withdrawal) and injection in
circular flow of income
• Leakages (Withdrawal):- Any income generated in the national output
which is not passed on within the economic circulation and system at
the same time like taxes paid to the government, saving in non
productive form money paid for import of goods and services.
Total leakages or withdrawal= Saving(S)+ Taxes(T) + Import(M)
• Injection:-Any addition to circular flow which does not arises from
consumer current income like encouragement in private investment,
government expenditure in economy and export of goods.
Total injection=Investment(I) + Government expenditure(G)+
Export(X)
Concept of National Income:

https://www.dreamstime.com/
national-income-word-cloud-hand-
sphere-concept-white-background-
image130436821

• National income is a macroeconomic concept which deals with the

aggregate income or economy as whole and it presents the data of over
all income generated in an economy a financial year. National income is
monetary evaluation of all goods and services produced in an economy.
• National income presents various information related to economy like
performance of the economic functions, importance and implications of
the economic policies made and implemented, outcomes of the
economic polices exercise etc.
Source: https://www.coastalwealthmanagement24.com/what-is-gross-domestic-product-and-why-is-it-important-to-investors/
Source: https://www.thebalance.com/u-s-gdp-5-latest-statistics-and-how-to-use-them-3306041
• Gross Domestic product (GDP):- Gross national product is the
total market value of all final goods and services produced within
the geographic boundaries of a country during an accounting
year. The value of factor income from abroad which is earned by
the residents of a country is not included in the calculation of
GDP.

GDP= C+ I+ G + (X-M)
• C= Expenditure of consumption goods, I= Expenditure on private
investment, G= government expenditure, X= export of goods and
M= import of goods
• GDP = Gross National Income - Net factor income from abroad
• Net Domestic Product at Market Prices:- Net domestic
product is defined as the money value of final goods and
services produced by the residents within the domestic
territory of a country in an accounting year deducted with
its depreciation.

NDP=C+I+G+(X-M)-D
NDP = Gross National Income
- Net factor income from abroad
- Depreciation
• Gross National Income/Product:- Gross national product
is the total market value of all final goods and services produced
by nationals of a country during a year. It is a monetary measure
of the current output of economic activity in an economy. While
calculating GNP, we should only include the value of final goods
and services and not of intermediate goods.
GNP = GDP + Net factor income from abroad
• Net National Product (NNP):- NNP is the market value of
all goods and services produced by residents of a country after
allowing for depreciation.
• NNP = GNP – Depreciation
• NNP = NDP + net income from abroad
• Personal Income:-The personal income refers to the sum
total of all current incomes received by the individuals or
households from all sources within the domestic territory of a
country during an accounting year. It is to be noted that a
certain part of the income earned by an individual in a year
may not be actually received.
Personal income =
National income
– Undistributed profit
+ Transfer payments

Source (Image): http://www.clker.com/clipart-puzzle-complete-big-income.html

• Disposable or personal disposable income:- Personal
disposable income refers to that part of personal income which is
actually available to households for consumption and saving. In
other words, it is the income of a person which he can spend as he
desires.
Disposable income = Personal income - Direct
Taxes paid by individuals
• Transfer Payments:- These are the payments made by the
government to households, enterprises and non-profit institutions
and vice-versa without any promise to supply goods and services.
E.g., payments made to households by the government in the form
of unemployment allowance, old-age pension, scholarships, etc.
• Per-capita Income:- Average income earned by an
individual in an economy in an accounting year
Per-capita income = National income /
Total population of the country

Source: 
"World Economic Outlook Database, October 2019". World Economic
Outlook. International Monetary Fund. October 2019. Retrieved 1
January 2020.
There are 3 Methods for measuring National Income:

1 2 3
EXPENDITURE INCOME VALUE ADDED
METHOD METHOD METHOD

• Consumption • Income of Labours Value added from

Expenditure (Wages & Salaries) each of the following
• Investment • Profits of Private economic sectors:
Expenditure Sector Businesses (I)Primary Sector
• Government • Rent Income from (II)Secondary Sector
Expenditure ownership of Land (III)Service / Tertiary
• Net Exports Sector
Measurement of National Income (Refer page no 113 topic no 17)

(1) Expenditure method:-

Measurement of national income by computing
final expenditure on gross domestic product by
households, government and private sector.
National Income by expenditure method =
C+I+G+(X-M)+(R-P)
Precautions in the Estimation of Expenditure
• Expenditure on secondhand goods should not be included
because they are the part of the stock of goods produced in the
past.
• Expenditure on the purchases of shares, bonds, etc., should not
be included because these are paper titles, which only
represent the ownership of property. No material things are
produced through the purchase/sale of shares, bonds, etc.,
• Expenditure on pensions, scholarships, unemployment
allowance, etc., should not be included because these are
transfer payments.
• Expenditure on intermediate goods or semi-finished goods
should be excluded to avoid double counting.
 (Refer page no 110 topic no 16)

(2) Income method:-

The income method measures national income at the point of factor
payments made to primary factors for the use of their services in the
production process. In other words, national income is measured by
taking sum total of all the incomes arising due to primary factors of
production. Thus, national income is the sum of rent, wages, interest
and profits.
National income by Income method
= Wages + Rent + Profit + Interest
[NOTE: Income from factors of production
Also known as Factor Income]
Precautions in the Estimation of National
Income by Income Method:
Income received from sale and purchase of second hand goods
should not be included but commission earned in such
transactions is to be included as this is new income generated in
the economy. Transfer payments which do not generate income
are to be excluded from the measurement of national income.
Difficulties of the Income Method:
• To estimate mixed income of self employed people is not an easy
task. It is difficult to get reliable information from unincorporated
sector/unorganized sector.
• Some economists opine that interest on national debt is used for
productive purposes and therefore its value should be included.
Thus, there is controversy whether to include it or not.
• Income tax returns (account of incomes of an individual) are the
basis of calculation of income received in the country. In
underdeveloped countries a very small proportion of income
earners actually pay taxes. Therefore, income method may be of
limited use in such countries.
 (Refer page no 107 topic no 15)

(3) Value added method:- This method measures national income as

the sum of net final output produced or net value added by all the
firms in a year. Net value added is estimated by estimating gross
output produced by each enterprise, intermediate consumption,
depreciation and net indirect taxes. The value added method is
measuring the changes in value of the product at each level and
consolidating all the values at the end to know the national income.
Stages of production Market Value of goods Value Added in the production

Cotton 20 20
Yarn 30 10
Cloth 40 10
Shirt 60 20
Aggregate Value Added 60
Difficulties of the Product Method
• Prices are not stable, in such situations, finding value of inventories becomes
quite difficult.
• It is difficult to determine the prices of goods which do not enter in to market
and are kept for self-consumption. For instance, the value of owner-occupied
buildings or imputed rent cannot be easily determined.
• A clear cut distinction between the intermediate goods and the final goods is
always not possible. Final goods for some may be intermediate goods for
others.
• In case the value of a capital good rises or falls due to changes in market
conditions, it becomes difficult to estimate the depreciation.
• It is still not clear whether services should be included in national income or
not.
• Lack of adequate and reliable data particularly in the unorganized and
unincorporated enterprises is also a major problem in measurement of national
income by value added method.
Real GDP VS Nominal GDP:
Nominal GDP:- Nominal GDP calculates the value of gross
domestic product at the current price level of goods and services
produced in an economy.

Real GDP:- Real GDP calculates the value of gross domestic

product at the base year price level of goods and services
produced in an economy.
Numerical calculation in real GDP and Nominal GDP:
Calculate the Nominal and Real GDP from following information
considering 2006 as a base year. Compare the GDP growth rate
between 2006 and 2008. Calculate the GDP deflator for 2007 and
inflation from 2006 to 2007.

260
SOLUTION
(1) Nominal GDP :

2005 = (1.4 X 555) + (15 X1220) + (185 X 200) = 56077

2006 = (1.5 X 620) + (16 X 1290) + (185 X 240) = 64770
2007 = (1.7 X 675) + (17 X 1340) + (170 X 260) = 68127.5
2008 = (1.8 X 750) + (18 X 1460) + (165 X 320) = 80430

= 80430 - 64770 X 100 = 24.17%

64770
SOLUTION

(2) Real GDP: Base Year is 2006

2005 = (1.5 X 555) + (16 X 1220) + (180 X 200) = 56352.5

2006 = (1.5 X 620) + (16 X 1290) + (180 X 240) = 64770
2007 = (1.5 X 675) + (16 X 1340) + (180 X 260) = 69252.5
2008 = (1.5 X 750) + (16 X 1460) + (180 X 320) = 82085

= 82085 – 64770 X 100 = 26.73%

64770
SOLUTION
Computation of 2007:
3. GDP Deflator for 2007 (1)Nominal GDP = 68127.5
(2)Real GDP = 69252.5

= 68127.5 X 100 = 98.37%

69252.5
4. Inflation from 2006 to 2007

= 69252.5 – 64770 x 100

Inflation 64770
= PI Current Prices – PI Constant Prices X 100
PI Constant Prices
= 6.92%
 CLASS WORK
Calculate the real and nominal GDP considering 2006 as
base year. Check the growth rate from 2005 to 2006.
1. If the real GDP is 1000 and Investment is 150, Government Spending is
250 and Net Exports equals -100, then Consumption must be?
2. Total national income in the country in the year 2015 was 315 OMR
million and total non-earning income (Transfer payment) was 0.3
million. Undistributed profit is 12% of the nation income. Calculate
Personal income. (Tax 10% )
3. Total national income in the country in the year 2015 was 840 OMR
million and total non-earning income was .9 million. Undistributed profit
is 16% of the nation income. Calculate Personal income. (Tax 12% )
4. Personal income is 620 million and the tax is 13%, calculate DI
5. Personal income is 1260 Million an tax is 16% calculate DI
6. Total national income in the country in the year 2012 was 710 OMR
million and total non factor income was .8 million. Undistributed profit
is 16% of the national income. Calculate Personal income also find the
disposable income if direct tax paid is Tax 12%.)
 CHAPTER - 3
CONCEPT OF MACROECONOMIC EQUILIBRIUM
AND AGGREGATE DEMAND & AGGREGATE
SUPPLY
Concept of macroeconomic equilibrium and
aggregate demand & aggregate supply:
(Refer page number 115-117, topic no. 18)

Aggregate Demand:- Aggregate demand refers to the total demand for all
goods and services taken together. In other words, “it is the total volume of
purchases that consumers, investors and government are willing to
undertake.” (Charles Schultze)

At Higher price levels, the total

spending / quantity demanded is
LESS
&
At lower price levels the total
spending / quantity demanded is
HIGHER
Four components of Aggregate Demand:
1. Household consumption demand: The total demand of goods and services for
consumption purposes, by all households of the country is the household
consumption demand.
2. Private investment demand: Investment is the money spent on the creation
of new capital assets. Private investment depends upon rate of interest and
marginal efficiency of capital.
3. Government demand for goods and services: Today, government has become
a prominent buyer of goods and services. Government demand these for
meeting public needs such as roads, schools, health, irrigation, power and
infrastructure, maintenance of law and order etc.
4. Net export demand: Net exports (exports minus imports) refer to foreign
demand for goods and services produced by an economy. It is affected by
many factors such as trade policy of the trading partners, relative prices of
goods, incomes of the nations, foreign exchange rates etc.
Aggregate demand is, thus, composed of consumption expenditure/demand and investment
expenditure/demand. In short,
Y = C + I, Where, Y = Income or aggregate demand; C = consumption demand and I = investment
demand.
The aggregate demand schedule which shows levels of consumption and investment is shown as under:
Real income Consumption Saving Investment Aggregate Change in  
output     Planned Expenditure Income
Y=GDP=DI C S I (C + I) Expenditure
(1) (2) (3) (4) (5) (6)
0 40 -40 20 60 Increase
50 80 -30 20 100 Increase Income
100 120 -20 20 140 Increase less
150 160 -10 20 180 Increase than
200 200 0 20 220 Increase expenditure
250 240 +10 20 260 Increase  
300 280 +20 20 300 Equilibrium Income =
expenditure
350 320 +30 20 340 Decrease Income
400 360 +40 20 380 Decrease greater than
450 400 +50 20 420 Decrease expenditure
500 440 +60 20 460 Decrease  
Feed the table given below for macroeconomic equilibrium
Real income Consumption Saving Investment Aggregate Change in Remarks
output     Planned Expenditure Income
Y=GDP=DI C S I (C + I)  
(1) (2) (3) (4) (5) (6)

0 50 -50 30 80
60 -40 30
150 -30 30 180
180 200 -20 30
240 250 -10 280
300 0 330
360 350 380
420 +20
480 450
500 +40 530
600 550  
Graphical
presentation
Meaning of Aggregate Supply:
• It refers to the sum-total of goods and services produced in
an economy during a certain period of time. It is nothing but
net national product. Thus, aggregate supply is the
aggregate cost of producing the output, which goes to
factors as income in the form of wages, rent, interest and
profits. The producers must receive the cost of producing
the output in the economy. Thus,
Aggregate Supply = Consumption + Saving
• i.e. Y = C + S, Where, Y is total factor income, or domestic
product, C is consumption, and S is saving
The aggregate supply schedule shows levels of
consumption and investment, which is shown as under:
Draw the graph using data given below and show the level of
equilibrium in respect to aggregate demand and aggregate supply:
Y C S Planned Aggregate Change in  
investment Expenditure income

0 35 -35 10 45 increasing  
35 50 -15 10 60 Increasing  
55 65 -10 10 75 Increasing  
75 80 -5 10 90 Increasing  
95 95 0 10 105 Increasing  
115 110 5 10 120 Increasing  
135 125 10 10 135 Equilibrium  
155 140 15 10 150 Decreasing  
175 155 20 10 165 Increasing  
195 170 25 10 180 Increasing  
 MID-TERM
EXAMINATION
 CHAPTER - 4

CONSUMPTION FUNCTION

Source (Image): https://www.investopedia.com/terms/c/consumptionfunction.asp

Consumption Function (Refer page number 129-134, topic no 20)

• The relationship between consumption and income is termed the

consumption function. There is a functional relationship between the
two aggregates i.e., total consumption and gross national income.
The Consumption Function or the propensity to consume indicates
the relationship between consumption and income.
• Consumption function can be expresses as , may be expressed as:

C = ƒ (Y)
Where, C = aggregate consumption expenditure, Y = gross national
income, ƒ = “a function of” or “depends upon”
Video Link: https://www.investopedia.com/terms/c/consumptionfunction.asp
Propensity to Consume:- We can tabulate the various amounts of consumption
expenditure which people are prepared to make, out of various corresponding
levels of income. Such a list is called a Schedule of the Propensity to Consume. A
Schedule of the propensity to consume is thus a statement showing the
functional relationship between the level of consumption at each level of
income.
  Income (Y) Consumption ( in Rial) Savings / Dis-savings
A 0 30 - 30
B 30 50 - 20
C 60 70 - 10
D 90 90 0
E 120 110 +10
F 150 130 +20
G 180 150 +30
H 210 170 +40
I 240 190 +50
J 270 210 +60
K 300 230 +70
Consumption function exhibits the following
terms: (Refer the table on previous slide)
• Consumption is an increasing function of income as the variables,
Y and C move in the same direction.
• At very low levels of income, consumption is actually greater than
income so that savings are a negative figure.
• Since consumption increases less than income, there is always a
widening gap between income & consumption, as income expands.
• Consumption function can be denoted as C=a+bY, where a is
constant consumption which does not depend upon income, b is
propensity to consume which depends upon increase or
decrease in income
Saving function:
• Saving is an economic surplus. Keynes defined saving as the excess of income over
expenditure on consumption. To derive saving function we simply deduct consumption from
income. Symbolically,
• S = Y – C, Where, S denotes saving, Y stands for income & C stands for consumption
• According to Keynes, saving is the function of income. Saving function expresses a functional
relationship between saving and income. As income increases, saving also increases & vice
versa. Symbolically,
S = f (Y), S = Y – C
S = Y – (a + bY)
S = Y – a – bY, S = - a + Y – bY thus, the saving function is found as:
S= - a + (1 – b) Y
(1 – b) is called the marginal propensity to save, abbreviated as MPS, and can also be calculated as:
MPS = (∆S / ∆Y) x 100
MPS is defined as: the change that happens to saving in response to a specific change in income.
 Average propensity to consume and average
propensity to save
(APC and APS)
• The average propensity to consume (APC) is the proportion of income
devoted to consumption. Total consumption in a given period divided by
total disposable income. The APC is calculated as:
APC = C / Y
• The average propensity to save (APS) is proportion of income devoted to
savings. Total savings in a given period divided by total disposable income.
The APS is calculated as:
APS = S / Y
At the same level of income , consumption and save, APC + APS = 1
 Marginal Propensity to Consume and
Marginal Propensity to Save
(MPC and MPS)
Marginal propensity to consume is a relationship between
increased income and increased in consumption.
MPC=∆C/∆Y, where ∆C is change in consumption and ∆Y is
change in income
Marginal propensity to save is a relationship between increased
income and increased in saving.
MPS=∆S/∆Y, where ∆S is change in Saving and ∆Y is change in
income
Exhibiting table shows APC, APS MPC and MPS:
(1) (2) (3) (4) (5) (6) (7)
Income Consumption Saving Average Average Marginal Marginal
Y C S Propensity to Propensity to Propensity to Propensity to
Consume Save Consume Save
APC=C/Y APS=S/Y MPC=∆C/∆Y MPS=∆S/∆Y

0 40 - 40 - -    
50 80 - 30 1.6 -0.6 0.8 0.2
100 120 - 20 1.2 -0.8 0.8 0.2
150 160 -10 1.1 -0.9 0.8 0.2
200 200 0 1.0 0 0.8 0.2
250 240 +10 0.96 0.04 0.8 0.2
300 280 +20 0.93 0.07 0.8 0.2
350 320 +30 0.91 0.09 0.8 0.2
400 360 +40 0.90 0.10 0.8 0.2
450 400 +50 0.89 0.11 0.8 0.2
500 440 +60 0.88 0.12 0.8 0.2
Graphical representation in slope of
consumption function
Numerical exercise:
1. Y= 2570, APC= 0.75, Calculate Total consumption and total saving
2. Y1=2270, Y2=3350, APC at first income is 0.6. Consumption on second is
1520. Calculate MPC and MPS
3. If a person income was 1560 Rial and his new income is 2250 Rial. His
old consumption was 840 and new consumption is 1350. Please
calculate the MPC and MPS.
4. A person saving is 840 Rial and his APS is 0.42, his new income is 3500
and consumption is 1750, calculate MPC and MPS.
5. Mr. Ahmed APC is 0.72 and consumption is 900, his new income is 2570
and new consumption is 1460, find the value of MPC and MPS.
6. An increase is income is by 750 and hence new income is 3500, if
consumption on the first income is 700 and on new income is 1100, then
find the value of MPC and MPS.
Numerical Exercise:
Mr. Ahmed’s
APC is 0.72 and
consumption is 900,
his new income is
2570 and new
consumption is
1460, find the value
of MPC and MPS.
 CHAPTER - 5

CONCEPT OF MULTIPLIER
The MULTIPLIER

Click Video Link: https://www.investopedia.com/terms/m/multiplier.asp

Click Video Link: https://www.investopedia.com/terms/m/multipliereffect.asp
Concept of Multiplier
Concept of Multiplier: (Refer page number 135-138, topic no. 21)

• Multiplier is a relationship of a small increase in investment to final

increase in income.
• It is the ratio expressing quantitative relationship between the final
increase in national income and the increase in investment which induces
the rise in income. Arithmetically,
ΔY = K.ΔI, Where, ΔY is the change in income; K
stands for multiplier and I for investment. Therefore,
multiplier coefficient can be expressed as,
K =ΔY/ΔI
The value of multiplier ranges between one to infinity. However, it can
never be one because whole of the increase in income is not consumed and
it can never be zero, which means the economy saves whole of its
additional income. As Keynes assumed that MPC is less than unity, its value
can never be equal to infinity. It has been observed in real life that actual
value generally varies from 2 to 4. The general formula for the multiplier is:

where K stands for multiplier and for is the marginal propensity to save
•Or , where is = MPS
Multiplier is also measure with the change
in income and change investment concept as:

Where ΔY is noted change in income and ΔI is noted as

change investment
Numerical exercise on Multiplier:
1.In an economy actual level of income is RO 500, Income level in full
employment is 800 RO.MPC is 0.75. How much investment is
required to activate Full employment?
2. In an economy MPC is 0.75, if the investment expenditure is
increased by RO 500 calculate total Increase in Income.
3. In an economy every time income rises 75% of the increase in
income is spent on consumption. If Income rises by RO 750 calculate
the following -
a. Change in Income
b. Change in Saving
 CHAPTER - 6

DETERMINATION OF INCOME
AND EMPLOYMENT

Image (Source):
https://www.employment.gov.au/newsroom/
supporting-workers-facing-retrenchment
 Determination of Income and Employment (Refer page number 118-128 topic no 19)

Unemployment:- Unemployment
is defined by the bureau of labor
statistics as people who do not have
a job, have actively looked for work
in the past four weeks, and are
currently available for work. An
individual is searching a suitable job
actively according to his/her skill,
qualification and specialized expertise
and is unable to find is to be consider
unemployed.
Image (Source): https://www.dreamstime.com/illustration/looking-job.html
Relationship between Income and
Unemployment
(Graphical presentation)
Natural rate of unemployment:
The equilibrium level of income and
employment is illustrated as AS and
AD are the aggregate supply and
aggregate demand curve respectively.
Because the sum of all income
received corresponds to the sum of
all production, AS is drawn as a 45
degree line. Both these curves
intersect each other at point E, which
is the equilibrium point. At this point
of equilibrium, income, the aggregate
demand and aggregate supply-all
amounts to OMR 40 million.
Condition for Unemployment
Full Employment is a situation when there is no
‘involuntary unemployment’, though there may be other types
of employment such as frictional, structural or voluntary
employment. Thus, full employment is a situation in which the
economy’s resources are being used fully. https://www.investopedia.com/terms/f/fullemployment.asp

https://www.clipartkey.com/view/bJhTmi_employed-people-icon-jobs-clipart/
Types of unemployment
• Cyclical unemployment exists due to inadequate effective aggregate demand.
Economy goes through the cyclical changes and during recession unemployment
increases and during growth period more employment opportunities created.
• Frictional unemployment is a situation when a worker is unemployed because he
lacks the required skills or placed in wrong jobs.
• Structural unemployment is said to exist when large number of persons are
unemployed because the co-operant factors of production which engage them fully
are not sufficiently available. It is a kind of technological changes unemployment
• Seasonal unemployment might be seen as a kind of structural unemployment, since
it is a type of unemployment that is linked to certain kinds of jobs like construction
work, migratory farm work etc.
• Involuntary unemployment is the situation in which people are willing to work at
current or slightly lower level of wages, but do not find jobs due to deficiency of
Involuntary Unemployment – Those who would
aggregate effective demand. like to work at an existing wage rate but is not able
to find one
Numerical exercise

1. Unemployment rate:-

2. Employment rate:- Employment/Labur force *100

3. Employment-to-Population ratio: = No. of people employed X 100

Working-age population
• Where:- Labor force = Unemployment + Employment
• Working age population is all population aged in working age category like
in Oman working age is all peoples aged 18 or more

Question for exercise:

In 2005, the labor force was 137.7 million and the working age population
was 205.2 million. By using the above (1) equation, we can calculate the
labor force participation rate and it was 67.1%.
137.7 / 205.2 = 67.1%
For example, in 2005, the number of people employed was 131.5 million and
the number of unemployed was 6.2 million. By using the above (2)
equation, we can verify that the labor force was 137.7 million (131.5 million
plus 6.2 million) and the unemployment rate was 4.5%.
6.2 / 131.5 + 6.2 (137.7) = 4.5%
Numerical exercise
1. Suppose a country’s total population is 70706536.
12% of total population is underage and 28% of total
population is unemployed, calculate unemployment
rate.
2. A country total population is 3658 million and 2019
million people are employed, 650 million people are
unemployed, 3250 million people are in working age
group, find labor force participation rate in the
country.
 CHAPTER - 7

EXCESS & DEFICIENT DEMAND

Source: https://keydifferences.com/difference-
between-demand-pull-and-cost-push-inflation.html
Inflation, excess and deficient demand
• Excess demand is a situation when aggregate demand
exceeds aggregate supply at the full employment level of
income.
• The difference between aggregate demand and supply at the
level of full employment is called the ‘inflationary gap’.
Inflationary gap in the economy exists when planned
expenditure is greater than the value of available output
produced by making full use of resources. It is to note that an
increase in demand beyond the equilibrium level of full
employment does not increase the output and employment
but only prices
(Refer page number 140-145, topic no 22)
• Figure illustrates excess demand in the economy. It is seen that
aggregate demand exceeds aggregate supply at full employment
level OY by AB length. This gap is called inflationary gap, where
aggregate demand is AY and aggregate supply is BY. Aggregate
demand AY > aggregate supply BY. Therefore, AY – BY = AB
(inflationary gap).
• DEFICIENT DEMAND:- Deficient demand is a situation when aggregate
demand is less than aggregate supply of goods and services at the full
employment level of income. The adjacent Fig. 22.2 explains deficient demand in
the economy. It is seen that aggregate demand falls short of aggregate supply at
full employment level OY by CD length. This gap CD is called deflationary gap,
where aggregate demand is DY and aggregate supply is CY. Aggregate demand DY
< aggregate supply CY. Therefore, CY – DY = CD (deflationary gap).
Excess demand and inflationary gap
Deflationary gap:
Image (Source): https://www.toprankers.com/exams/what-is-inflation/
What is Inflation?
• Inflation means rise in general level of prices
• Inflation reduces purchasing power of money
• When inflation occurs, each Rial of income will buy fewer goods than before
TYPES OF INFLATION
• Demand-pull Inflation: This type of inflation occurs when total
demand for goods and services in an economy exceeds the supply of
the same. When the supply is less, the prices of these goods and
services would rise, leading to a situation called demand-pull
inflation. This type of inflation affects the market economy adversely
during the wartime.
• Cost-push Inflation: As the name suggests, if there is increase in the
cost of production of goods and services, there is likely to be a
forceful increase in the prices of finished goods and services. For
instance, a rise in the wages of laborers would raise the per-unit
costs of production and this would lead to rise in prices for the
related products.
• Sectorial Inflation: The sectorial inflation takes place when there is an
increase in the price of the goods and services produced by a certain sector
of industries. For instance, an increase in the cost of crude oil would directly
affect all the other sectors, which are directly related to the oil industry
• Creeping inflation: When the price level persistently rises over a period of
time at a mild rate (up to 3%). This could be a condition for economic
growth. This may provide necessary inducement for investment.
• Galloping inflation: If mild inflation is not checked and if it is allowed to go
uncontrolled, it may assume the characteristics of the galloping inflation.
Here, the general price level increases at a faster rate, say around, 8 to 10%
a year
• Hyperinflation: It occurs when the price line goes out of control and the
monetary authorities find it beyond their resources to impose any check on
it. At this stage there is no limit to which the price level may rise.
Example of Hyper Inflation:

Source(Image) : https://lenpenzo.com/blog/id602-18-scary-things-you-didnt-know-about-inflation-and-hyperinflation.html
Causes of excess and deficient demand
• An increase in government expenditure (spending), which is not
matched by a corresponding increase in taxation. Deficient demand may be
caused if the government expenditure falls short of the revenue.
• Increase in autonomous investment (due to past savings) without any
increase in current savings. And no corresponding increase in taxation.
Reduction in autonomous investment may lead to deficient demand.
• Increasing surplus on the balance of payments. Increasing deficits on the
balance of payments may result in deficient demand.
• If available resources are used for the production of goods other than
consumer goods, it will result in the fall in the supply of consumer goods
and services. The available output will not be sufficient to match the
aggregate demand, i.e., there will be excess demand. Conversely, deficient
demand will occur due to cut in capital formation.
Measures to control inflation,
using economic policies
There are generally the following ways to come
out of excess or deficient demand
1.Fiscal Policy
2.Monetary Policy
3.Foreign Trade Policy
 Fiscal Policy:- This is referred to as government expenditure and taxation policy.
Fiscal policy influences aggregate demand significantly. In a situation of excess demand,
it may help if there is cut in the government expenditure to reduce budgetary deficit
and rise in incomes/revenues through ways that are not inflationary such as
progressive taxation and borrowing.
1. Expansionary fiscal policy: is implemented when recession occurs. An increase in
government spending or a reduction in net taxes aimed at increasing aggregate output
(income or Y)
The government has three main fiscal options:
• Increase government spending/expenditure
• Reduce taxes , or
• Some combinations of the two that is to increase government spending and reduce
taxes.
• Command:- It will increase the employment opportunities but similarly in will increase
inflation as well.
2. Contractionary fiscal policy:-  This policy is implemented when
the economy is suffering from inflation, caused by excess demand.
There is a decrease in government spending or an increase in net
taxes aimed at decreasing aggregate output (income or Y).
The government has three main fiscal options to control inflation:
•Decrease government spending/expenditure
•Raise taxes , or
•Some combinations of the two that is to decrease government
spending and reduce taxes.
•Command:- It will control inflation but will impact negatively on
employment opportunity. In brief it will increase unemployment in
economy.
• Foreign Trade Policy:-
Foreign trade generally relates to
exports and imports of a country.
Excess and deficient demand can
be influenced substantially by
adopting a favorable foreign trade
policy.
In case inflation is increasing due to
insufficient supply or excess in
demand then in such situation we
should increase the import to
maintain the required supply level
and reduce the excess demand in
economy.
Consumer price index and inflation
relationship:
• Higher consumer price
index is an indicator of
increase in inflation rate
in the economy.
• An increased CPI
indicates that consumer
pays more money for
the same level of
consumption.
Numerical exercise to calculate inflation
Calculate the consumer price index and inflation rate between 2016 -2017 and 2015 -2018.
Year 800 Kg Rice 900 Hair cut 700 Chair
  Price /Kg Total Price / per Total Price/per Total
Expenditure haircut Expenditure Chair Expenditure

2015 2.5   2.8   8.5  

2016 2.5   3.0   9  

2017 3   3.5   9.5  

2018 3.5   4   10.5  

•Formula
CPI= Total expenditure in current year/total expenditure in base year
Inflation rate= CPI-1*100
2. Assume that consumer buys 4 goods like food, shelter, healthcare,
entertainment. According to a hypothetical survey consumer spent
40% of total budget on food, 20% on shelter, 30% on healthcare and
10% on entertainment. Using 2016 as base year the price unit of food
is 80, shelter is 110, healthcare is 120 and entertainment is 60. In
Current year 2017 food price increased by 8% shelter by 6%
healthcare by 10% and entertainment by 9%. Calculate the inflation
rate using the above information.
3. Suppose consumer price index in Muscat is 125 and annual income
is 78500 OMR, where consumer price index in Sohar is 120 and
annual income in 72500, show calculation and describe which city is
better for higher consumption with given CPI and income
Numerical Exercises:
National income at current prices can be converted into national income at
constant prices when comparison is required, by using the following formula:

As per the previous table National

income at current price is 740 and
at constant price is 600, using the
above formula:-

600=740/Price index*100
Price index= 740/600*100,
=123.24
So inflation rate= 123.24 - 100
=23.24%
Chapter - 8:
Money and banking
(Refer page number 146-159 topic no 23 and 24)

• Money:- Money is any marketable good or token used by a

society as a store of value, a medium of exchange, or a unit of
account. Money is any thing which is having ability to create
exchange in economy.

• Money objects can meet some or all of these needs. Since the
needs arise naturally, societies organically create a money
object when none exists. In other cases, a central authority
creates a money object; this is more frequently the case in
modern societies with paper money.
9000 BC 3600 BC 700 BC 618 AD 1951 AD 1990 AD 2009 AD
TIMELINE
• BARTER SYSTEM:- Barter system involves the system of
trading or exchange where goods and services are exchanged
with other goods and services. This system was prevalent
before the invention of money.

Before invention of money

Difficulties of Barter:
• Lack of double coincidence of wants:- The most serious problem in barter
system is the lack of double coincidence of wants. Thus, a seller of a commodity
must not find some person who is willing to purchase and sell his goods to him.
• Absence of common unit of measure:- There was no common unit of measuring
the values of different goods and services. As such the value of each commodity
in the market does not remain as same and constant.
• Lack of store of value:- There is lack of any good method to store the generalized
purchasing power or wealth. People can store wealth in terms of specific
commodities. The stored commodities may lose its value due to damage with
passage of time. Moreover, the method of storing goods is somewhat expensive.
• Problem of future payments:- A barter system suffered from the disadvantages
of lack of any satisfactory unit in terms of which deferred payments for any
future contracts can be made.
FUNCTIONS OF MONEY
Primary Functions:- FUNCTIONS OF MONEY:

(a) Medium of exchange: Money serves

as a medium of exchange. It facilitates
the buying and selling of goods.
(b) Measure of Value: Money acts as a
common and uniform measure of value.
The values of various commodities are
measured in terms of money. Now a
days, money made transactions simple
and easy. Thus, money serves as a unit
of account. For instance, in Sultanate of
Oman’s the unit of account is Omani
Rial.
Secondary Functions of money:
(a) Store of value: Money also serves as a store of value. It means people can keep
wealth in the form of money. In other words, storing money means holding of
purchasing power. Money is a very liquid (quick conversion of assets into cash)
asset, and therefore it can purchase goods and services at any time.
(b) Standard of deferred/delayed payments: Standard of deferred payment
means that future payments of any transaction can be made in terms of money. It
means payment can be spread over a period of time. A person who borrows a
certain sum of money in the present may make payment in the future, and the
amount of money to be paid is definite.
(c) Transfer of value: Money helps to transfer value from one person to another.
For example, when we purchase a good from a seller, we actually transfer value to
the seller by making payment in terms of money equal to the price of the good.
Contingent Functions:- This refers to the use of money in assisting various
economic entities, such as consumers, producers etc. in taking important
decisions.
(a) Distribution of income: Money helps in the distribution of national income. In
other words, factors of production contribute to production process by rendering
their services and for such act they get reward in terms of money and not in terms
of goods and services.
(b) Maximization of utility: A rational consumer or a producer always tries to
maximize utility (satisfaction). For instance, a consumer equalizes his total utility by
equalizing the ratios of marginal utilities of different goods with the price ratio of
different goods in terms of money.
(c) Basis of credit system: Credit plays important role in the modern economy.
Commercial and business activities are highly dependent upon the credit system.
All credit instruments like cheques, bills of exchange etc., cannot be used in
absence of money.
Supply of Money:
• M1 is the narrowest definition of money. M1 consists
of coins and currency in circulation, checking accounts
and traveler's checks.
• M2 is a more broad definition of money than M1. M2 =
M1 + small savings accounts, money market funds and
small time deposits.
• M3 is even more broad and includes M2 + large time
deposits, large money market funds and repurchase
agreements, which are financial instruments generally
used by large businesses and institutions.
• Ordinary money: - Currency held by the public (C) +
demand deposit in short term
• High power money: - Currency held by the public (C),
(ii) Cash reserves of banks (R), and (iii) other deposits’
of the central bank (OD).
Components of money:
• Metallic Money: It is made out of different metals such as gold, silver,
copper, lead, nickel etc. Metallic money may be classified into three
categories. These are—standard money, token money and subsidiary
money. Standard money is also known as full-bodied money.
• Paper Money: Currency notes are the paper money. In Oman, paper
money consists of all paper currency of various denominations issued by
the central bank of the country.
• Near Money: On the basis of liquidity money is classified into—actual
money and near money. Actual money is perfectly liquid (quickly and
without loss of value converted into cash) but near money is not
perfectly liquid asset. Examples of near money are treasury bills, bonds,
debentures etc.
• Legal Tender Money: It is money accepted as medium of exchange. It is
legally sanctioned money. No person can refuse it to as a means of
transactions. Legal tender money can be grouped into two categories—
limited legal tender and unlimited legal tender.
• Optional Money: It is the money which has no legal
sanction behind it but generally accepted by people. No
person can be forced to accept such money. It is an option
to accept or not. For example, credit instruments like
cheques, and bills of exchange are optional money.
• Money Proper: Money proper or actual money is the
money which circulates in a country as a medium of
exchange. It is also the basis of deferred payments. Goods
and services are purchased and sold in the market with
the help of this money.
• Money of Accounts: It is that form of money in which
accounts are maintained and value is measured.
According to Keynes, money of account is “that in which
debts and prices and general purchasing power are
expressed”. For example, OMR in Oman and dollar in
America is being used as money of accounts.
Commercial banks:- A bank is a financial institution
which lend and accepts money. It is an institution which deals
mainly in money. Thus, a bank is a financial institution that
accepts deposits of money from the public, which can be
withdrawn by cheques. Banks utilize money collected for
lending to the households, the firms and the government.
Functions of commercial banks
Commercial banks, today, perform a variety of functions
and provide a number of services to their customers. The
important functions of commercial banks can be discussed
under the following heads.
•Accepting of Deposits: The most important function of
commercial banks is to accept deposits from the public.
Banks withdraw surplus funds from people or depositors.
•Advancing of Loans: Another important function of
commercial banks is to extend loans and advances to their
customers. Banks charge interest from the borrowers,
which is relatively higher than the interest they pay on
deposits to their customers.
•Transfer of Funds: Banks help in the remittance or transfer
of funds from one place to another through the use of
various credit instruments such as cheques, drafts, mail
transfers, online communications, etc.
Agency Functions: Banks provide various agency
functions to their customers. The banks charge a very
nominal fee for these services. The important agency
services are the following:
(i) Collection of cheques, drafts, bills of exchange, etc.
(ii) Payments and collection of insurance premium,
pensions, scholarships, dividends, interest etc. on
behalf of customers;
(iii) Sale and purchase of securities. They provide
investment services to the companies by acting as
underwriters and bankers for new issues of securities
to the public;
(iv) Obtaining and selling of foreign currency on behalf
of customers;
(v) Acting as trusties and executors. For example, they
keep safe the wills of their customers and execute the
same after their death.
• Miscellaneous Services: Banks provide services like
locker facilities for safe custody of jewellery and
other valuables, issue of travelers cheques, gift
cheques, credit cards, ATM (Automated Teller
Machine), internet banking services, tax assistance
and investment advice.
• Credit Creation: A very important function of
modern banks is to create credit in the economy.
Banks have the capacity of credit creation. They are
able to create credit by accepting deposits from and
providing loans and advances to their customers. In
simple words, banks are able to multiply the initial
deposits to a great extent which is called credit
creation. Credit creation is the process of
multiplying initial deposits of banks into a huge
amount. Banks create credit by advancing loans to
its customers out of what they have received in the
form of deposits from the public
Numerical exercise
1. Suppose there is an initial deposit
in a bank is RO 1000 where CRR is
20%. Calculate the credit creation in
first four banks and over
equilibrium level.

BANKS INITIAL CRR EXCESS

DEPOSIT DEPOSIT RESERVE
A 1000 200 800
B 800 160 640
C 640 128 512
D 512 102.5 409.6
5000 1000 D=4000
CENTRAL BANK
Central bank:
• A central bank is the apex institution in the banking and
financial structure of the country. It plays a leading role in
organizing, regulating, supervising and developing the
banking and financial system of a country.
• Every country has a central bank known by different
names. For instance, in Oman it is central bank of Oman, in
India known as Reserve Bank of India, while in England, it
is the Bank of England and Federal Reserve System in USA.
https://www.khaleejtimes.com/business/global/oman-
central-bank-to-offer-20b-in-extra-liquidity
Central Bank of Oman (CBO)
Functions of a Central Bank:
• Bank of Note Issue: A central bank has been empowered to issue currency notes in the
country. Currency notes issued by the central bank are the legal tender. The issue department
of a central bank issues currency and coins. The central bank is required to maintain a certain
amount of gold and foreign securities against the issue of notes.
• Banker and Adviser to the Government: A Central bank acts as banker, agent and adviser to
the government. As banker to the government, it receives the deposits of cash, cheques and
drafts, etc., from the governments. It provides short term loans to the government and sells
and buys foreign currencies on behalf of the government.
• Banker to Banks: As a bankers’ bank, the central bank performs several functions. It acts as
custodian of cash reserves of commercial and other banks. It also maintains deposits of cash
reserves as required by the commercial banks. It also discounts bills of commercial banks. It
provides guidance to all banks and regulates their activities.
• Custodian of Foreign Reserves: A central bank is the custodian of foreign exchange reserves of
a country. All the foreign exchange transactions of a country are done through the central
bank. It controls both the receipts and payments of foreign exchange. It helps in maintaining
stability of the exchange rate by buying and selling foreign currencies in the market.
Functions of a Central Bank:
• Lender of the last Resort: The central bank acts as the lender of the last resort. It provides
ultimate need of finance to all banks by discounting approved securities and collateral loans
and advances.
• Clearing House for Transfer and Settlement: A central bank acts as a clearing house for
transfer and settlement of mutual claims of the commercial banks. Since commercial banks
keep their cash reserves with the central bank, it is easier and convenient to clear and settle
claims between them by making transfer entries in their accounts maintained with the central
bank.
• Controller of Credit: The most important function of the central bank is to control credit
creation by the commercial banks. Supply of credit must be regulated so as to ensure the
smooth functioning of the economy. Central bank adopts quantitative and qualitative methods
to control credit in the economy. Quantitative methods aim at controlling the cost and
availability of credit, while qualitative methods influence the use and direction of credit.
• Promotional and Developmental Functions: Central bank develops and promotes a strong
banking system. It assists in the development of financial institutions like developmental banks
to provide investible funds for the development of agriculture, industry and other sectors of
the economy. It helps in the development of money and capital market in the country.
Credit control by Central Bank: (Refer page number 143)

Commercial banks create credit in the economy. Important monetary tools that are
available with the central bank of a country to control credit are explained as under:
•Cash reserve ratio: Every commercial bank in a country is required to maintain a
minimum percentage of its total deposits in the form of cash with the central bank. If
the central bank increases this ratio, the cash reserves with the commercial banks get
reduced.
•Bank rate: Bank rate is the rate at which central bank lends money to commercial
banks. If this rate is raised, cost of borrowing increases as interest rate rises. This
results in credit contraction.
•Open market operations: Open market operations refer to sale and purchase of
government securities in the open market by the central bank. These operations have
an effect on the volume of cash reserves and hence the overall cost and availability of
credit. At the times of excess demand, central bank sells these securities which are
generally purchased by commercial banks or by their customers
Credit control by Central Bank: (Refer page number 143)

• Changing margin requirements: Margin requirement is the

percentage down payment on borrowing to finance purchase of
stock by firms. For example, if central bank fixes a 30 percentage
margin on the value of a security worth OMR. 20000, then
commercial banks can lend OMR. 6000 only to the holder of the
security. To correct excess demand, central bank raises the margin
requirement.
• Moral suasion: Moral suasion is the method of persuasion, request,
advice and suggestion to the commercial banks by the central bank
of a country. Central bank arranges the meeting of the heads of the
commercial banks and clarify them the need for implementation of a
particular monetary policy and requests them to follow this policy
 Chapter - 9:

OMR
 Foreign exchange rate meaning and determination:
(Refer page number 167-172 topic no 26)

Foreign exchange rate or forex is the conversion of one

country's currency into another.
In a free economy, a country's currency is valued according to
the laws of demand and supply.
Foreign exchange is a term used for foreign money which is
internationally acceptable by all the countries.
Supply of Foreign Exchange:- Supply of Demand for Foreign Exchange:- We
foreign exchange consists of foreign demand foreign exchange to perform
the following balance of payments
money earned by export of various transactions:
goods and services, receiving unilateral
•To buy foreign goods and services,
payments from abroad and short term
•To make unilateral transfer
and long term capital inflows. The
payments,
supply of foreign exchange, therefore,
•To make deposits in overseas banks,
is derived from the credit transactions
in the balance of payments current •To make short and long term lending
to foreign residents, firms and
account and capital accounts of a governments
country.
Foreign exchange rate determination with the help of demand and supply forces is shown
in the figure. The demand curve for foreign exchange is D, which represents autonomous debit
transactions in the balance of payments. All autonomous credit transactions are depicted in
the figure by the supply curve of foreign exchange S. At point E, the two curves intersect each
other so that OR quantity of foreign exchange supply is equal to same quantity of demand for
foreign exchange. Foreign exchange rate at this equilibrium point is OF. At this point balance
of payments is said to be in equilibrium.
Types of Exchange Rate:
• Spot foreign exchange:- Transaction
refers to the purchase or sale of
foreign exchange for immediate
delivery. The exchange rate at which
the transaction takes place is called
the spot rate.
• Forward foreign exchange:-
Transaction refers to agreement
made today to buy or sell a specified
amount of foreign exchange at a
specified future date at the rate
which is agreed upon today.
Exchange rate systems:
A broad classification of Managed Flexibility
the system is as follows:
1.Floating Exchange
Rates

2.Pegged or rigidly fixed

exchange rates

3.Managed Flexibility
Floating Exchange Rates:- Under this system, there is no intervention by the
government or central bank of a country in foreign exchange rate market.
Thus an independent economic policy can be pursued under flexible
exchange rate. Its monetary policy is not rigid to a certain rate of exchange.
Pegged or Rigidly Fixed Exchange Rates:- Under this system, there is
complete government interference in the foreign exchange market. The
exchange rate is fixed at a given equilibrium level and if there is any upset in
the equilibrium, the government would intervene and take attempts to
establish equilibrium.
Managed Flexibility exchange rate:-
Under this system, we have the following categories:
•Adjustable peg system
•Crawling or trotting or gliding parity
•System of clean float and dirty float.
• Adjustable peg system: Under the system of
adjustable peg, a country should try to have a
system of fixed exchange rates for as long as it
can, i.e., until the country exhausts all its foreign
exchange reserves.
• Crawling or trotting or gliding parity: We have
seen that there is sudden devaluation of
currency in the above system, which in fact is
harmful for an economy and therefore it is need
to avoid. Crawling peg systems advocates
adjusting of exchange rate to a new demand and
supply conditions continuously and regulate the
exchange rate at frequent intervals
• System of clean float and dirty float: In case of
clean float, the exchange rate is allowed to be
determined by free market forces of demand
and supply of foreign exchange. There is no
government intervention in the foreign exchange
market. Thus it is identical to freely fluctuating
exchange rate policy.
BAND SYSTEM: System of fixed exchange rates has some
degree of flexibility within a limited band or range of
exchange rates fluctuations
Numerical Exercise:
• If 1 OMR is equal to 2.54 USD, then find the value of 3000 OMR value in
USD and 200USD in OMR.
• If 20000 SAR is equal to 5500 USD and 4500 Pound find the value 5000
SAR in USD and Pound.
• A laptop price in Oman is 650 Rial, in USA it 1750 $ and in UK it 1600
pound. If another laptop price in USA is 1450 $ and considering the same
exchange rate as mentioned above, what is price in Oman and UK?
• A Machine price in Oman is 3000 Rial, in USA it 8000 $ and in UK it 7000
Pound. If another machine price in UK is 2000 Pound while considering
the same exchange rate as mentioned above, what is price in Oman and
USA?
THANK
YOU