Macroeconomics Sem II Ebook.pdf

BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 1 – BASIC CONCEPTS...

BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 1 – BASIC CONCEPTS Macroeconomics and its Scope Macroeconomics is the study of the economy as a whole. It looks at big-picture aspects such as economic growth, inflation, unemployment, and trade. It focuses on how policies like government spending, taxation, and interest rates affect overall economic performance and stability. Macroeconomics helps us understand how an entire country's economy functions and how different factors influence one another. Scope of Macroeconomics The scope of macroeconomics encompasses a broad range of topics that relate to the functioning of the entire economy. Here are some key areas that fall under the scope of macroeconomics: 1. Economic Growth: Analyzing how a country's economy expands over time, including the factors that drive growth such as investment, technology, and population changes. 2. Inflation and Deflation: Studying how the general level of prices changes over time and the impact these changes have on purchasing power and economic stability. 3. Unemployment: Understanding the causes of joblessness and the different types of unemployment, as well as finding ways to achieve full employment. 4. Monetary Policy: Examining how central banks manage the money supply and interest rates to influence economic activity, control inflation, and stabilize the currency. 5. Fiscal Policy: Investigating how government spending and taxation can influence economic growth, employment, and income distribution. 1 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Macroeconomics Variables Macroeconomic variables are indicators that give an overview of a country's economic health and performance. 1. Gross Domestic Product (GDP): This measures the total value of goods and services produced in a country, giving an overall picture of the economy's size and growth. 2. Unemployment Rate: This is the percentage of the labour force that is unemployed but actively seeking work. It indicates the availability of jobs and the health of the job market. 3. Inflation Rate: This measures the rate at which the general level of prices for goods and services is rising. Moderate inflation can signal a healthy economy, but high inflation can erode purchasing power. 4. Interest Rates: These rates are set by the central bank and influence borrowing costs. They affect investment, spending, and savings in the economy. 5. Trade Balance: This variable measures the difference between a country's exports and imports. A trade surplus indicates a country-exports more than it imports, while a trade deficit indicates the opposite. These variables help economists assess economic conditions and guide policy decisions to promote growth and stability 2 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Objectives of Macroeconomics The objectives of macroeconomics are the goals that policymakers aim to achieve for the overall economy. Here are the main objectives in short and easy points: 1. Economic Growth: Achieving a steady increase in the production of goods and services over time, usually measured by GDP growth. 2. Full Employment: Striving for a low unemployment rate so that as many people as possible have jobs and the economy can make use of its full labour force. 3. Price Stability: Keeping inflation low and stable to protect the purchasing power of money and avoid excessive fluctuations in prices. 4. Balance of Trade: Aiming for a sustainable balance between exports and imports to maintain a healthy relationship with other countries and ensure stability in foreign exchange markets. 5. Equitable Income Distribution: Promoting a fair distribution of income across society to reduce inequality and improve living standards for all. 6. Economic Stability: Managing economic fluctuations (business cycles) to avoid severe booms and busts that can cause hardship and instability. 7. Sustainable Development: Encouraging economic growth that considers environmental impact and conserves resources for future generations. 3 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Differences Microeconomics Macroeconomics Microeconomics is the study of Macroeconomics studies the economy Definition economic actions of individuals and as a whole and not a single unit but small groups of individuals. combination of all. Particular households, firms and National income, general price levels, Concern with industries national output, unemployment and poverty On demand side is to maximize utility Full employment, price stability, Objective whereas on the supply side is to economic growth and favourable minimize profits at minimum cost balance of payments. Price mechanism which operates with National income, output and the help of demand and supply forces employment which are determined by Basis aggregate demand and aggregate supply Rational behavior of individuals Aggregate volume of output of an Assumptions economy, the extent to which its resources are employed Limitations Existence of full employment Involvement of 'Fallacy of Composition' which doesn't prove true 4 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 2 – NATIONAL INCOME National Income National income refers to the total value of all goods and services produced by a country's residents over a specified period, typically a year. It includes the income earned by individuals, businesses, and the government within the country's borders. National income is a key indicator of a nation's economic performance and is often used to assess living standards, economic growth, and overall economic health. Personal Income In macroeconomics, personal income refers to the total amount of income received by individuals from all sources before taxes are deducted. It includes wages and salaries, income. from investments, rental income, and government transfer payments such as social security. benefits and welfare payments. Personal income is an important indicator of individuals' purchasing power and their ability to consume goods and services within an economy. It is. often used to analyze trends in consumer spending, savings behavior, and overall economic well-being. Disposable Income Disposable income is the amount of money an individual or household has available to spend or save after taxes have been deducted from their gross income. It represents the money that can be used for consumption or saving purposes and is a key indicator of an individual's or household's financial flexibility and standard of living. 5 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Per Capita Income Per capita income is the average income earned by each person in a specific group, typically a country, region, or demographic group. It is calculated by dividing the total income of the group by the total population. Per capita income is used as a measure of the average wealth or standard of living within a population and helps compare economic prosperity across different regions or time periods. Domestic Product [GDP] GDP, or Gross Domestic Product, is a measure of the total value of all goods and services produced within a country's borders over a specific period, usually a year or a quarter. It serves as a key indicator of a nation's economic performance and is often used to gauge the size and growth of an economy National Income Aggregate The following are the aggregates to the national income: 1. Gross Domestic Product at Market Price or 𝐆𝐃𝐏𝐌𝐏: It is the gross market value of all final goods and services that is produced within the domestic territory of a nation within an accounting year. It is shown as: 𝐆𝐃𝐏𝐌𝐏 = Net domestic product at FC (𝐍𝐃𝐏𝐅𝐂) + Depreciation + Net Indirect tax 2. Gross domestic product at Factor Cost or 𝐆𝐃𝐏𝐅𝐂: It refers to the total money value of goods and services excluding net indirect taxes that are produced within the domestic territory of a nation within one accounting year. It can be shown as: 𝐆𝐃𝐏𝐅𝐂 = 𝐆𝐃𝐏𝐌𝐏 – Net Indirect tax 6 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 3. Net Domestic Product at Market Price or 𝐍𝐃𝐏𝐌𝐏 : It is the net market value of all the final goods and services produced within the domestic territory of the nation within a year excluding depreciation. It can be shown as: 𝐍𝐃𝐏𝐌𝐏 = 𝐆𝐃𝐏𝐌𝐏 - Depreciation 4. Net Domestic Product at Factor Cost or 𝐍𝐃𝐏𝐅𝐂 : It refers to the net money value of all the final goods and services that are produced within the domestic territory of a nation excluding the net indirect taxes and depreciation. It is shown as: 𝐍𝐃𝐏𝐅𝐂 = 𝐆𝐃𝐏𝐌𝐏 - Net Indirect tax - Depreciation 5. Net National Product at Factor Cost or 𝐍𝐍𝐏𝐅𝐂: It is the net value of all the final goods and services that are produced by the residents of a nation within a period of one year. It can be shown as 𝐍𝐍𝐏𝐅𝐂 = 𝐆𝐍𝐏𝐌𝐏 – Net Indirect Taxes - Depreciation 𝐍𝐍𝐏𝐅𝐂 is also known as the National Income. 6. Gross National Product at Factor Cost or 𝐆𝐍𝐏𝐅𝐂 : It is referred to as the gross money value of all the final goods and services that are produced by the residents living within the boundaries of a nation during one accounting year excluding the net indirect taxes. It is shown as: 𝐆𝐍𝐏𝐅𝐂 = 𝐆𝐍𝐏𝐌𝐏 – Net Indirect Taxes 7. Net National Product at Market Price or 𝐍𝐍𝐏𝐌𝐏: It is the net market value of all the final goods and services produced by the residents living within boundaries of the nation during one accounting year. It is shown as 𝐍𝐍𝐏𝐌𝐏 = 𝐆𝐍𝐏𝐌𝐏 – Depreciation 8. Gross National Product at Market Price or 𝐆𝐍𝐏𝐌𝐏: This is the gross market value of all final goods and services that are produced by the residents living within the boundaries of a nation. It can be said as the sum total of all the factor incomes by the residents of a country during a year and is inclusive of depreciation and net indirect taxes. 𝐆𝐍𝐏𝐌𝐏 = 𝐍𝐍𝐏𝐅𝐂 + Net Indirect Taxes + Dep 7 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Problems of Measurement of National Income Several problems arise in measuring national income, which can impact the accuracy and usefulness of the data: 1. Non-market Transactions: National income calculations often exclude non-market transactions like household work, volunteer work, and the informal economy, leading to an underestimation of economic activity. 2. Quality of Data: Data collection methods may vary across sectors and regions, leading to inconsistencies and inaccuracies in measuring production and income. 3. Double Counting: There's a risk of double-counting when including intermediate goods and services in GDP calculations, as they are already accounted for in the final products. 4. Inflation and Price Changes: Changes in prices over time (inflation) can distort the real value of national income figures if not adjusted properly, leading to misleading conclusions about economic growth. 5. Income Distribution: National income figures may not reflect the distribution of income within a country, which can skew perceptions of economic well-being and inequality. 6. Environmental Impact: National income measures often fail to account for environmental degradation and resource depletion, leading to an overestimation of economic welfare. 7. Globalization: In an increasingly globalized world, accurately attributing production and income to specific countries becomes challenging due to multinational corporations and complex supply chains. 8 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Circular flow of Income in Two Sector Economy In a two-sector economy, the circular flow of income model simplifies the economy into two main sectors: households and firms. Here's how it works: 1. Households: In this model, households are the sole owners of resources, such as labor and capital. They provide these resources to firms in exchange for income. 2. Firms: Firms produce goods and services using the resources provided by households. They pay wages, salaries, rent, and interest to households in exchange for these resources. The circular flow of income in a two-sector economy can be represented as follows: Factor Market: This is where households provide resources (such as labor and capital) to firms in exchange for payments (wages, salaries, rent, and interest). Product Market: Firms produce goods and services, which are sold to households in exchange for revenue. In this simplified model, money flows from firms to households in the form of payments for the resources provided. Then, households spend their income on goods and services produced by firms. This spending becomes revenue for firms, which they use to pay for resources, thereby completing the circular flow of income. 9 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Circular flow of Income in 3 sector Economy In a three-sector economy, the circular flow of income model expands the traditional framework to include the interactions between households, businesses, and the government. Here's how it works: 1. Households: - Households are the primary consumers and owners of factors of production (land, labor, capital, and entrepreneurship). - They supply factors of production to businesses in exchange for income, such as wages, salaries, rent, interest, and profits. - Households also pay taxes to the government and receive transfer payments, such as social security benefits and subsidies. 2. Businesses (Firms): - Businesses produce goods and services using the factors of production supplied by households. - They pay wages, salaries, rent, interest, and profits to households for their contribution to the production process. - Businesses sell goods and services to households and the government in exchange for revenue. 3. Government: - The government collects taxes from households and businesses. - It uses tax revenues to provide public goods and services, such as infrastructure, education, healthcare, and defense. - The government also makes transfer payments to households, such as social welfare benefits and subsidies to firms. 10 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 The circular flow of income in a three-sector economy illustrates the continuous flow of money and resources between households, businesses, and the government: - Households supply factors of production to businesses, receive income in return, and spend that income on goods and services produced by businesses. - Businesses use the factors of production to produce goods and services, generate revenue from sales to households and the government, and pay income to households. - The government collects taxes, provides public goods and services, and redistributes income through transfer payments. This cycle demonstrates how economic activity, income, and spending are interconnected among the three sectors of the economy, forming a continuous flow of goods, services, and payments. 11 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Production Method of National Income The production method of calculating national income, also known as the value-added approach, focuses on the value added at each stage of production within an economy. Here's a simplified explanation: 1. Value Added: Each stage of production adds value to goods and services. Value added is calculated by subtracting the cost of intermediate goods and services from the revenue generated at each stage of production. 2. Summation: The value added at each stage of production is summed up across all sectors of the economy. This provides the total value added by the economy as a whole. 3. GDP Calculation: Gross Domestic Product (GDP) is calculated by summing up the value added at each stage of production, including all sectors of the economy. It represents the total value of all final goods and services produced within a country's borders over a specific period. The production method emphasizes the contribution of each stage of production to the overall economy and provides insights into the efficiency and productivity of different sectors. It is one of the three main approaches, along with the expenditure method and income method, used to calculate national income or GDP. 12 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Expenditure Method of National Income The expenditure method of national income calculation is based on the expenditures taking place in the economy. The expenditures that happen in an economy can be done by individuals, households, business enterprises, and the government. Therefore, the formula for calculating the national income by the expenditure method can be expressed as: National income (NI) = C + G + I + (х – м) Income Method of National Income The third method to calculate national income is the income method. It is based on the income generated by the individuals by providing services to the other people in the country either individually or by using the assets at disposal. The income method takes the income generated from land, capital in the form of rent, interest, wages and profit into consideration. The national income by income method is calculated by adding up the wages, interest earned on capital, profits earned, rent obtained from land, and income generated by the self- employed people in an economy. It is known as net domestic product at factor cost or 𝐍𝐃𝐏𝐅𝐂. The addition of the net factor income from abroad to the net domestic product at factor cost gives the national income. It can be expressed in a formula as: 𝐍𝐍𝐏𝐅𝐂 = (𝐍𝐃𝐏𝐅𝐂 ) + Net factor income from abroad Value Added Method The value-added method is also known as the product method or output method. Its primary objective is to calculate national income by taking the value added to a product during the various stages of production into account. 13 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Therefore, the formula for calculating the national income by the value added method can be expressed as: National income (NI) = (𝐍𝐃𝐏𝐅𝐂 ) + Net factor income from abroad GDP Deflator GDP Deflator is also known as GDP Price Deflator or Implicit Price Deflator. It measures the impact of inflation on the GDP of an economy during a period of one specific fiscal year. GDP Deflator is a factor by which Normal GDP is adjusted to calculate Real GDP Formula of GDP: 𝑵𝒐𝒓𝒎𝒂𝒍 𝑮𝑫𝑷 GDP Deflator = { 𝑥100} 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 14 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Difference between Nominal and Real GDP Comparing Nominal GDP & Real GDP Basis For Nominal GDP Real GDP Comparison Nominal GDP is Sum-total of economic Real GDP is Sum-total of economic Meaning output produced in a year valued at output produced in a year valued at a current market price pre-determined base market price Nominal GDP doesn't take inflation into Effect of Inflation Real GDP is a Inflation-Adjusted GDP account Expressed in Current Market Price Base Year's Market Price Is much higher since current market Is much lower since market price of the Value of GDP changes are taken into effect base year is taken into consideration Can be compared with various quarters Can be compared with two or more Uses of the given year financial years From Nominal GDP, economic growth Real GDP is a Good Indicator of Economic Growth can't be analysed easily economic growth 15 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Numerical Questions 1. Calculate National Income or 𝑁𝑁𝑃𝐹𝐶 Particulars ₹ in crores 1. GDP at MP 4,800 2. Indirect Taxes 300 3. Net Factor Income from abroad 80 4. Consumption of fixed capital 200 5. Subsidies 60 Solution: NNP at FC = 4440 Crores 2. Calculate GNP at FC (Gross National Product at Factor Cost) Particulars ₹ in crores 1. NDP at MP 80,000 2. Net Factor income from abroad (NFIA) -200 3. Deprecation 4,950 4. Subsidies 1,770 5. Indirect Tax 10,600 Solution: GNP at FC = 75,920 Crores 3. Calculate GDP at MP Particulars ₹ in crores 1. National Income 6700 2. Consumption of fixed capital 180 3. Factor income from abroad 100 4. Indirect taxes 130 5. Subsidies 70 6. Factor income to abroad 150 Solution: GDP at MP = 6990 16 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 4. Calculate Domestic Income (Or NDP at FC) Particulars ₹ in crores 1. Gross National Product at market price 58,350 2. Indirect tax 2,590 3. Subsidies 1,540 4. Depreciation 1,625 5. Net Factor income from abroad -240 Solution: NDP at FC = 55,915 crores 5. Calculate Indirect taxes from the following data: Particulars ₹ in crores 1. NDP at FC 55915 2. Subsidies 1540 3. Factor income from abroad 625 4. Consumption of fixed capital 1625 5. Factor income to abroad 865 6. GNP at MP 58350 Solution: NDP at MP = 56965 ; Net Indirect tax = 1050 ; Indirect tax = 2590 6. Calculate Domestic Income (i.e. NDP at FC) Particulars ₹ in crores 1. GNP at FC 2700 2. Indirect Taxes 60 3. Factor income from abroad 150 4. Factor income to abroad 180 5. Replacement of Ferd Capital 150 Solution: NDP at FC = 2580 17 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 7. Calculate (a) Domestic Income (i.e. NDP at FC), (b) National Income Particulars ₹ in crores 1. GDP at MP 70150 2. Indirect taxes 5200 3. Factor income from abroad 800 4. Consumption of fixed capital 3100 5. Factor income to abroad 300 6. Subsidies 4000 Solution: (a) NDP at FC=65850 ; (b) NNP at FC = 66,350 8. From the following data relating to a firm estimate, estimate the operating surplus: (₹ '000) (1) Interest 350 (ii) Net Rent 50 (iii) Undistributed Profit before Tax 100 (iv) Subsidies 20 (v) Dividends 80 Solution: 580 thousand 9. Calculate compensation of employees from the following data: (₹ in lakh) (i) Rent 40 (ii) Interest 70 (iii) Profit 30 (iv) Consumption of fixed capital 100 (v) Gross domestic product at factor cost 500 vi) Mixed income of self-employed 100 Solution: 160 Lakh 18 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 10. Calculate compensation of employees from the following data: (₹ in lakh) (1) Value of free medical facilities provided to the employees 20 (ii) Value of rent-free accommodation provided to the employees 80 (iii) Wages and salaries 900 (iv) Bonus 75 (v) Employers' contribution to social security scheme 90 Solution: 1,165 Lakh 11. From the information given below, find out operating surplus: (₹ in crore) (i) Mixed Income 50 (ii) Rent 625 (iii) Interest 375 (iv) Royalty 25 (v) Dividends 225 (vi) Corporation Tax 75 (vii) Undistributed Profits 50 Solution: 1,375 Crore 12. Calculate compensation of employees from the following data: (₹ in crore) (i) Wages and Salaries 410 (ii) Employers' contribution to social security scheme 35 (iii) Value of free medical facilities provided to the employees 55 (iv) Bonus 40 (v) Employees' subscription to Provident Fund 30 Solution: 540 Crore 19 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 13. Calculate (a) NDP at factor cost (b) National Income from the following data: (₹ in crore) (i) Wages and salaries 1,000 (ii) Rent 100 (iii) Interest paid by production units 130 (iv) National debt interest 30 (v) Corporation tax 50 (vi) Contribution to provident fund by employers 200 (vii) Contribution to provident fund by employees 200 (viii) Dividends 100 (ix) Undistributed profits 20 (x) Net factor income from abroad 0 Solution: (a) NDP at FC = 1600 Crore (b) NI = 1600 Crore 14. Calculate National Income from the following data: (₹ in crore) (i) Private final consumption expenditure 900 (ii) Profits 100 (iii) Government final consumption expenditure 400 (iv) Net indirect taxes 100 (v) Gross domestic capital formation 250 (vi) Change in stock 50 (vii) Net factor income from abroad (-) 40 (viii) Consumption of fixed capital 20 (ix) Net imports 30 Solution: NI = 1,410 Crore 20 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 15. On the basis of the following data, (a) Estimate net value added at MP (b) National Income by value-added method (₹ in crore) (i) Domestic sale 10,800 (ii) Increase in stocks 1,200 (iii) Imports of raw material 600 (iv) Exports 1,100 (v) Purchase of raw materials and other inputs 3,600 (vi) Depreciation of fixed capital 450 (vii) Net indirect taxes 300 (viii) Net factor income from abroad (-) 20 Solution: (a) 8,450 Crore (b) 8,130 Crore 16. From the following data, calculate National Income by (a) Income Method (b) Expenditure Method (₹ in crore) (i) Compensation of employees 600 (ii) Government final consumption expenditure 550 (iii) Net factor income from abroad (-) 10 (iv) Net exports (-) 15 (v) Profits 400 (vi) Net indirect taxes 60 (vii) Mixed income of self-employed 350 (viii) Rent 200 (ix) Interest 310 (x) Private final consumption expenditure 1,000 (xi) Net domestic capital formation 385 (xii) Consumption of fixed capital 65 Solution: (a) ₹1,850 crore (b) ₹1,850 crore 21 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 17. On the basis of the information given below, calculate national income by value-added (net output) method: (₹ in crore) (i) Gross value of output at market prices 15,500 (ii) Value of intermediate consumption 4,800 (iii) Consumption of fixed capital 1,550 (iv) Net indirect taxes 750 (v) Net factor income from abroad 200 Solution: NI = 8,600 Crore 22 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 3 – DETERMINATION OF EQUILIBRIUM INCOME Consumption Function Consumption function shows the relationship between consumption and the various levels of income. As the income rises, consumption also rises. there is a direct relationship between consumption and income. It is written as: C = C0 + bY Consumption function has two types: (a) Autonomous consumption: It means that the level of consumption is independent of the changes in income. This is an amount of consumption which will take place even when the income is zero. In the equation, C0 is the autonomous consumption. (b) Induced consumption: It means the level of consumption which changes with the change in income. As the income rises, consumption also rises. In the equation, "bY" represents induced consumption. Propensity of Consumption The propensity to consume refers to the tendency of households to spend a portion of their income on consumption rather than saving it. There are two key concepts: 1. Average Propensity to Consume (APC): The ratio of total consumption to total income. It shows the average amount of income spent on consumption. APC is calculated as: APC = C/Y ; where C is consumption and Y is income. 2. Marginal Propensity to Consume (MPC): The fraction of any additional (marginal) income that is spent on consumption. It indicates how much consumption will change with a change in income. MPC is calculated as: MPC = ΔC / ΔΥ here ΔC is the change in consumption and ΔΥ is the change in income. Short Run Consumption Curve 23 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Saving Function Meaning of Saving: Saving is defined as the excess of income over consumption expenditure. The concept of saving is closely related to the concept of consumption. Saving is the part of income that is not consumed. Generally, as the level of income increase, saving also increases and vice versa. Saving Function Saving function or the propensity to save expresses the relationship between saving and the level of income. It is simply the desire of the households to hoard a part of their total disposable income. Symbolically, the functional relation between saving and income can be defined as S= f(Y). We know, Y = C + S; Thus, S = Y — C; Where, Y= Income; S= Saving; C= Consumption The equation shows that the remaining amount after the deduction of total expenditure from total income is saving. Thus, saving is that part of income which is not spent on consumption 24 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Determinants of Saving Function The saving function, which describes how saving levels respond to changes in income, is influenced by several determinants: 1. Income Levels: Higher income generally leads to higher savings, as people have more disposable income to save after meeting their consumption needs. 2. Interest Rates: Higher interest rates can encourage saving by increasing the return on savings, while lower rates may discourage saving. 3. Expectations: Expectations about future income and economic conditions affect saving behavior. If people expect future income to rise or economic conditions to improve, they might save more. 4. Consumer Confidence: Greater confidence in the economy and personal financial stability can lead to higher saving rates, while lower confidence can result in reduced saving. 5. Government Policies: Tax policies, incentives for retirement accounts, and government savings programs can influence saving behavior. Propensity to Save The propensity to save, in economics, refers to the proportion of income that households save rather than spend on consumption. It is often analyzed through two key concepts: 1. Average Propensity to Save (APS): The ratio of total savings to total income. It shows the average portion of income that is saved. Mathematically, it's expressed as: APS = S/Y where S is total savings and Y is total income. 2. Marginal Propensity to Save (MPS): The fraction of an additional unit of income that is saved. It indicates how saving changes with a change in income. Mathematically, it's expressed as: MPS = ΔS / ΔY where ΔS is the change in savings and ΔY is the change in income. Difference between APC and MPC 25 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Average Propensity to Consume (APC) Marginal Propensity to Consume (MPC) Ratio of consumption expenditure to the Ratio of change in consumption corresponding income level expenditure to the change in total income APC can never be zero MPC can be zero When the income increases, APC falls at When the income increases, MPC falls at lower rate higher rate Investment Function The investment function in economics describes the relationship between the level of investment made by firms and the factors that determine it. It primarily explains how much businesses spend on capital goods like machinery, buildings, and equipment. The investment function can be represented as: I = f (r, E, B, T, C, G) where. I = Investment r = Interest rates E = Expected returns B = Business confidence T = Technological advancements C = Capacity utilization G = Government policy Autonomous and Induced Investment Autonomous Investment: This type of investment is not influenced by the current level of national income or output. It includes expenditures that are necessary and happen regardless of economic conditions, such as infrastructure spending, research and development, and certain types of government expenditure. Autonomous investment is often driven by long-term considerations, such as technological advancements or strategic goals, rather than immediate economic fluctuations. 26 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Induced Investment: This investment is directly influenced by changes in the level of national income or output. It is generally seen as a response to the economic environment. For instance, if the economy is growing and consumer demand is increasing, businesses may invest more in expanding their production capacity to meet the higher demand. This type of investment tends to be cyclical and fluctuates with the economic cycle. Ex-ante and Ex post Ex ante and ex post saving and investment refer to different perspectives on saving and investment relative to expectations and actual outcomes: 1. Ex Ante: o Ex ante saving: Refers to the saving planned or intended by individuals or the economy before the actual outcome is realized. It is based on expected future income and economic conditions. o Ex ante investment: Refers to the investment planned or intended by businesses or the economy before the actual outcome occurs, based on expected future demand and economic conditions. 2. Ex Post: o Ex post saving: Refers to the actual saving that occurs after the outcome is realized. It is the saving that results from actual income and consumption levels. o Ex post investment: Refers to the actual investment that occurs after the outcome is realized, reflecting the actual demand and economic conditions. In summary, ex ante is about planned or intended saving and investment, while ex post is about realized or actual saving and investment. Relation between Saving and Investment 27 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 The relationship between saving and investment is fundamental in economics and can be summarized as follows: 1. Equality in a Closed Economy: In a closed economy with no government or external trade, total saving always equals total investment. This is because whatever portion of income is not consumed (i.e., saved) is available to be invested. This relationship can be represented as: S = I where S is saving and I is investment. 2. National Income Accounting: In an open economy with government and international trade, the equality holds in an aggregate sense due to the national income accounting identity: Y = C + I + G + (X — M) where Y is national income, C is consumption, G is government spending. X is exports, and M is imports. Rearranging terms, we get: S + (T — G) + (M — X) = I where, T is taxes, and (T-G) (is the government surplus/deficit, and (M-X) is the net exports. 3. Market Mechanism: Savings provide the funds that are available for investment. In financial markets, households save money by depositing it in banks or buying financial instruments, and businesses borrow these funds to invest in capital goods. Keynesian Consumption Function and Its Characteristics The Keynesian consumption function, developed by John Maynard Keynes, is a formula that represents the relationship between total consumption and total disposable income in an economy. Keynes introduced this concept in his work "The General Theory of Employment, Interest, and Money" (1936). The function suggests that as income increases, consumption will also increase, but not by as much as the increase in income. The Keynesian consumption function can be expressed as: C = a +bYd where, C = Total consumption a = Autonomous consumption (consumption when income is zero) b = Marginal propensity to consume (MPC), which is the fraction of additional income that is spent on consumption Yd = Disposable income (total income minus taxes) 28 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 CHARACTERISTICS: 1. Autonomous Consumption (a): This is the level of consumption that occurs even when disposable income is zero. It reflects basic needs and is financed by savings or borrowing. 2. Marginal Propensity to Consume (MPC) (b): The MPC is the change in consumption resulting from a change in disposable income. It is a positive fraction less than one, indicating that as income increases, consumption increases, but by a smaller proportion. 3. Positive Relationship between Income and Consumption: The function shows a direct relationship between disposable income and consumption. As disposable income increases, consumption also increases, but at a decreasing rate. 4. Short-term Focus: The Keynesian consumption function is generally considered more applicable to the short-term analysis of consumption behavior. Long-term factors, such as changes in consumer preferences and expectations, are less emphasized. GROSS INVESTMENT AND NET INVESTMENT Gross Investment: Definition: Gross investment is the total amount spent on new capital goods (such as machinery, buildings, and infrastructure) during a given period. Includes: It includes all expenditures on new capital assets without accounting for depreciation. Formula: Gross Investment Net Investment + Depreciation Purpose: It measures the total increase in the capital stock. Net Investment: Definition: Net investment refers to the total amount spent on new capital goods minus the depreciation of existing capital. 29 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Includes: It accounts for the wear and tear or reduction in value of existing capital assets over time. Formula: Net Investment Gross Investment-Depreciation Purpose: It measures the actual increase in the capital stock after accounting for depreciation. Planned and Unplanned Investment Planned Investment: This is the amount of investment that businesses intend to make based on their expectations of future economic conditions. It is often influenced by factors such as interest rates, economic forecasts, and business confidence. Unplanned Investment: This refers to changes in inventory levels that occur when actual investment differs from planned investment. It happens when businesses either unintentionally accumulate more inventory than planned (unplanned inventory buildup) or deplete their inventory more than expected (unplanned inventory reduction). Show that MPC + MPS = 1 HANDWRITTEN Show that APC + APS = 1 HANDWRITTEN... Will cover in Class Simple Keynesian model of National income Determination The Simple Keynesian Model of National Income Determination provides a straightforward way to understand how national income is determined in an economy. Here's a simplified explanation: 30 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 1. Basic Components: o Aggregate Demand (AD): The total demand for goods and services in the economy, which is the sum of consumption (C), investment (I), government spending (G), and net exports (NX, which is exports minus imports). o Aggregate Supply (AS): The total output of goods and services produced by the economy. 2. Equilibrium Condition: o In the Simple Keynesian Model, national income is determined at the point where aggregate demand equals aggregate supply. This is expressed as: AD = C + I + G + NX where Y= AD And Y represents national income or output. 3. Consumption Function: o The consumption function describes how consumption spending changes with changes in income. It’s often expressed as: C = C0 + c (Y − T) where C0 is autonomous consumption (consumption when income is zero), c is the marginal propensity to consume (the fraction of additional income that is spent), and (Y − T) is disposable income (income after taxes). 4. Investment, Government Spending, and Net Exports: o In the basic model, investment (I), government spending (G), and net exports (NX) are considered exogenous, meaning they are determined outside the model and are not influenced by current national income. 5. Equilibrium Output: o To find the equilibrium level of national income, set aggregate demand equal to aggregate supply: Y = C0 + c (Y − T) + I + G + NX o Solve this equation to find the equilibrium level of national income (Y). 6. Adjustment Mechanism: o If actual output is greater than aggregate demand, there will be unsold goods, leading firms to cut back on production, reducing income and output. o If actual output is less than aggregate demand, firms will increase production, boosting income and output. 31 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 In summary, the Simple Keynesian Model of National Income Determination shows that national income is determined by the level of aggregate demand, with equilibrium occurring where total spending matches total output. The model helps illustrate how changes in consumption, investment, government spending, and net exports can influence overall economic activity Investment Multiplier The investment multiplier is a concept that shows how a change in investment spending affects the overall economy. Here’s a simple explanation: 1. Definition: It measures how much national income or GDP will increase for every additional unit of investment spending. 2. How It Works: When businesses invest in new projects or equipment, they spend money that creates income for others (like construction workers or suppliers). These people then spend part of their new income, which creates even more income for others, and so on. This chain reaction increases overall economic activity more than the initial investment. 3. Formula: The multiplier is calculated as: Investment Multiplier = ΔY / ΔI where ΔY is the change in national income and ΔI is the change in investment spending. 32 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 4. Effect: A small increase in investment can lead to a larger increase in national income because of this ripple effect. In essence, the investment multiplier shows how initial increases in investment can lead to a larger overall increase in the economy. Assumption of Keynesian theory of Investment Multiplier The Keynesian investment multiplier theory is based on a few key assumptions: 1. Constant Marginal Propensity to Consume (MPC): The proportion of additional income that is consumed remains constant. 2. Fixed Price Level: The price level in the economy is assumed to be constant, so changes in investment directly affect output without influencing prices. 3. No Crowding Out: Government investment does not displace private investment; all investment contributes to aggregate demand. 4. Linear Consumption Function: The consumption function is linear, meaning it increases at a constant rate with income. Government Expenditure Multiplier The government expenditure multiplier quantifies how a change in government spending affects the overall national income or GDP. Here’s a simple overview: 1. Definition: It measures the impact on national income from an increase in government spending. 2. How It Works: When the government increases its spending, it directly boosts aggregate demand (the total demand for goods and services). This initial increase leads to higher production and income, which then leads to more spending by households and businesses. This ripple effect increases overall economic activity. 3. Formula: The government expenditure multiplier can be calculated as: Government Expenditure Multiplier = ΔY / ΔG 33 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 where ΔY the change in national income and ΔG is the change in government spending. 4. Size of the Multiplier: The size of the multiplier depends on factors such as the marginal propensity to consume (MPC) and the level of savings. A higher MPC means that more of the additional income is spent, leading to a larger multiplier effect. 5. Effect: For example, if the government spends $100 million on infrastructure, and this results in a $300 million increase in national income, the multiplier would be 3. This indicates that each dollar of government spending generates three dollars of national income. In essence, the government expenditure multiplier shows how government spending can lead to a larger increase in economic activity through a chain reaction of increased demand and income. Tax Multiplier 1. Definition: It shows the impact on national income from a change in tax levels, typically an increase or decrease in taxes. 2. How It Works: When taxes are cut, people have more disposable income to spend, which boosts aggregate demand. Conversely, when taxes are increased, disposable income 34 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 falls, reducing spending and aggregate demand. This change in spending affects the overall economy. 3. Formula: The tax multiplier is calculated as: Tax Multiplier = ΔY / ΔT where ΔY is the change in national income and ΔT is the change in taxes. 4. Effect: The tax multiplier is generally smaller than the government spending multiplier because a tax change only indirectly affects aggregate demand through changes in disposable income, compared to direct government spending. In summary, the tax multiplier measures how changes in taxes influence overall economic activity, reflecting the effect of tax changes on national income. Balance Budget Multiplier The balanced budget multiplier refers to the effect on national income when government spending and taxes are increased by the same amount. According to Keynesian economics, this multiplier is always equal to 1. This means that if the government increases both spending and taxes by one unit, the national income will also increase by exactly one unit. The formula for the balanced budget multiplier is: Balanced Budget Multiplier=ΔY / ΔG − ΔY /ΔT = 1 where ΔY is the change in national income, ΔG is the change in government spending, and ΔT is the change in taxes. This occurs because the initial increase in government spending directly raises aggregate demand, while the increase in taxes reduces disposable income and consumption by a smaller amount, leading to a net positive effect on national income. 35 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 4 – MONEY AND INFLATION Meaning of Money and its Functions Money is a medium of exchange that facilitates transactions by serving as a universally accepted unit of value. Money is widely accepted in transactions involving goods and services. It can take various forms, such as coins, banknotes (physical cash), and digital balances held in bank accounts or electronic payment system. FUNCTIONS 1. "Medium of Exchange": Money simplifies transactions by eliminating the need for barter, where goods or services are directly exchanged for other goods or services. 2. "Unit of Account: Money provides a common measure of the value of goods and services. Prices are expressed in monetary terms, allowing for easier comparison of different goods and services. 3. "Store of Value": Money allows individuals and businesses to store purchasing power over time. Unlike perishable goods or certain assets, money can be held and exchanged later for goods and services. 4. "Standard of Deferred Payment": Money enables contracts and debts to be denominated in a stable unit of value, facilitating borrowing, lending, and other financial transactions over time. 36 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Demand For Money The concept of demand for money refers to the desire of individuals and businesses to hold money balances for various purposes. This demand arises from the functions that money serves in an economy. There are three main motives for holding money: 1. Transaction Demand: This is the demand for money to facilitate day-to- day transactions. Individuals and businesses hold money to pay for goods and services without needing to convert other assets into cash immediately. The transaction demand for money is influenced by the level of income and the frequency of transactions. 2. Precautionary Demand: Money is also held as a precautionary measure to meet unexpected expenses or emergencies. This motive reflects the desire to hold liquid assets for unforeseen needs without incurring costs associated with converting fewer liquid assets into money. 3. Speculative Demand: This refers to the demand for money as a store of value in anticipation of future opportunities to make profitable investments. When people expect interest rates to rise or asset prices to fall, they may hold more money temporarily to take advantage of better investment opportunities in the future. Money Supply and Determinants of Money supply Money supply refers to the total amount of monetary assets available in an economy at a specific time. It includes all physical currency, such as coins and notes, as well as various types of deposits and other liquid instruments that can be readily converted into cash. Governments and central banks monitor the money supply closely because it has implications for inflation, economic growth, and financial stability. Central banks often use monetary policy tools, such as open market operations (buying or selling government securities) or adjusting interest rates, to influence the money supply in order to achieve their economic objectives. 37 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Determinants of Money Supply Monetary Policy of Central Bank: The central bank (like the Federal Reserve in the US) can influence the money supply through actions such as buying or selling government securities (bonds) in the open market. When the central bank buys securities, it injects money into the economy, increasing the money supply. Conversely, selling securities reduces the money supply. Banking System Behavior: Commercial banks play a crucial role in the money creation process through lending. When banks issue loans, they create new money in the form of deposits. The amount of loans banks issue affects the money supply; more lending increases it, while reduced lending decreases it. Deposit Inflows and Outflows: Money supply can also be affected by changes in how much money people deposit into banks (like savings and checking accounts) versus how much they withdraw. More deposits increase the money supply, while withdrawals decrease it. Currency Issuance: The physical cash (coins and notes) circulating in the economy is also part of the money supply. Changes in the amount of currency issued by the government influence the money supply directly. 38 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Measures of Supply of Money The measures of money supply, often categorized as M1, M2, M3, and sometimes M4, represent different levels of liquidity and types of money within an economy. Here's a brief overview: 1. "M1 Money Supply": This includes the most liquid forms of money: - Currency (physical cash in circulation) - Demand deposits (checking accounts and other types of accounts from which funds can be withdrawn on demand) 2. "M2 Money Supply**: This includes M1 plus slightly less liquid assets: - Savings deposits (including money market deposit accounts) - Small time deposits (less than $100,000) - Retail money market mutual fund shares 3. "M3 Money Supply": This includes M2 plus larger time deposits and institutional money market mutual funds. 4. "M4 Money Supply": Sometimes used to refer to M3 plus all other financial assets, such as large time deposits, institutional money market funds, short-term repurchase agreements, along with other larger liquid assets. High Powered Money High powered money," also known as "base money" or "monetary base," refers to the total amount of a country's physical currency (notes and coins) in circulation and commercial banks' reserves with the central bank. It's called "high powered" because changes in this base money can potentially lead to larger changes in the broader money supply through the banking system. Key components of high-powered money include: 1. Currency in Circulation: The total amount of physical currency (notes and coins) that is in public hands or held by banks. 2. Reserves: Commercial banks are required to hold a portion of their deposits as reserves. These reserves are typically held in accounts at the central bank. 39 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Narrow money and Broad money Narrow Money: Narrow money is a category of money supply that includes all physical money such as coins and currency, demand deposit and other liquid assets held by Central Bank. M1 or m0 are used to describe narrow money. Narrow money is a subset of broad money. This category of money is considered to be the most readily available for transaction and commerce. "The narrow money definition of money supply is a measure of valuable coin and notes in circulation and other Mani equivalent that are easily convertible into cash such a short-term deposit in the banking system". Broad Money: Broad money is a measure of total amount of money held by household and company in the economy. Broad money is made up of commercial Bank deposit. The sum of M1 and time deposit is called broad money. In other words, M2, M3, M4 quality as broad mores and M4 represent the largest concept of money supply. These are often referred to as long term time deposit because their activity is restricted by specific time requirement "In economics, board money is a measure of the amount of money, or money supply in a national economy including both highly liquid "narrow money and less liquid forms. Differences between Narrow money & Board Money: Narrow Money Broad Money The narrow money definition of the money Broad money is a measure of the total amount supply is a measure of the value coins and of money held by households and companies in nates circulation and other money equivalents the economy. Bread money is made up mainly that are easily convertible to can such as of commercial bank deposits short-term deposits in the banking system M1 or M0 used to describe narrow money. M2/M3/M4 qualify as broad money and M4 Narrow money is a subject of broad money represents the largest concept of the money supply This category of money is considered to be the These are often referred to as longer-term most readily available for transactions and time deposits because their activity is commerce. restricted by a specific time requirement. 40 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Money Multiplier Money multiplier refers to human initial deposit can lead greater increase in the total money supply. For example, if the commercial bank gain deposits of Rs.1 million and that leads to the final money supply of Rs 10 million. The money multiplier is 10 The banking system a can take multiple expansion of deposits. Concept of Inflation Inflation: Inflation is defined as a sustained increase in the aggregate price level. Inflation means a rising price level. Money a high level of prices is not called inflation because prices may be stable at that high level. Whenever, there is a rise in the price level, there is an inflation, irrespective of the level of prices before or after the rise. If should be noted that inflation means a rise in the aggregate price level. According to Samuelson-Nordhaus, "Inflation is a rise in the general level prices" According to Coulbourne inflation can be defined as, "too much money chasing too few goods." 41 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Types of Inflation: (i) Demand Pull Inflation: A demand-pull inflation is a inflation created by the pressure of excess demand in the market. If there is an excess of demand over supply price tends to increase under the pressure of excess demand. If aggregate demand exceeds aggregate supply, there will be upward pressure on the aggregate price level. This type of inflation is called demand-pull inflation. If there is no change in the aggregate demand curve or aggregate supply curve. So, there will be no change in the equilibrium price. (ii) Cost Push Inflation: If there is an increase in the cost of production of commodities due to rise in the price of inputs used in the production process, it is shown that a rise in the average and marginal cost of production leads to the leftward shift of the supply curve of a commodity. Thus, the supplier is ready to supply, the same quantity at the higher price. As a result, the aggregate output of goods and services in the economy will fall and the aggregate price level will rise. So, this type of inflation is called Cost push inflation. (iii) Built in Inflation: It occurs when workers demand higher wages to keep up with rising living cost. Causes of Demand-Pull Inflation (i) A Growing economy: When customer feel confident, they will spend more take on more debt by borrowing more. This leads to steady increase in demand which means higher price. (ii) Asset Inflation: A sudden rise in exports which translates to an undervaluation of involved currencies. (iii) Inflation expectation: Forecasts and expectation where companies increase that price to go on with the flow of expected price. (iv) More money in the system: Demand-pull Inflation is produced by a excess in monetary growth or expansion in the money supply. (v) Population Growth: Growth of population also increases total demand in the market, the pressure of excess demand will create inflation. 42 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Causes of Cost-Pull Inflation (i) Higher price of Commodity: A rise in the price of all would leads to higher petrol prices and transportation cost. (ii) Higher Wages: Wages are one of the main cost of firms. Rising wages will push up the price as firm has to pay higher cost. Higher wages also cause rising inflation. (iii) Rising Tax: Higher VAT and excise duty will increase the price of the goods. (iv) Profit push Inflation: If firm gain increased monopoly power, they are in a position to push up price to make profit. Inflationary Gap & its Causes Inflationary gap is a situation which arises when Aggregate demand in an economy exceeds the Aggregate supply at the full employment level. Its Causes: A rise in aggregate demand. A rise in demand will naturally create a discrepancy between real demand and potential demand. Excess demand can be caused by a variety of things: lower unemployment, a rise in consumer confidence, an increase in government expenditure, or an increase in private investments. A fall in aggregate supply - A fall in supply will also naturally create a discrepancy between real demand and potential demand. Potential causes of supply decreases include increased tariffs, wage increases, or wartime (when facilities are used for war purposes instead of producing commercial goods). 43 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Monetary and Fiscal measures to control inflation Monetary Measures 1. Interest Rates: - Central banks, like the Reserve Bank of India, increase interest rates to make borrowing more expensive and saving more attractive, which reduces spending and investment. 2. Open Market Operations: - Buying and selling government securities to regulate the money supply. Selling securities reduces the money supply, which can help control inflation. 3. Reserve Requirements: - Increasing the reserve ratio means banks hold more money in reserves and have less to lend out, reducing the money supply. 4. Discount Rate: - Raising the discount rate (the interest rate at which banks can borrow from the central bank) makes borrowing more expensive, reducing the money supply. Fiscal Measures 1. Government Spending: - Reducing government spending lowers overall demand in the economy, which can help reduce inflationary pressures. 2. Taxation: - Increasing taxes reduces disposable income, leading to lower consumer spending and investment, thus reducing demand-pull inflation. 3. Public Debt Management: - Governments can issue more bonds to absorb excess money from the economy, reducing the money supply and controlling inflation. 4. Subsidy Reductions: - Reducing subsidies can increase prices, which may initially seem counterintuitive, but can help control inflation by reducing fiscal deficits and excessive demand. 44 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 UNIT 5 – PUBLIC FINANCE Government Budget A government budget is a comprehensive financial statement presented by the government detailing its projected revenues and planned expenditures for a specific fiscal year. It serves as a tool for economic policy implementation, reflecting the government's priorities and strategies for managing the country's economy. The budget aims to allocate resources efficiently, control public spending, and achieve economic stability and growth. Components of Government Budget The components of a government budget are broadly classified into the Capital Budget and the Revenue Budget. 1. Revenue Budget - This part of the budget deals with the current or recurring expenditures and revenues of the government. It is further divided into: Revenue Receipts: Revenue receipts refer to the income that the government collects without creating any liabilities or reducing assets. They primarily come from taxes and non-tax sources such as fees, fines, and interest income. They include: o Tax Revenues: Income from taxes such as income tax, corporate tax, GST, customs duties, and excise duties. o Non-Tax Revenues: Earnings from sources other than taxes, such as interest receipts, dividends and profits from public enterprises, fees for services, and grants. Revenue Expenditure: Revenue expenditure refers to the government's spending on day-to-day operations that do not create lasting assets. These expenditures are recurring and typically consumed within the fiscal year. They include: o Salaries and Pensions: Payments to government employees. o Subsidies: Financial support to various sectors like agriculture, food, and fuel. o Interest Payments: Payments made on the borrowings of the government. o Maintenance and Operational Costs: Costs of running government services and maintaining existing infrastructure. 45 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 2. Capital Budget - This part of the budget is concerned with expenditures and receipts related to the creation and acquisition of assets and liabilities. It is divided into: Capital Receipts- Capital receipts are funds that a government receives, which either create a future obligation or reduce its existing assets. This includes money from borrowing, selling government-owned assets, or recovering loans given to others. They include: o Borrowings: Loans raised by the government from the public, foreign governments, and international institutions. o Disinvestment: Proceeds from the sale of government shares in public sector enterprises. o Recovery of Loans: Repayments received from loans given to state governments, union territories, and other parties. Capital Expenditure: Capital expenditure refers to spending by the government on long-term projects and assets. This includes building infrastructure like roads and bridges, buying machinery, or investing in new public facilities. They include: o Infrastructure Development: Spending on building roads, bridges, ports, and other public works. o Purchasing Assets: Acquisition of machinery, equipment, land, and buildings. o Investments: Investments in public sector enterprises and financial institutions. o Loans and Advances: Loans given to state governments, union territories, and other parties. Objectives of Government Budget The objectives of a government budget are crucial for managing the economy and fulfilling policy goals. Here are key objectives often highlighted: 1. Economic Stability: The budget aims to maintain economic stability by controlling inflation, managing public debt, and regulating the overall economic environment. It helps in smoothing out economic cycles and reducing economic volatility. 2. Resource Allocation: The budget allocates financial resources to various sectors and projects based on priorities and needs. This includes funding for essential services like 46 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 healthcare, education, and infrastructure, ensuring that resources are distributed efficiently. 3. Income Redistribution: Through taxation and public expenditure, the budget seeks to reduce income inequality. It supports social welfare programs, subsidies, and transfers to lower-income groups, aiming to achieve a more equitable distribution of wealth. 4. Economic Growth: The budget supports economic growth by investing in infrastructure, education, and research. It aims to create an environment conducive to business development, job creation, and overall economic development. 5. Fiscal Discipline: The budget ensures fiscal discipline by setting limits on government spending and borrowing. It aims to balance the government's revenue and expenditure to avoid excessive debt and maintain financial health. Functions of Government Budget The government budget serves several important functions: 1. Economic Planning and Control: It helps the government plan and manage the economy by setting priorities for spending and revenue collection. This includes planning for growth, controlling inflation, and managing public debt. 2. Resource Allocation: The budget allocates resources to various sectors and programs, ensuring funds are directed towards priority areas such as health, education, and infrastructure. This helps in achieving strategic goals and addressing public needs. 3. Fiscal Policy Implementation: It is a tool for implementing fiscal policy by adjusting taxation and expenditure levels to influence economic conditions. For example, increasing spending during a recession to stimulate growth or cutting taxes to boost consumer spending. 4. Income Redistribution: The budget helps in redistributing income by funding social programs and subsidies aimed at reducing inequality. It ensures support for vulnerable populations and provides public goods and services that might not be adequately provided by the private sector. 5. Accountability and Transparency: The budget process provides a framework for government accountability by detailing how public funds will be raised and spent. It promotes transparency and allows citizens to understand and evaluate government financial decisions and their impact. 47 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Classification of Receipts Government receipts are classified into two main categories: revenue receipts and capital receipts. Revenue Receipts are regular, recurring inflows that do not lead to the creation of assets or liabilities. They include tax revenues, such as income and corporate taxes, and non-tax revenues, such as fees, fines, and dividends from public enterprises. These receipts are used to meet the government's day-to-day expenses. Capital Receipts, on the other hand, involve inflows that create liabilities or reduce assets. They include borrowings from domestic and foreign sources, disinvestment proceeds from the sale of government assets, and recovery of loans given to other entities. Capital receipts are used for financing long-term investments and managing debt. Classification of Expenditure Government expenditure is classified into two main categories: revenue expenditure and capital expenditure. Revenue Expenditure involves spending on regular, day-to-day operations that do not create assets or reduce liabilities. It includes payments for salaries, pensions, subsidies, and interest on debt, as well as maintenance of existing assets. This type of expenditure supports ongoing government functions and services. Capital Expenditure, on the other hand, pertains to spending that results in the creation or acquisition of long-term assets. It includes investments in infrastructure projects like roads and bridges, the purchase of machinery and equipment, and loans and advances to other entities. Capital expenditure is aimed at building or improving assets that will benefit the economy over the long term. 48 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Measures of Government deficit - Revenue Deficit, Fiscal Deficit, Primary Deficit o Revenue Deficit: This occurs when the government's revenue expenditure exceeds its revenue receipts. It indicates that the government is spending more on day-to-day operations and services than it is earning from taxes and other revenue sources. Revenue deficit highlights a gap in covering routine expenses with current income. Revenue Deficit = Revenue Expenditure — Revenue Receipts o Fiscal Deficit: This is the difference between the government's total expenditure and its total revenue, excluding borrowings. It represents the total amount the government needs to borrow to cover its budgetary gap. A fiscal deficit indicates that the government's spending exceeds its total revenue and is a broader measure of deficit than the revenue deficit. Fiscal Deficit = Total Expenditure — Total Revenue o Primary Deficit: This measures the fiscal deficit minus interest payments on previous borrowings. It shows the government's fiscal position excluding the cost of servicing existing debt. A primary deficit indicates whether the government is borrowing to cover current expenditure or just to pay interest on past borrowings. PRIMARY DEFICIT = FISCAL DEFICIT — INTEREST PAYMENT Comparative Table: Capital Receipts and Revenue Receipts Parameters Capital Receipts Revenue Receipts Capital receipts refer to those related Revenue receipts refer to those Meaning to the capital transactions of an related to the day-to-day operations organization or a government. of an organization or a government. Capital receipts come from sources Revenue receipts come from taxes, Sources such as the sale of assets, borrowing, fees, and fines. and capital grants. Capital receipts are used for long-term Revenue receipts are used for Purpose investments, such as building recurring expenses, such as salaries, infrastructure or acquiring fixed assets. maintenance, and services. 49 ADMISSION GOING ON BCOM SEMESTER 2 PRO BATCH BCOM SEMESTER 2 [CCF] JAI SIYA RAM [NEW SYLLABUS] MACROECONOMICS FOR ADMISSION: WHATSAPP 6291137153 Capital receipts have a long-term Revenue receipts have a short-term Duration impact on an organization's finances. impact. Capital receipts are considered capital Revenue receipts are considered Nature in nature. revenue in nature. Capital receipts are shown on an Revenue receipts are shown on the Treatment organization’s balance sheet. income statement. Accounting Capital receipts are recorded as capital Revenue receipts are recorded as Treatment reserves or surplus. reserves or surplus. Capital receipts increase an Revenue receipts increase the Effect organization's capital base. revenue base of an organization. Difference between Primary Deficit and Fisca