ECONOMICS

STANDARD TWELVE

Prof.Viraja R Kanawally
MBA,MA Economics,(Phd)

2020
 Class 12 Economics

Competency Statement
 Explains the subject matter of Micro and Macro Economics.
 Explains the features of Micro and Macro Economics.
 Explains the importance of the study of Micro and Macro Economics in practice.
 Defines Total utility and Marginal utility.
 Explains the Law of Diminishing Marginal Utility with the help of a table and diagram.
 Examines cardinal approach to the measurement of utility.
 Defines the concept of Demand.
 Explains the Law of Demand with the help of a demand schedule and a demand curve.
 Defines the concepts of Price, Income and Cross-elasticity of demand.
 Analyses the various types of price elasticity of demand with illustrations.
 Applies quantitative skills to measure price elasticity of demand.
 Defines the concept of Supply.
 Explains the Law of Supply with the help of a supply schedule and a supply curve.
 Defines various Revenue and Cost concepts and derives their calculations.
 Defines Market.
 Defines Perfect Competition, Monopoly, Oligopoly and Monopolistic Competition.
 Explains the features of different market structures.
 Explains Equilibrium Price with the help of a suitable illustration.
 Defines Index Numbers and examines its features.
 Differentiates between Simple and Weighted Index Numbers.
 Explains the steps in the construction of Index Numbers.
 Applies quantitative skills to calculate Simple and Weighted Index Numbers.
 Defines National Income.
 Explains the concepts of GDP, GNP, NDP and NNP.
 Explains the Output, Income and Expenditure methods of computing National Income.
 Examines the structure of Public Finance.
 Defines Public Revenue, Public Expenditure and Public Debt.
 Analyzes the Tax and Non-Tax Sources of Public Revenue.
 Examines the causes of rising Public Expenditure in India.
 Defines Fiscal policy and Budget.
 Explains the meaning and classification of Financial Markets.
 Explains the structure of Money market and Capital market in India.
 Defines Central Bank and Commercial Bank.
 Explains the functions of Central Bank and Commercial Bank.
 Examines the role and problems of Money market and Capital market in India.
 Explains the reforms introduced in the Money and Capital markets in India.
 Explains the role of Foreign Trade with reference to India.
 Explains the Composition and Direction of India’s foreign trade.
 Defines the concepts of Balance of Payments and Balance of Trade.
 Contents

Tentative number
Sr. No. Name of the Chapter Page No.
of periods
INTRODUCTION TO MICRO AND MACRO
1. 1–7 10
ECONOMICS

2. UTILITY ANALYSIS 8 – 16 10

3. A DEMAND ANALYSIS 17 – 26 10

3. B ELASTICITY OF DEMAND 27 – 36 10

4. SUPPLY ANALYSIS 37 – 45 12

5. FORMS OF MARKET 46 – 52 10

6. INDEX NUMBERS 53 – 60 10

7. NATIONAL INCOME 61 – 69 16

8. PUBLIC FINANCE IN INDIA 70 – 80 16

MONEY MARKET AND CAPITAL MARKET

9. 81 – 92 16
IN INDIA

10. FOREIGN TRADE OF INDIA 93 – 98 10

 GLOSSARY OF ECONOMIC TERMS

  LIST OF ABBREVIATIONS 99 – 104 Total : 130
 REFERENCES, IMPORTANT WEBSITES/LINKS

DISCLAIMER Note : All attempts have been made to contact copy right/s (©) but we have not heard from them. We will
be pleased to acknowledge the copy right holder (s) in our next edition if we learn from them.

Front Page : Students of Std. XI have now come to Std. XII. They are going to study Economics as an
independent subject. The front cover is a visual presentation of different economic concepts discussed in the
textbook.
Back Page : It shows various economic activities and symbolic representation of different financial institutions.
 1 Introduction to Micro Economics and Macro Economics

Let's recall : likely the first person to have referred to

You have already studied in Class XI, the study of individual firm and producer
the meaning and definitions of economics as “Microeconomics.” Moreover, he
given by different economists. referred to the study of the aggregate
economy as “Macroeconomics.”

You should know :

Historical review of Micro Economics :
Micro Economic analysis was developed
first. It is a traditional approach. Origin
of this approach can be traced back to the
era of Classical Economists- Adam Smith,
David Ricardo, J. S. Mill etc.
Fig. 1.1 It was popularized by Neo-Classical
Introduction : Economist, Prof. Alfred Marshall in his
Micro economics and Macro economics book, 'Principles of Economics', published
are the two main branches of modern in 1890. Other economists like Prof. Pigou,
economics. The term ‘micro’ is derived from J. R. Hicks, Prof. Samuelson, Mrs. Joan
the Greek word, ‘Mikros’ which means small or Robinson, etc. have also contributed to the
a millionth part. The term ‘macro’ is derived development of Micro Economics.
from the Greek word, ‘Makros’ which means Historical Review of Macro Economics :
large. These terms were coined by Norwegian Macro Economics did exist in the past
Economist Ragnar Frisch of Oslo University in before the evolution of Micro Economics.
1933. In the 16th and 17th century, followers
Main Branches of Economics of Mercantilists (a group of English
merchants) advocated policies to the
Micro Economics Macro Economics government which were based on macro
approach. In the 18th century, Physiocrats
Do you know? (French Thinkers) tried to analyse the
Ragnar Anton Kittil Frisch (1895-1973), concept of national income and wealth.
a Norwegian econometrician Even the Classical Economic theories
and economist was a joint of Prof. Adam Smith, Prof. Ricardo and
winner with Jan Tinbergen Prof. J. S. Mill discussed the determination
of the first Nobel Prize for of national income and wealth. But their
Economics in 1969. He was macro analysis was combined with micro
a pioneer of econometrics- analysis. Thus, micro analysis ruled the
the application of mathematical models and world of economics till the Great
statistical techniques to economic data and Depression of 1930s.
theories. He coined many economic terms. After the Great Depression, Lord John
In an article on business cycles, Frisch was

1
Maynard Keynes published his famous book the (a) Theory of Product Pricing : The price of
"General Theory of Employment, Interest and an individual commodity is determined by
Money" in 1936. Keynes used macro economic the market forces of demand and supply.
approch to analyse economic problems. The Micro economics is concerned with
credit for the development of macro economic demand analysis i.e. individual consumer
approach goes to Lord Keynes. Besides Keynes, behaviour, and supply analysis i.e.
Malthus, Wicksell, Walras, Irving Fisher are other individual producer behaviour.
economists who have contributed to the (b) Theory of Factor Pricing : In Micro
development of macro economics. economics, land, labour, capital and
entrepreneur are the factors that contribute
to the production process. Micro
Meaning of Micro Economics : economics helps in determining the factor
Micro means a small part of a thing. Micro rewards for land, labour, capital, and
economics thus deals with a small part of the
entrepreneur in the form of rent, wages,
national economy. It studies the economic
interest, and profit respectively.
actions and behaviour of individual units such
as an individual consumer, individual producer (c) Theory of Economic Welfare : Theory of
or a firm, the price of a particular commodity or Welfare basically deals with efficiency in
a factor etc. the allocation of resources. Efficiency in
Definitions of Micro Economics : the allocation of resources is attained when
You have already studied some important it results in maximization of satisfaction of
definitions of micro economics, let us review the people. Economic efficiency involves
some more definitions : three efficiencies :
1) Maurice Dobb - “Micro economics is in • Efficiency in production : Efficiency in
fact a microscopic study of the economy.” production means producing maximum
2) Prof A. P. Lerner - “Micro economics possible amount of goods and services
consists of looking at the economy through from the given amount of resources.
a microscope, as it were, to see how the • Efficiency in consumption : Efficiency
millions of cells in the body of economy – in consumption means distribution of
the individuals or households as consumers produced goods and services among the
and individuals or firms as producers play people for consumption in such a way as to
their part in the working of the whole maximize total satisfaction of the society.
economic organism.” The following chart • Overall economic efficiency : It means the
gives an idea of the scope of micro production of those goods which are most
economics. desired by the people.
Scope of Micro Economics
Micro economic theory shows under what
T t D pply Analysis
he P e Analysis
or r m
y i a
of c n
Pr i d
o n
d g S
uc u
2
 Theory of Th c iencies are deals with assumption,
Factor eor o achieved. determination of “Other things
Pricing y n Thus, the the prices of remaining
Rent of
d focus of
Wag Ec goods and constant” (Ceteris
on it
es micro services as well Paribus) such as
Inter om i
ic o economics is as factors of perfect
est
Profi We n mainly production. competition,
t lfar s confined to
e Hence, it is laissez-faire
t price theory known as price policy, pure
h
and resource theory. capitalism, full
e
s allocation. It 3) Partial employment etc.
e does not study Equilibrium : These assumptions
e the aggregates Equilibrium is make the analysis
ff relating to the the balance simple.
i
whole between two 5) Slicing Method :
c
economy. factors. Micro Micro economics
Eff
Effi Overa This approach economic uses slicing
ic does not study
cien ll analysis deals method. It splits or
ie
cy in E national with partial divides the whole
n
Cons c economic
c equilibrium economy into
umpt o
y
ion n
problems such as
in which analyses small individual
o unemployment,
P
m equilibrium units and then
ro studies each unit
ic position of an
d
E individual separately in
u
ff
ct economic unit detail. For
ic
io
ie i.e. individual example, study of
n
n
c
consumer, individual income
y individual firm, out of national
poverty, 1) Study of individual income, study of
inequality of Individual Units industry etc. It individual demand
income etc. : Micro isolates an out of aggregate
Theory of economics is the individual unit demand etc.
growth, theory study of the from other forces 6) Use of
of business behaviour of and studies its Marginalism
cycles, monetary small individual equilibrium Principle : The
and fiscal economic units, independently. concept of
policies etc. are like individual 4) Based on Marginalism is
beyond the firm, individual Certain the key tool of
limits of micro price, individual Assumptions : micro economic
economics. household etc. Micro economics analysis. The term
Features of Micro 2) Price Theory : begins with the 'marginal' means
Economics : Micro economics fundamental change brought in

3
total by an additional poverty, to produce?
unit. Marginal unemployment etc.’ are taken at
analysis helps , population, individual
to study a economic levels. There is
variable growth etc. no intervention
through the Importance of Micro by the
changes. Economics : Government or
Producers and 1) Price any other
consumers take Determinatio agency.
economic n : Micro 3) Foreign
decisions using economics Trade : Micro
this principle. explains how economics helps
7) Analysis of the prices of in explaining
Market different various aspects
Structure : products and of foreign trade
Micro various factors like effects of
economics of production tariff on a
analyses are particular
different determined. commodity,
market 2) Free Market determination
structures such Economy : of currency
as Perfect Micro exchange rates
Competition, economics of any two
Monopoly, helps in countries, gains
Monopolistic understanding from
Competition, the working of international
Oligopoly etc. a free market trade to a
8) Limited Scope economy. A particular
: The scope of free market country etc.
micro economy is 4) Economic
economics is that economy Model
limited to only where the Building :
individual economic Micro
units. It doesn’t decisions economics helps
deal with the regarding in
nationwide production of understanding
economic goods, such as various
problems such ‘What to complex
as inflation, produce?, How economic
deflation, much to situations with
balance of produce?, How the help
payments,
of economic models. It has
4
 made a valuable v n n
2) Prof Carl
e t c
contribution to Shapiro - s t
economics by “Macro t F i
developing economics m u o
e n
various terms, deals with the
concepts, government in branch of economics
functioning of
terminologies, framing which analyses the
the economy as
tools of economic entire economy. It
a whole.”
economic policies such as deals with the total
The following taxation policy, employment, national
analysis etc. chart gives an
Economic public income, national
idea about the expenditure output, total
models are built scope of macro
using various policy, price investment, total
economics. policy etc. These consumption, total
economic Scope of
variables. Macro policies help the savings, general price
Economics government to level interest rates,
5) Business
attain its goals inflation, trade cycles,
Decisions :
of efficient business fluctuations
Micro economic
allocation of etc. Thus, macro
theories are
resources and economics is the study
helpful to
promoting of aggregates.
businessmen for
T Th The Ma economic
taking crucial Definitions of Macro
he eor ory cro welfare of the
business or y of Th Economics :
y of Eco society.
decisions. These of
eor 1) J. L. Hansen -
Ge nom y
decisions are Inc ner 7) Basis of Welfare “Macro economics
ic of
ome al Economics : is that branch of
related to the Gro Di
and Pri
determination of wth stri Micro economics economics which
Em ce and but explains how
cost of plo Le Dev
considers the
yme ion
production, vel elop best results can relationship
nt and
determination of ment be obtained between large
Infl
prices of goods, atio through aggregates such as
n optimum the volume of
maximization of
output utilization of employment, total
and profit, etc. The T resources and its amount of savings,
ory h best allocation. It investment,
6) Useful to of e
Con
also studies how national income
Government : o
It is useful to sum r taxes affect etc.”
ptio y social welfare.
n
Fun Meaning of Macro
o
ctio Economics :
f
n
Macro
I
economics is the
n
5
 is determined, development. It growth and
T
h we have to study explains the development.
e the consumption causes of iv) Macro Theory
o function and underdevelopm
r
of Distribution :
y investment ent and poverty. Macro theory of
function. Theory It also suggests distribution deals
o of Business strategies for with the relative
f
Cycles is also a accelerating
B part and parcel shares of rent, social accounting.
u of the Theory of wages, interest Macro economics
s
Income and and profit in the deals with
i
n Employment. total national aggregate demand
e ii) Theory of income. and aggregate
s
s General Price Features of Macro supply. It explains
Level and Economics : the causes of
C Inflation : fluctuations in the
y 1) Study of
Macro economic Aggregates : national income
c
l analysis shows Macro that lead to
e how the general economics deals business cycles
s
price level is with the study of i.e. inflation and
i) Theory of determined and deflation.
economy as a
Income and further explains whole. It is 3) General
Employment : what causes concerned with Equilibrium
Macro fluctuations in it. the aggregate Analysis : Macro
economic The study of concepts such as economics deals
analysis general price national income, with the behaviour
explains which level is national output, of large
factors significant on national aggregates and
determine the account of the employment, their functional
level of problems general price relationship.
national created by level, business General
income and inflation and cycles etc. Equilibrium deals
employment deflation.
2) Income Theory : with the behaviour
and what
iii) Theory of of demand, supply
causes Macro
Growth and and prices in the
fluctuations in economics
Development : whole economy.
the level of studies the
Macro 4) Interdependence
income, output concept of
economics : Macro analysis
and national income,
consists of the takes into account
employment. its different
theory of interdependence
To understand, elements,
economic between aggregate
how the level methods of
growth and economic
of employment measurement and
6
 variables, such 6) Growth Models : various factors policy oriented
as income, Macro economics
that contribute science. It
output, studies
to economic suggests
employment, growth and suitable
investments, development. economic
price level etc. It is useful in policies to
For example, developing promote
changes in the growth economic
level of models. These growth,
investment will growth models generate
finally result are used for employment,
into changes in studying control of
the levels of economic inflation, and
income, levels development. depression etc.
of output, For example, Importance of
employment and Mahalanobis Macroeconomics :
eventually the growth model 1) Functioning of
level of emphasized on an Economy :
economic basic heavy Macro
growth. industries. economic
5) Lumping 7) General Price analysis gives
Method : Level : us an idea of the
Lumping Determination functioning of
method is the and changes in an economic
study of the general price system. It helps
whole economy level are us to
rather than its studied in understand the
part. According macroeconomi behaviour
to Prof. cs. General pattern of
Boulding, price level is aggregative
“Forest is an the average of variables in a
aggregation of all prices of large and
trees but it does goods and complex
not reveal the services economic
properties of an currently being system.
individual tree.” produced in 2) Economic
This reveals the the economy. Fluctuations :
difference 8) Policy- Macro
between micro oriented : economics helps
economics and According to to analyse the
macro Keynes, macro causes of
economics. economics is a fluctuations in
7
 income, as poverty,
output and inequalities of
employment income and
and makes an wealth,
attempt to differences in
control them the standards
or reduce their of living of the
severity.
3) National
Income :
Study of
macro
economics has
brought
forward the
immense
importance of
the study of
national
income and
social
accounts.
Without a
study of
national
income, it is
not possible to
formulate
correct
economic
policies.
4) Economic
Development
: Advanced
studies in
macro
economics
help to
understand the
problems of
developing
countries such
8
 people etc. It suggests important steps to
achieve economic development. Tools Individual Aggregate
5) Performance of an Economy : Macro Demand and Demand and
economics helps us to analyse the Individual Aggregate
performance of an economy. National Supply Supply
Scope Demand, National
Income (NI) estimates are used to measure
supply, prod- income,
the performance of an economy over time
uct pricing, general
by comparing the production of goods and
factor pricing, price level,
services in one period with that of the other
production, employment,
period.
consumption, money etc.
6) Study of Macro economic Variables : To economic
understand the working of the economy, welfare, etc.
study of macro economic variables are Importance Price Economic
important. Main economic problems are determination, fluctuations,
related to the economic variables such Model Study of
as behaviour of total income, output, building, national
employment and general price level in the Business income,
economy. decisions etc. Economic
7) Level of Employment : Macro economics development
helps to analyse the general level of etc.
employment and output in an economy. Theory Price Theory Income and
Employment
Theory
You should knowand: Macro Examples Individual National
Micro Economics
Economics at a glance income, income,
Basis for Micro Macro Individual National
comparison economics economics output etc. output etc.
Try this :
Meaning Micro Macro
economics economics 1) Visit the vegetable market in
studies the studies the the nearest area and try to get
behaviour of behaviour of information about income and
individual aggregates of expenditure items of a particular
unit of an the economy seller
economy as a whole
 EXERCISE

Q. 1. Choose the correct option :

4) Makros : Macro economics : : Mikros :
1) The branch of economics that deals with the
5) General equilibrium : Macro economics ::
allocation of resources.
: Micro economics
a) Micro economics b) Macro economics
c) Econometrics d) None of these Q. 3. Identify and explain the concepts from the
given illustrations :
Options :1) a, b and c 2) a and b
1) Gauri collected the information about the
3) only a 4) None of these
income of a particular firm.
2) Concepts studied under Micro economics.
2) Ramesh decided to take all decisions related to
a) National income b) General price level production, such as what and how to produce?
c) Factor pricing d) Product pricing 3) Shabana paid wages to workers in her factory
Options :1) b and c 2) b, c and d and interest on her bank loan.
3) a, b and c 4) c and d
Q. 4. Answer the following :
3) Method adopted in micro economic analysis. 1) Explain the features of Micro economics.
a) Lumping method b)Aggregative method
2) Explain the importance of Macro economics.
c) Slicing method d) Inclusive method
3) Explain the scope of Macro economics.
Options :1) a, c and d 2) a, b and d
3) only c 4) only a Q. 5. State with reasons whether you agree or
disagree with the following statements :
4) Concepts studied under Macro economics.
1) The scope of micro economics is unlimited.
a) Whole economy b) Economic development
2) Macro economics deals with the study of
c) Aggregate supply d) Product pricing
individual behaviour.
Options :1) a, b and c 2) b, c and d
3) Macro economics is different from micro
3) only d 4) a, b, c and d
economics.
Q. 2. Complete the correlation : 4) Micro economics uses slicing method.
1) Micro economics : Slicing method : : Macro
5) Micro economics is known as Income theory.
economics :
2) Micro economics : Tree : : Macro economics : Q. 6. Answer in detail :
1) Explain the importance of Micro economics.
3) Macro economic theory : Income and 2) Explain the concept of Macro economics and
employment : : Micro economics : its features.


 2 Utility Analysis

Let's recall : 2) Subjective concept : It is a psychological

1) Want denotes a feeling of lack of concept. Utility differs from person to
satisfaction. person. This is due to differences in taste,
2) Wants are unlimited. preferences, likes, dislikes, nature, habits,
3) They are recurring in nature. profession etc. For example, stethoscope
4) They differ with age, gender, seasons, has utility to a doctor but not to a layman.
habits and culture. 3) Ethically neutral concept : The concept
5) Utility is the capacity of a commodity of utility has no ethical consideration. It is
to satisfy human wants. In other words, a morally colourless concept. The
utility is the want satisfying power of a commodity should satisfy any want of a
good. person without consideration of what is
good or bad, desirable or undesirable. For
Introduction : example, a knife has utility to cut fruits and
You have been already introduced to the vegetables as well as it can be used to harm
concept of utility in class XI. This unit gives a someone. Both wants are of different
detailed explanation of consumer’s behaviour. nature but are satisfied by the same
In practice, every individual tries to commodity. Thus, utility is ethically
satisfy his wants with available resources. neutral.
It is true that all human wants cannot be 4) Utility differs from usefulness : Utility
satisfied fully at a specific time. Utility analysis is the capacity of a commodity to satisfy
explains a consumer’s behaviour in relation to human wants, whereas usefulness indicates
maximization of satisfaction. value in use of the commodity. For
example, milk has both utility as well as
usefulness to a consumer, while liquor has
utility only to an addict, but has no
Try this :
usefulness.
Make a list of 10 commodities which satisfy 5) Utility differs from pleasure : A
your wants. commodity may possess utility but it may
Make a list of 10 commodities which satisfy not give any pleasure to the consumer. For
the wants of particular individuals example, injection for a patient has utility
performing specific because it cures the ailment but it hardly
Features of Utility : activities. For example, A
chalk has utility gives any enjoyment or pleasure to him.
Following are for
the afeatures
teacher.
of utility :
6) Utility differs from satisfaction : Utility
1) Relative concept : Utility is related to is a cause of consumption, satisfaction is
time and place. It varies from time to the end result of consumption. They are
time and place to place. For example, (i) interrelated but still different concepts. For
woollen clothes have a greater utility in the example, a thirsty person drinks a glass
winter. (ii) sand has greater utility at the of water since water has the capacity to
construction site than at the sea shore. satisfy thirst. Utility of water is the cause
 of consumption and the satisfaction derived is the end result of consumption.
7) Measurement of utility is hypothetical : from wood
Utility is an abstract concept. Cardinal or etc.
numerical measurement of utility is not
possible. For example, a thirsty person
after drinking water, may derive higher or
lower level of utility. Thus, utility can only
be experienced and found either positive,
zero or negative. Negative utility is called
disutility.
8) Utility is multi-purpose : A commodity Fig. 2.1
can satisfy the want of more than one
person, it can also be put to several uses.
For example, electricity can be used to
serve many purposes and for many people
at some point of time.
9) Utility depends on the intensity of want :
Utility depends on the intensity of a want.
More intense the want, greater will be the
utility. As and when the urgency of want
declines, utility diminishes. For example,
a hungry person finds more utility in food,
than a person who is not hungry.
10) Utility is the basis of demand : A person
will demand a commodity only if it gives
utility to him. For example, a sick person
has utility in medicines hence, he demands
medicines.
Types of Utility :
Following are some of the different types of
utility
1) Form utility : When utility is created due
to a change in the shape or structure of an
existing material, it is called form utility.
For example, toys made of clay, furniture
2) Place utility : When utility of a
commodity increases due to a change in
its place, it is called place utilities. For
example, woollen clothes have more
utility at cold places than at warm places.
Transport creates place utility.

Fig. 2.2
3) Service utility : Service utility arises
when personal services are rendered by
various professionals. For example,
services of doctors, teachers, lawyers etc.

Fig. 2.3
4) Knowledge utility : When a consumer
acquires knowledge about a particular
product, it is called knowled uitility. For
example, utility of a mobile phone or a
computer increases when a person knows
about its various functions.

Fig. 2.4
5) Possession utility : Possession utility Try this :
arises when the ownership of goods is Following are the various types
transferred from one person to another. For of utility and their respective
example, transfer of goods from the sellers examples. Arrange the
to the buyers. information in the form of pairs:
Types of utility : Time utility,
possession utility, service utility
and place utility.
Examples : 1) A dentist giving
dental treatment to a patient.
A mountaineer using oxygen
Fig. 2.5 cylinder at a high altitude.
6) Time utility : When the utility of a A farmer selling rice stored in
commodity increases with a change in its the warehouse at the end of the
time of utilization, it is called time utility. season.
Concepts of Utility :
For example, a student has more utility for A retail trader purchasing 100
Following are the two main concepts of
text books during examinations than in the chairs from the wholesale
utility :
vacations. Time utility is also observed trader.
1) Total Utility (TU) : Total utility refers
when goods are stored and used at the time
to the aggregate of utility derived by the
of scarcity. For example, Blood bank.
consumer from all units of a commodity
consumed. It is an aggregate of utilities
from all successive units of a commodity
consumed.
2) Marginal Utility (MU) : Marginal utility
refers to the additional utility derived by
a consumer from an additional unit of a
commodity consumed. In other words, it
is the addition made by the last unit of a
Fig. 2.6 A
commodity consumed.

Fig. 2.6 B Fig. 2.6 C Fig. 2.6 D

 TU Curve = Total Utility Curve
You should know :
MU Curve = Marginal Utility Curve
Formulaeexplainingtherelationship between
total utility and marginal utility : TU =  MU X axis measures the units of the
or commodity consumed while Y axis indicates
TU =M U 1 + M U 2 + MU3+ MUn the figures of total and marginal utility.
MUn = TUn – TU (–1) n–1)
Fig. 2.7 shows that total utility curve slopes
W hereTU = ==TotalU tility M U = M arginal
upwards whereas marginal utility curve slopes
Utility
downwards. Marginal utility curve shows zero
MU1, M U 2, MU3 = Marginal Utility of each
MU n= Marginal Utility of n unit.
unit.
th and negative levels of marginal utility whereas
TU
n = Total Utility at nth level. total utility curve shows maximum and constant
TU(n–1) = Total Utility at previous level. total utility level.
Relationship between Total Utility and 1) Total utility and marginal utility of the very
Marginal Utility : first unit of x consumed, are the same.
Marginal utility derived from various 2) As the consumer consumes further
units of a commodity and its total utility are units of x, the total utility increases at a
interrelated. This can be easily followed from diminishing rate and marginal utility goes
the hypothetical example given in the table 2.1 on diminishing. (TU🡑 MU🡓)
Table 2.1 Utility Schedule 3) At a particular stage, total utility reaches to
Units of x Total utility Marginal utility
1 10 10 its maximum and remains constant whereas
2 18 8 marginal utility becomes zero. This is
3 24 6 called the point of satiety. (TU highest,
4 28 4
5 30 2 MU = 0)
6 30 0 4) After this point, any additional unit
7 28 –2
consumed further results in a decline in the
Table 2.1 explains the relationship between total utility, while marginal utility becomes
total utility and marginal utility.
negative. (TU🡓 MU negative)
On the basis of Table 2.1 Total utility and
Marginal Utility curves (TU and MU) can be 5) After reaching the point of satiety, a
derived with the following diagram. rational consumer should stop his
consumption since the maximum limit of
satisfaction is reached and there is no
Y
32
Point of satiety addition
utility by anyto total increase in the stock of a
further
S
28 commodity.
TU
Curve 6) Consumption beyond the point of satiety
Total and Marginal utility

24
transforms satisfaction into dissatisfaction.
20
In othe words, a consume start
16 r r s
experiencing ill effects of consumption.
12
Try this :
8
Complete the following chart with proper
4
statement and bring about the difference
0 1234 567 X between the two concepts i.e total utility
MU
-4
Disutility Curve and marginal utility.
Units of Commodity x Fig. 2.7
11
 which a person derives from a given increase
Total Utility Marginal Utility in his stock of a thing, diminishes with every
1) Total utility is the 1) Marginal utility is increase in the stock that he already has.”
sum total of the the addition made In other words, marginal utility that any
individual utilities to the total utility
consumer derives from successive units of a
derived from the from every
particular commodity goes on diminishing as
consumption of a additional unit
single unit of good. consumed. his or her total consumption of that commodity
2) Total utility 2) increases. In short, the more of a thing you
increases at a have, the less you want to have more of it.
diminishing rate. Assumptions :
3) 3) At the point of Following are the assumptions of the law
satiety MU = O
of diminishing marginal utility :
4) Total utility declines 4) 1) Rationality : Consumer is assumed to
if consumption be rational. It means that his behaviour
continues. is normal and he tries to maximize his
satisfaction.
5) Total utility deter- 5)
2) Cardinal measurement : The law
mines value in use of a
commodity.
assumes that utility can be cardinally or
6) Marginal utility numerically measured. Hence,
6)
can be positive, mathematical operations are easily possible
negative, zero. to know and compare the utility derived
7) Diagram : 7) Diagram : from each unit of a commodity.
y 3) Homogeneity : All units of a commodity
consumed are exactly homogeneous or
4
TU

identical in size, shape, colour, taste etc.

TU curve
2 4) Continuity : All units of commodity are
Unitsx consumed in quick succession without any
0
lapse of time.
Law of Diminishing Marginal Utility : 5) Reasonability : All the units of a
Introduction : commodity consumed are of reasonable
This law was first proposed by Prof. size. They are neither too big nor too small.
Gossen but was discussed in that utility derived
detail by Prof. Alfred diminishes with the
Marshall in his book reduction in the
‘Principles of intensity of a want.
Economics’ published Statement of the
in 1890. Law :
The law of According to Prof.
diminishing marginal Alfred Marshall,
utility is universal in “Other things
character. It is based remaining constant, the
on the common additional benefit
consumer behaviour
12
6) Constancy : assumes that are plotted on the brings disutility
All the related the commodity graph as per the given (negative utility)
factors like consumed by schedule. When the which is shown by
income, tastes, the consumer is locus of all the points the shaded portion in
habits, choices, divisible so that is joined, MU curve is the diagram.
likes, dislikes it can be derived.
Exceptions to the
of a consumer acquired in
MU curve slopes Law of Diminishing
should remain small
downwards from left Marginal Utility :
constant. quantities.
to right which shows
Marginal 8) Single want : Following are
that MU goes on
utility of A given the exceptions to the
diminishing with
money is also commodity can law of diminishing
every successive
assumed to be satisfy a single marginal utility :
increase in the
constant. want of a 1) Hobbies : In
consumption of a
7) Divisibility : person. The commodity. certain hobbies
The law law like collection of
When MU
assumes an it becomes zero and becomes zero, MU various stamps
experience of a then negative. curve intercepts the X and coins, rare
single want axis. Further paintings, music,
which is consumption of a reading etc., the
completely commodity law does not
satiable at a hold true
given point of because every
time. additional
Table 2.2 increase in the
explains the Law stock gives more
of Diminishing pleasure. This
Marginal Utility. increases
Ta marginal utility.
ble Units of Commodity x However, this
: Fig. 2.8 violates the
2.2
Expla assumption of
Units of x Marginal
natio homogeneity
1 n of and continuity.
2 the
3 Diagr 2) Miser : In the
4 am : case of a miser,
5 In the above every additional
6 rupee gives him
diagram, units of
7
commodity x are more and more
The table shows satisfaction.
measured on X axis
that marginal utility Marginal utility
and marginal utility is
keeps on diminishing of money tends
measured on Y axis.
with increase in to increase with
Various points of MU
consumption,
Y further MU = Marginal Utility
MU an increase in
Curve 13
10
8
utility
 4

2
his stock of power, his lust hence, they are 3) Indivisible goods :
0 1234567 X
money. for power
MU not real The law is not
-2 Disutilit
However, this increases. He exceptions. applicable to
y
situation desires to have Criticisms of the Law indivisible and
ignores the more and more : bulky goods like
assumption of of it. However, refrigerator, car,
The law of
rationality. this again TV sets etc. which
diminishing marginal
violates the are normally
3) Addictions : utility is criticised on
rationality purchased in single
It is observed the following grounds.
assumption. unit at a time.
in case of a 1) Unrealistic
drunkard that 5) Money : It is 4) Constant
assumptions :
the level of said that the marginal utility of
The law of
intoxication MU of money money : The law
diminishing
increases with never becomes assumes that MU
marginal utility is
every zero. It of each unit of
based upon
additional unit increases when money remains
various
of liquor the stock of constant. However,
assumptions like
consumed. So money critics argue that
homogeneity,
MU received increases. This MU of money
continuity,
by drunkard is because differs from person
constancy,
may increase. money is a to person. It is
rationality etc.
Actually it is medium of influenced by
but in reality it is
only an exchange changes in prices,
difficult to fulfil
illusion. This which is used stock of money etc.
all these
condition is to satisfy conditions at a 5) A single want :
similar to various wants. point of time. The law is
almost all However, restricted to the
2) Cardinal
addictions. according to satisfaction of a
measurement :
However, this some single want at a
The law assumes
violates the economists, point of time.
that utility can
assumption of this law is However, in
be expressed
rationality. applicable to reality, a man has
cardinally so it
4) Power : This money too. For to satisfy many
can be added,
is an example, wants at a point of
compared and
exception to marginal utility time.
presented through
the law of money is
a schedule. In Significance of the
because when more to a poor Law :
reality cardinal
a person person than to In spite of the
measurement of
acquires a rich person. criticisms, the law of
utility is not
However, these, violate some or possible because diminishing marginal
exceptions are the other utility is a utility is a very popular
only apparent. assumptions of psychological and an important law in
Since they the law and concept. Economics because of

14
its universal resources, it is demand : The Relationship
application. necessary to law of demand between Marginal
1) Usefulness to ‘diversify’ the is based on the Utility and Price :
the consumers : consumption. law of Let us discuss
This law creates diminishing the relationship
2) Useful to the
awareness marginal between marginal
government :
among the utility. utility and price in
The law is
consumers. To According to order to understand
useful to the
obtain maximum the law of how the law of
government in
utility from the demand, the diminishing marginal
framing various
limited quantity utility forms the basis
policies such as
demanded of a of law of demand. It
progressive tax
good rises with is a perfect example
policy, trade
a fall in price of practical
policy, pricing
and falls with application of the law
policy etc.
an increase in of Diminishing
3) Basis of price. When a Marginal Utility
paradox of consumer (DMU).
values : The purchases more To understand
law of and more units the relation, it is
diminishing of a good, its essential to convert
marginal marginal utility marginal utility in
utility helps steadily terms of money so
us to declines. that it can be
understand the Hence, he compared with
paradox of would buy market price.
values. It additional units Let us assume : One
includes goods of a unit of marginal utility
that have more commodity =
value-in-use only at a lower ` 10.
and zero or less price. Market price per
value-in-
unit of x = ` 50.
exchange such Try this :
as air, water, Write an informative note on paradox of values
sunshine etc. as along with examples.
well as goods
that have more Table 2.3 3 7 70 (7 × ` 10 ) ` 50
value-in- No MU/ MU in terms 4 5 50 (5 × ` 10 ) ` 50
exchange and of units of money
unit of x 1unit = ` 10 5 3 30 (3 × ` 10 ) ` 50
less value-in-
s 6 1
use such as 10 (1 × ` 10 ) ` 50
1 10 100 (10 × `10
gold, diamonds Table 2.3 explains
)
etc. the relationship
2 8 80 (8 × ` 10 )
4) Basis of law of between marginal

15
utility (MU) and A rational consumer marginal utility and
price. will not buy further price :
The table once the equality 1) Units which a
shows that a between marginal consumer
consumer starts utility and price is willingly buys
buying units of established. because MU is
commodity x for his From the given greater than
consumption, one table 2.3, following price are called
after the other. inferences can be “Intra-marginal
Marginal utility made with reference units”
which is added to his to (MUx>Px)
stock goes on 2) Unit at
diminishing with which MU
every further unit becomes
consumed. When equal with
MU is converted in market price is
terms of money, one “marginal
can easily compare it unit”.
with market price (MUx=Px) =
which is shown in the Consumer’s
column 5 of the table equilibrium
2.3
3) Units which a
For the first rational
three units consumer is not
consumed, it is found willing to buy
that marginal utility and consume
in terms of money is where he has to
greater than the price pay more than
paid. A rational the MU are
consumer will called “Extra-
willingly buy these marginal
units since the units.”
benefit derived is (MUx<Px)
more than the price
Thus, a rational
paid. At the 4th unit
consumer attains
marginal utility and
equilibrium where
price become equal.
MUx=Px. This
So the consumer
relationship
can also think of
between marginal
buying the 4th unit. In
utility and price
the case of 5th and 6th Do you know?
paved way for law
units, marginal utility Two English Economists, J. R.
of demand.
derived is less than Hicks
the market price paid. and R. G. D. Allen were the
main exponents of
16
‘Indifference Method’. It
cardinalutilityanaly
was evolved to supersede
sis b Pr Alfr
 Indifference curve
analysis adopts
the concept of
EXERCISE
ordinal utility.
An indifference
Q. 1. A) Complete the following statements by curve is the locus
2) Statments indicating consumer equilibrium :
choosing the correct alternatives. of points
a) MU is greater than price
R.G.D
1) In the law of diminishing marginal utility, a to
result, heindicating
is indifferent to
b) MU is equalAllen price
Alfred Marshall assumes that marginal utility the particular
particular
c) MU is less than price
of money………. combination combinations
that he of
d) Price is less than one
a) increases b) remains constant consumes.two goods from
Options :
c) decreases d) rises and then falls which the
i) a and b ii) a, b, c and d
consumer derives
2) As per the law of diminishing marginal utility, iii) a, b and c iv) only b
the same level of
measurement of utility is assumed to be Q. 3. Identify and explain the concepts from
satisfaction. As the
………. given illustration :
a) ordinal 1) Salma purchased sweater for her father in
b) cardinal winter season.
c) both ordinal and cardinal 2) Nilesh purchased ornaments for his sister.
d) none of the above 3) Kavita consumed five units of oranges one
after the other.
3) MU of the commodity becomes negative when
4) Bhushan refused to eat fifth chapati after eating
TU of a commodity is ……… four chapatis.
a) rising b) constant c) falling d) zero 5) Lalita satisfied her want of writing on essay by
4) Point of Satiety means ………. using pen and notebook.
a) TU is rising and MU is falling Q. 4. Observe the given table and answer the
b) TU is falling and MU is negative questions:
Unit of a commodity TU units MU units
c) TU is maximum and MU is zero
1 6 6
d) MU is falling and TU is rising. 2 11 5
3 15 4
5) When MU is falling, TU is………. 4 15 0
a) rising b) falling 5 14 –1
c) not changing d) maximum 1) Draw total utility curve and marginal utility
curve.
Q. 2. Choose the correct option :
2) a) When total utility is maximum marginal
1) A B
utility is
1) Time utility a) Transport
b) When total utility falls, marginal utility
2) Place utility b) Blood Bank
becomes
3) Service utility c) Mobile phone
4) Knowledge utility d) Doctor Q. 5. Answer in detail :
Options : 1) State and explain the law of diminishing
i) 1-d, 2-b, 3-a, 4-c ii) 1-b, 2-a, 3-d, 4-c marginal utility with exceptions.
iii) 1-a, 2-b, 3-c, 4-d iv) 1-b, 2-c, 3-d, 4-a


3ADemand Analysis

Introduction : Demand Schedule :

You have already studied the concept of Demand schedule is a tabular
utility in the previous chapter. Utility is the representation of the functional relationship
basis of demand. Utility may generate a desire between price and quantity demanded for a
or a need to have a particular commodity, but particular commodity.
utility on its own cannot generate demand for A demand schedule may be either
the commodity. This chapter is an effort to individual demand schedule or market demand
analyse the concept of demand. Demand schedule.
analysis is concerned with consumer behaviour.
Individual Demand Schedule :
Meaning of Demand : Individual demand is the quantity of a
In ordinary language, demand means a commodity demanded by a consumer at a given
desire. Desire means an urge to have something. price during a given period of time.
In Economics, demand means a desire which is Individual demand schedule is a tabular
backed by willingness and ability to pay. representation showing different quantities of
For example, if a person has the desire to commodities that an individual consumer is
purchase a television set but does not have prepared to buy at various prices over a given
the adequate purchasing power then it will be period of time.
simply a desire and not a demand. This can be explained with the help of the
Thus, demand is an effective desire. All following individual demand schedule.
desires are not demand. Individual demand schedule :
In short, Table 3.1
Demand = Desire + willingness to purchase + Price of commodity Quantity demanded of
‘x’ ( ` ) commodity ‘x’ (in kgs)
Ability to pay.
10 1
Try this : 8 2
6 3
Identify the concepts :
4 4
A poor person wants to have a car …… 2 5
A rich person bought a car …… Table 3.1 shows different quantities of
commodity ‘x’ purchased by an individual
Definition of Demand : consumer at various prices. It can be observed
According to Benham, “the demand for that less quantity of commodity is demanded at
anything at a given price is the amount of it, rising prices and more quantity of commodity
which will be bought per unit of time at that is demanded at falling prices. It indicates an
price.” inverse relationship between price and quantity
Thus, following are the features of demand : demanded.
1) Demand is a relative concept. Individual Demand Curve :
2) Demand is essentially expressed with Individual demand curve is a graphical
reference to time and price. representation of the individual demand
 schedule. Fig. 3.1 represents an individual demand curve
which is based on table 3.1 the demand of all consumers at various prices.
Individual Demand Curve It also indicates an inverse relationship between
price and quantity demanded.
Y DD = Demand This can be explained with the help of
D
Curve following market demand schedule.
10
Price in `

8 Market demand schedule :

Table. 3.2
6
Price of Quantity of ‘x’ Market
4 commodity demanded Kgs. demand
D ‘x’( ` ) Con- Con- Con-
2 A+B+C
sumer sumer sumer
A B C
0 1234567X 10 5 10 15 30
Quantity Demanded in (Kgs) 8 10 15 20 45
6 15 20 25 60
Fig. 3.1
4 20 25 30 75
In figure 3.1, X axis represents quantity 2 25 30 35 90
demanded and Y axis represents the price of
Table 3.2 shows different quantities of
the commodity. The demand curve DD slopes
commodity x purchased by different consumers
downward from left to right, indicating an
(A, B, C) at various prices. It can be observed
inverse relationship between price and quantity
that less quantity of commodity is demanded at
demanded.
time. It is obtained by a horizontal summation of

Fig. 3.2 Individual Demand

Market Demand Schedule :
Market demand is total demand for a
commodity from all the consumers at a given
price during a given period of time.
Market demand schedule is a tabular
representation showing different quantities of
commodity which all consumers are prepared to
buy at various prices over a given period of
rising prices and more quantity of
commodity is demanded at falling prices.
Thus, there is an inverse relationship between
price and quantity demanded.
Market Demand Curve :
Graphically, the market demand curve
is a horizontal summation of individual
demand curves. It is based on the market
demand schedule. Fig. 3.3 represents the
market demand curve Quantity Demanded in (Kgs)
Market Demand Curve Fig. 3.3
DD = Market
In figure 3.3, X axis represents market Y Demand Curve
4) Multi-purpose uses : When a commodity
demand and Y axis represents the price of the can be used for satisfying
1 D several needs, its

Price in `
commodity. The market demand curve ‘DD’ demand will rise0with a fall in its price and
slopes downward from left to right, indicating fall with a rise in86its price.
an inverse relationship between price and
5) New Consumers : When the price of a
market demand. 4
commodity falls, a new consumer class
appears who 2can now afford D the
commodity. Thus, total demand for
0 20406080
commodity increases 100
with fall in price.
X
Try this :
Completethefollowinghypothetic
al demand schedule.
Price of Qty.
350 ‘x’(`) Demanded
commodity 3
kgs
300
250 10
Fig. 3.4 Market Demand 200
150
100 30

falls and vice-versa. This implies that demand

curve is downward sloping.
Reasons justifying downward sloping
2) Income effect : In the case of normal goods,
demand curve are as follows :
when price falls, purchasing power (real
1) Law of Diminishing Marginal Utility :
income) of a consumer increases which
We have seen that marginal utility goes on
enables him to buy more of that commodity.
diminishing with an increase in the stock
This is known as income effect.
of a commodity and vice-versa. Therefore,
a consumer tends to buy more when price 3) Substitution effect : In case of substitute
goods, when the price of a commodity rises,
Prepare a monthly demand schedule of your
family for various commodities. For example,
vegetables, fruits, medicines etc.
the consumer tends to buy more of its Types of Demand :
substitute and less of that commodity Direct demand
whose price has increased. This is known
Indirect demand
as substitution effect. Types of
Complementary/ Joint demand
Demand
Composite demand
Competitive demand

1) Direct demand : It is the demand by

the consumer for goods which satisfy
their wants directly. They serve direct
consumption needs of the consumers.
Thus, it is the demand for consumer goods.
For example, demand for cloth, sugar, etc.
2) Indirect demand : Indirect demand is
also known as derived demand. It refers
to demand for goods which are needed
for further production. It is the demand
for producer's goods. Hence, all factors of
production have indirect or derived
demand. For example, demand for workers
in a sugar factory is derived or indirect
demand.
3) Complementary/Joint demand : When Workers in cotton textile
two or more goods are demanded jointly to industry
satisfy a single want, it is known as joint or Joint demand Coffee
Powder
complementary demand. For example, car
For
and fuel etc. preparing
Coffee
4) Composite demand : The demand for a CNG and petrol, pen and
commodity which can be put to several pencil
uses is known as composite demand. For Tea
example, electricity is demanded for Curd
Milk Direct
several uses such as light, fan, washing consumption
machine etc. Sweets
5) Competitive demand : It is demand for
those goods which are substitute for each Determinants of Demand :
other. For example, tea or coffee, sugar or The demand for goods is determined by the
jaggery etc. following factors :
1) Price : Price determines the demand for a
commodity to a large extent. Consumers
prefer to purchase a product in large
Try this :
Type of demand Example quantities when price of a product is less and
Complete the table
Direct demand they purchase a product in small quantities
when price of a product is high. 2) Income : Income of a consumer decides
purchasing power which in turn influences
the demand for the product. Rise in income
will lead to a rise in demand for the
commodity and a fall in income will lead to
a fall in demand for the commodity.
3) Prices of Substitute Goods : If a
substitute good is available at a lower price
then people will demand cheaper substitute
good than costly good. For example, if the
price of sugar rises then demand for
jaggery will rise.
4) Price of Complementary Goods : Change
in the price of one commodity would also
affect the demand for other commodity.
For example, car and fuel. If the price of
fuel rises, then demand for cars will fall.
5) Nature of product : If a commodity is a
necessity and its use is unavoidable, then
its demand will continue to be the same
irrespective of the corresponding price.
For example, medicine to control blood
pressure.
6) Size of population : Larger the size of
population, greater will be the demand
for a commodity and smaller the size of
population smaller will be the demand for
a commodity.
7) Expectations about future prices : If
the consumer expects the price to fall in
future, he will buy less in the present at the
prevailing price. Similarly, if he expects
the price to rise in future, he will buy more
in the present at the prevailing price.
8) Advertisement : Advertisement, sales
promotion scheme and effective sales-
manship tend to change the preferences
of the consumers and lead to demand for
many products. For example, cosmetics,
tooth brush etc.
9) Tastes, Habits and Fashions : Taste and
habits of a consumer influence the demand
 for a commodity. If a consumer likes to
eat chocolates or consume tea, he will Where D = Demand for a commodity
demand more of them. Similarly, when a
new fashion hits the market, the consumer
demands that particular type of
commodity. If a commodity goes out of
fashion then suddenly the demand for that
product tends to fall.
10) Level of Taxation : High rates of taxes on
goods or services would increase the price
of the goods or services. This, in turn
would result in a decrease in demand for
goods or services and vice-versa.
11) Other factors :
1) Climatic conditions
2) Changes in technology
3) Government policy
4) Customs and traditions etc.

Law of Demand :
Introduction :
The law of demand was introduced by
Prof. Alfred Marshall in his book, ‘Principles of
Economics’, which was published in 1890. The
law explains the functional relationship between
price and quantity demanded.
Statement of the Law :
According to Prof. Alfred Marshall,
“Other things being equal, higher the price of a
commodity, smaller is the quantity demanded
and lower the price of a commodity, larger is
the quantity demanded.”
In other words, other factors remaining
constant, if the price of a commodity rises,
demand for it falls and when price of a
commodity falls demand for the commodity
rises. Thus, there is an inverse relationship
between price and quantity demanded.
Symbolically, the functional relationship
between demand and price is expressed as :
Dx = f (Px)
x = Commodity affect the demand for the commodity.
f = Function 4) Prices of complementary goods remain
Px = Price of a commodity constant : It is assumed that the prices
of complementary goods remain
Assumptions :
unchanged because a change in the price of
Law of demand is based on the
one good will affect the demand for the
following assumptions :
other.
1) Constant level of income : If the
5) No expectations about future changes in
law of demand is to find true operate
prices : It is assumed that consumers do
then, consumers' income should remain
not expect any further change in price in
constant. If there is a rise in income,
the near future. If consumers expect a rise
people may demand more at a given
in prices in future, they may demand more
price.
in the present even at existing high price.
2) No change in size of population : It is
6) No change in tastes, habits, preferences,
assumed that the size of population
fashions etc. : It is assumed that
remains unchanged. Any change in the
consumers' tastes, habits, preferences,
size and composition of population of a
fashions etc. should remain unchanged.
country affects the total demand for the
Any change in these factors will lead to a
product.
change in demand.
3) Prices of substitute goods remain constant
7) No change in taxation policy : Taxation
: It is assumed that the prices of
policy of the government has a great
substitutes remain unchanged. Any
impact on demand for various goods and
change in the price of the substitute will
services.
Therefore, it is assumed that there is no demanded rises from 1 kg to 2 kgs. Similarly, at
price ` 30, quantity demanded is 3 kgs and when
change in the policy of taxation declared price falls from ` 20 to ` 10, quantity demanded
by Government. rises from 4 kg sto 5 kgs
The law of demand is explained with the Thus, as the price of a commodity falls,
help of the following demand schedule and quantity demanded rises and when price of
diagram. commodity rises, quantity demanded falls. This
shows an inverse relationship between price and
Demand schedule :
quantity demanded.
Table. 3.3
Demand Curve
Price of Quantity demanded of
commodity ‘x’ (`) commodity ‘x’ (in kgs.)
Y50 1
D
Price in `

40
50 2
40
30 3
20
30 4
10
20 5

As 10
shown in Table 3.3 when D price of
commodity ‘x’ is ` 50, quantity demanded is 1
kg. When price falls from ` 50 to ` 40, quantity
0 12345X Try this :
Draw a demand curve from the
following demand schedule :
 kg demanded (in
40 kgs.) 5
50 4
In fig. 3.5, X axis represents the demand
60 3
for the commodity and Y axis represents the
70 2
price of commodity x. DD is the demand
curve which slopes downward from left to 80 1
right due to an inverse relationship between
price and quantity demanded. Exceptions to the Law of Demand :
There are certain exceptions to the law
of demand. It means that under exceptional
circumstances, consumer buys more when the
price of commodity rises and buys less when
price of commodity falls. In such cases, demand
curve slopes upwards from left to right. i.e. the
demand curve has a positive slope as shown in
fig. 3.6.
Exceptional Demand Curve

Y DD = Exceptional
Demand curve
D
Price in `

D
0 X
Quantity Demanded in kgs Quantity Demanded in kgs
Fig. 3.5 Fig. 3.6
Following are the exceptions to the law of Giffen's paradox.
demand: 2) Prestige goods : Expensive goods like
1) Giffen's paradox : Inferior goods or low diamond, gold etc. are status symbol. So rich
quality goods are those goods whose people buy more of it, even when their prices
demand does not rise even if their price are high.
falls. At times, demand decreases when the
3) Speculation : The law of demand does not
price of such commodities fall.
hold true when people expect prices to rise
Sir Robert Giffen observed this still further. In this case, although the prices
behaviour in England in relation to bread. have risen today, consumers will demand
He noted that, when the price of bread more in anticipation of further rise in price.
declined, people did not buy more because For example, prices of oil, sugar etc. tend to
of an increase in their real income or rise before Diwali. So people go on
purchasing power. They preferred to buy purchasing more at a high price as they
superior good like meat. This is known as anticipate that prices may rise during Diwali.
4) Price illusion : Consumers have an consumption, certain goods like tea is
illusion that high priced goods are of a purchased in required quantities even at a
better quality. Therefore, the demand for higher price.
such goods tend to increase with a rise in
their prices. For example, branded products Find out :
which are expensive are demanded even at
Examples of the given
a high price.
exceptions to the law of
5) Ignorance : Sometimes, due to ignorance demand.
people buy more of a commodity at high Prestigious goods –
price. This may happen when consumer is
Habitual goods –
ignorant about the price of that commodity
at other places. Branded goods –
Variations in Demand :
6) Habitual goods : Due to habit of When the demand for a commodity falls or
rises due to a change in price alone and other
factors remain constant, it is called variations in
demand. It is of two types :
1) Expansion of demand : Expansion of
demand refers to rise in quantity demanded
due to fall in price alone while other factors
like tastes, income of the consumer, size of
population etc. remain unchanged.
Demand moves in downward direction
on the same demand curve.
This is explained with the help of
following fig. 3.7
Expansion of Demand

Y
Price in `

D
P a

P1 b
D
0 QQ1 X
Quantity Demanded in kgs
Fig. 3.7
As shown in fig. 3.7, DD is demand
curve. A downward movement on the
same demand curve from point a to point b
indicates an expansion of demand.
 2) Contraction of Demand : Contraction of Increase in Demand
demand refers to a fall in demand due to
rise in price alone. Other factors like tastes,
income of the consumer, size of population Y
etc. remain unchanged.

Price in `
Demand curve moves in the upward
direction on the same demand curve. DD1
This can be explained with the help of P aincr b
following fig. 3.8 ease
D
Contraction of Demand
0 D Q 1 X
Q 1
Quantity Demanded in kgs
Y
Fig. 3.9
Price in `

As shown in fig. 3.9, DD is the original

D demand curve. Demand curve shifts
P2 a outward to the right from DD to D1D1
which indicates increase in demand.
P b
2) Decrease in demand : It refers to decrease
D
in quantity demanded due to unfavourable
0 Q 2Q X changes in other factors like tastes, income
of the consumer, climatic conditions etc.
Quantity Demanded in kgs
and price remains constant.
Fig. 3.8
Demand curve shifts to left hand side of
As shown in fig. 3.8, DD is a demand
the original demand curve. This can be
curve. An upward movement on the same
explained with the help of fig. 3.10
demand curve from point b to point a Decrease in Demand
shows contraction of demand.
Changes in Demand :
Y
When demand for a commodity increases
or decreases due to changes in other factors and
price remains constant, it is known as changes
Price

in demand. It is of two types : D2D

1) Increase in demand : It refers to increase P bdecr a
ease
in quantity demanded due to favourable D
changes in other factors like tastes, income 0 D2 Q X
of the consumer, climatic conditions etc. Q2
and price remains constant. Quantity Demanded
Fig. 3.10
Demand curve shifts to the right hand
As show in fig. 3.10, DD is the original demand
side of the original demand curve. This can
curve. It shifts inward to the left from DD to
be explained with the help of fig. 3.9
D2D2 which indicates decrease in demand.
You should know : 2) Aggregate demand is a macro economic
1) Demand is a micro economic concept. Demand concept. It refers to the total amount of sales
is that quantity of a commodity which a person is proceeds which an entrepreneur actually expects
ready to buy at a particular price and during a from the sale of output produced at a given level
specific period of time. of employment during the year.

EXERCISE

Q. 1. Complete the following statments : Q. 2. Give economic terms :

1) The relationship between demand for a good 1) A situation where more quantity is demanded
and price of its substitute is…….. at lower price ………
a) direct
2) Graphical representation of demand schedule
b) inverse ………
c) no effect
3) A commodity which can be put to several uses
d) can be direct and inverse ………
2) The relationship between income and demand 4) More quantity is demanded due to changes in
for inferior goods is……. the factors determining demand other than
a) direct price
b) inverse ………
c) no effect 5) A desire which is backed by willingness to
d) can be direct and inverse purchase and ability to pay ………
3) Symbolically, the functional relationship
Q. 3. Distinguish between :
between Demand and Price can be expressed
1) Desire and Demand
as
................ 2) Expansion of demand and Contraction of demand
a) Dx = f(Px) 3) Increase in demand and Decrease in demand
b) Dx = f(Pz)
Q. 4. State with reasons whether you agree or
c) Dx = f(y)
disagree with the following statements :
d) Dx = f(T)
1) Demand curve slopes downward from left to
4) When less units are demanded at high price it right.
shows ...............
2) Price is the only determinant of demand.
a) increase in demand
3) When price of Giffen goods fall, the demand
b) expansion of demand
for it increases.
c) decrease in demand
d) contraction in demand
Q. 5. Observe the following table and answer the Quantity demanded
following questions :
 Market 3) Explain the diagrams :
Price Con- Con- Con-
demand
per kg. sumer sumer sumer A) B)
in ` (in kgs)
A B C
(A+B+C) Y Y
25 16 15 12

Price in `

Price in `
D D
30 12 11 10 P a P a
b 2 b
35 10 09 08 P1 D D
P
40 08 06 04 0QQ1 X 0Q2 X
Q
a) Complete the market demand schedule. Quantity Demanded in kgs Quantity Demanded in kgs
A) B)
1) Diagram A 1) Diagram B
represents ...... in represents........in
demand demand
b) Draw market demand carve based on above
2) In diagram A 2) In diagram B
market demand schedule.
movement of movement of
2) Observe the given diagram and answer the demand curve demand curve
following questions : is in ...... direction is in.......direction
Y
D2 DD1 Q. 6. Answer in detail :
P 1) State and explain the law of demand with
Price in `

D1 exceptions.
D
D2
2) Explain in detail the determinants of demand.

0Q2 Q Q1 X 

Quantity Demanded in kgs

1) Rightward shift in demand curve ............
2) Leftward shift in demand curve ............
3) Price remains ..........
4) Increase and decrease in demand comes
under..........
3BElasticity of Demand

Introduction : unchanged. It is expressed as :

In the previous chapter you have already Percentage change in Qty. Demanded
studied the law of demand which shows the Ey = Percentage change in Income
inverse relationship between quantity demanded Symbolically,
and price of a commodity. The law of demand % △Q
Ey =
does not explain the extent of a change in % △Y
demand due to a change in the price. Thus, △Q △Y
= ÷
law of demand fails to explain the quantitative Q Y
relationship between price and quantity only, other factors including price remain
demanded. Therefore, Prof. Alfred Marshall
explained the concept of elasticity of demand.
Concept of Elasticity of Demand :
The term elasticity indicates
responsiveness of one variable to a change in
the other variable. Elasticity of demand refers to
the degree of responsiveness of quanitity
demanded to a change in its price or any other
factor.
According to Prof. Marshall, “Elasticity
of demand is great or small according to the
amount demanded which rises much or little for
a given fall in price and quantity demanded falls
much or little for a given rise in price.”
It is clear from the above definition that
elasticity of demand is a technical term which
describes the responsiveness of change in
quantity demanded to fall or rise in its price. In
other words, it is the ratio of percentage change
in quantity demanded of a commodity to a
percentage change in price.
Types of Elasticity of Demand :
1) Income elasticity
2) Cross elasticity
3) Price elasticity
1) Income elasticity : It refers to the degree
of responsiveness of a change in quantity
demanded to a change in the income
 △Q Y
= Q × △Y You should know :
Where, Positive income elasticity
△ = Represents Normal goods for which demand increases with
change Q = Orignal increase in income.
demand Y = Negative income elasticity
Orignal income Inferior or goods for which demand decreases
△Q = Change in quantity demanded with increase in income of consumer.
△Y = Change in income of a consumer Zero income elasticity
Necessary goods for which demand remains
constant with increase in income of the
consumer.

2) Cross elasticity : It refers to a change in

quantity demanded of one commodity due
to a change in the price of other
commodity. (Complementary goods or
substitutes)

Percentage change in Qty. demanded of A

Ec = Percentage change in Price of B
(A = Original commodity, B = Other commodity)
% △QA
Symbolically, Ec = price
% △PB
Types of Price Elasticity of Demand :
△QA △PB 1) Perfectly Elastic Demand (Ed = ) :
= Q ÷ P
A B

△QA PB When a slight or zero change in the price

= QA × △PB brings about an infinite change in the
quantity demanded of that commodity, it is
Where, called perfectly elastic demand. It is only
QA = Original quantity demanded of commodity a theoretical concept. For example, 10%
A
fall in price may lead to an infinite rise in
△QA = Change in quantity demanded of
demand.
commodity A Percentage change in Quantity Demanded
PB = Original price of commodity B
△PB = Change in price of commodity B Ed = =
Percentage change in Price

Ed = 
You should know :
Positive cross elasticity : Substitute goods.
Example, tea and coffee.
Negative cross elasticity : Complementary
goods. Example, tea and sugar.
Zero cross elasticity : Non-related goods.
Example, tea and books.
 Perfectly
elastic
demand
Y
P D

Price
D
Ed
=

3) Price elasticity : According to Prof. Alfred

0 X
Marshall, price elasticity of demand is
Quantity Demanded
a ratio of proportionate change in the
quantity demanded of a commodity to a Fig. 3.11
given proportionate change in its price. In figure 3.11, the demand curve is a
Percentage change in Quantity Demanded horizontal line parallel to the X axis indicating
Ed = perfectly elastic demand.
Percentage change in Price
%△Q 2) Perfectly inelastic demand (Ed = 0) :
Symbolically, Ed = % △ P , When a percentage change in price has
no effect on the quantity demanded of a
Ed = △ Q ÷ △ P commodity it is called perfectly inelastic
Q P
demand. For example, 20% fall in price
Ed = △QQ × △ P
P
will have no effect on quantity demanded.

Where, %△Q
Ed =
Q = Original quantity demanded %△P
0
△Q = Difference between the new quantity and Ed = =0
20
original quantity demanded
Ed = 0
P = Original price
In practice, such a situation rarely occurs.
△P = Difference between new price and original
For example, demand for salt, milk.
 Perfectly inelastic demand Ed more than proportionate change in quantity
=0 demanded, the demand is said to be
Y relatively elastic. For example, 50% fall in
price leads to 100% rise in quantity
D demanded.
P1 %△Q
Price

P Ed = Ed =
%△P
P2 0 100
Ed = 50 Ed = 2
D
0QX Ed > 1
Relatively
Quantity Demanded elastic
Y
Fig. 3.12 demand
D
In figure 3.12, when price rises from OP to

Price
P E >1
OP or when price falls from OP to OP2, demand
d D
1 P
remains unchanged at OQ. Therefore, the 1

demand curve is a vertical straight line parallel 0 Q Q X

1

to the Y axis, indicating perfectly inelastic

demand. Quantity Demanded
Fig. 3.14
3) Unitary elastic demand (Ed = 1) :
In figure 3.14, when price falls from OP to
When a percentage change in price leads to
OP1 (50%), demand rises from OQ to OQ1
a proportionate change in quantity
(100%). Therefore, the demand curve has a
demanded then demand is said to be
flatter slope.
unitary elastic. For example, 50% fall in
price of a commodity leads to 50% rise in 5) Relatively inelastic demand (Ed < 1) :
quantity demanded.

Ed 50 When a percentage change in price leads

%△Q =1  Ed = 1
= = 50 to less than proportionate change in the
%△P
quantity demanded, demand is said to be
Unitary elastic
demand relatively inelastic. For example, 50%
Y fall in price leads to 25% rise in quantity
demanded.
D
% △ Q 25 = 0.5
Price

P Ed = Ed = =
%△P 50
1 Ed = 0.5 Ed < 1
P
1
D
0 QQ1 X
Quantity Demanded (50%). Therefore, the slope of the
Fig. 3.13 demand curve is a 'rectangular
In figure 3.13, when price falls from OP hyperbola'.
to OP1 (50%), demand rises from OQ to OQ1
4) Relatively elastic demand (Ed
 Relatively inelastic
demand. Ed < 1
>1) : Y
When a percentage change in price leads to D

Price
P
Ed
P <1
1

D
0 Q X
Q1
Quantity Demanded
Fig. 3.15
 In figure 3.15, when price falls from in price. Percentage method is also known
OP to OP1 (50%), demand rises from OQ to as Arithmetic method. Price elasticity is
OQ1 (25%). Therefore, the demand curve has a measured as :
steeper slope. Percentage change in Quantity demanded
E
d Percentage
Find
out : t t of elast % change in
=△ Price
Identif h y pri icity
y e p ce of Q
E%
e
d△
P
=
demand for the
following Mathematically
goods. , the above formula
1) Cosmetics can be presented as
Medicine under.
3) School
uniform
conditioners
△
△ P  Ed =
÷ P Q P
T ×
ry Q
th
is △
:
P
Complete the Numerical example :
table Price Qty. Demanded
(`) (in Kg)
20 10 Ed =
25 09
Original Price, P = 20,
New price P = 25
Sr. Degree of Types of Description
No. elasticity elasticity Percentage △P = 5 (Difference
of of between new and
demand demand original price)
1 Perfectly Change in Original Quantity
inelastic price does not
Demanded, Q =
affect demand
at all. 10, New demand
2 Ed = 1 Change in =9
demand is △Q = 1 (Difference
equal to between new and
change in original quantity
price
demanded)
3 Ed > 1 Relatively
elastic Ed =
4 Relatively Change in
 △
Q

×
P

△P
Ed =20
10× 5
Ed = 0.4
Ed < 1
It means
elasticity of demand
is relatively inelastic.

Do you know?
Methods of While using
Measuring Price percentage
Elasticity of method of
Demand : measuring price
1) Ratio or elasticity of
Percentage demand we must
method : Ratio keep following
method is points in our
developed by mind :
Prof. Marshall.
1) Value of
According to
elasticity of
this method,
demand is
elasticity of
negative
demand is
because of the
measured by
negative slope
dividing the
of demand
percentage
curve but for
change in
the sake of
demand by the
simplicity we
percentage
ignore
change
negative sign.
30
 ` 10 per unit and quantity demanded is 6 units.
Therefore, total expenditure incurred is ` 60.
2) Price elasticity of demand is a pure number. When price rises to ` 20 quantity demanded
It does not depend upon units in which price of falls to 5 units, the total expenditure incurred is
` 100.
the commodity and its quantity are measured. In this case, total outlay is greater than original
expenditure. Hence, in this example elasticity
2) Total Expenditure Method : This method of demand is greater than one. (Ed >1) that is
was developed by Prof. Marshall. In this relatively elastic demand.
method, total amount of expenditure before In example ‘B’, original price is ` 30 per
and after the price change is compared. unit and quantity demanded is 4 units. Therefore
total expenditure is ` 120. When price rises to
Here the total expenditure refers to the ` 40 quantity demanded falls to ‘3’ units. Total
product of price and quantity demanded. expenditure incurred is ` 120. In this case total
Total expenditure = Price × Quantity outlay is same (equal) to original expenditure.
demanded
In this connection, Marshall has given the Hence, in this example, elasticity of demand
following propositions : is equal to one (Ed = 1) that is unitary elastic
A) Relatively elastic demand (Ed >1) : demand.
When with a given change in the price of a In example ‘C’, original price is ` 50 per
commodity total outlay increases, elasticity unit and quantity demanded is 2 units.
Therefore total expenditure is ` 100. When
of demand is greater than one. price rises to ` 60, quantity demand falls to
1 unit and
B) Unitary elastic demand (Ed = 1) :
total expenditure incurred is ` 60. In this case
When price falls or rises, total outlay does
total outlay is less than original expenditure.
not change or remains constant, elasticity
Hence, elasticity of demand is less than one
of demand is equal to one.
(Ed <1) that is relatively inelastic demand.
C) Relatively inelastic demand (Ed <1) :
When with a given change in price of a
commodity total outlay decreases, Find out :
elasticity of demand is less than one. As the price of peanut
This can be explained with the help of packets increases by 5% the
the following example. demand for number of
peanut packets falls by 8%.
Table 3.4 : Total outlay method
What is formula,
Apply the the elasticity
Ed of
Price in Quantity Total Elasticity demand % △
= % △ Qfor peanut packets?
` (P) demanded outlay of 3) Point method or GeometricP Method :
in units (Q) (P×Q) ` demand
Prof. Marshall has developed another
10 6 60 method to measure elasticity of demand,
A 20 Ed >1
5 100 which is known as point method or
30 4 120 geometric method. The ratio method and
B 40 Ed = 1
3 120 total outlay methods are unable to measure
50 2 100 elasticity of demand at a given point on the
C 60 Ed <1
1 60 demand curve.
In table 3.4 in example ‘A’ original price is At any point on elasticity of demand
the demand curve, is measured with
31
 the help of the Thus, at point P1, Thus, at point demand curve
P2, demand is
following demand is is non-linear
relatively
formula : relatively inelastic elastic (ed > 1) i.e. convex to
L (ed < 1) origin, to
4) At point A, the
o measure price
w 3) At point P2, the point elasticity
er elasticity of
point elasticity is  because
se demand we have
is measured upper segment
g to draw a
m as : is zero.
tangent ‘AB’
e (perfectly
nt elastic demand) touching the
of given point on
d 5) At point B, the
the demand
e point elasticity
curve and
m is zero because
a extending it to
lower segment
n meet ‘Y’ axis at
d P2B 6 is zero
point ‘A’ and
Point elasticity P = = =3 (perfectly
curve below a given
= 2 ‘X’ axis at point
point (L) inelastic
of Upper P2A 2 ‘B’.
dema segment demand.)
nd of
(Ed) demand Lower
B) Non-linear
Price in `

cur and X axis at ‘B’. segment of

ve Price elasticity of demand curve the tangent
abo demand at ‘X’ : When the
ve below a
a axis is zero and E given point
giv ‘Y’ axis is d Upper segment
of the tangent
en infinite. Elasticity =
poi of demand will be = U
above a given
nt different at each Quantity Demanded point
(U) Fig. 3.16 Point method - Non-
point.
Demand curve linear demand curve
Let us assume
may be either YA
that AB is a demand
linear or non- d
curve and its length
linear as shown
is 8 cm. Point
below :
elasticity at various P E
A) Linear Demand points on a linear d
Price

Curve : When demand curve can be

the demand measured as follows :
curve is linear 0 Q BX
1) At point P, the
i.e. a straight point elasticity is
line, we extend measured as :
the demand PB 4 demand is unitary
curve Point
to meet P= = =
method (Linear an cu v ) 1 PA 4 elastic (ed = 1)
the Y axis at ‘A’
dem d r e Thus, at point P, 2) At point P1, the
Y
A Ed = ∞ 32

P2 Ed > 1
 P Ed < 1
1

point elasticity is Ed =
0 B X
0
measured Q
as : u
PB 2
a
n
t
i
t
y

D
e
m
a
n
d
e
d
F
i
g
.

3
.
1
7
If EB = EA (Ed =
1) - Unitary
elastic demand
EB > EA (Ed >1)
- Relatively
elastic demand
P = EB < EA (Ed
= 1
1 0 <1) -
= . Relatively
P3 inelastic
A3 demand
6

33
Factors influencing the elasticity of demand : 8) Urgency of needs : Goods which are
Elasticity of demand depends upon several urgently needed will have relatively
factors which are discussed below : inelastic demand. For example, medicines.
1) Nature of commodity : By nature we Luxury goods which are less urgent have
can classify commodities as necessaries, relatively elastic demand.
comforts and luxury goods. Demand for 9) Time period : Elasticity of demand is
necessaries like foodgrains, medicines, always related to period of time. It varies
textbooks etc. is relatively inelastic and with the length of time period. Generally
for comforts and luxury goods like cars, speaking, longer the duration of period
perfumes, furniture etc. demand is greater will be the elasticity of demand and
relatively elastic. vice-versa. This is because a consumer can
2) Availability of substitutes : Demand for a change the consumption habits in the long
commodity will be more elastic, if its close run in favour of cheaper substitutes of the
substitutes are available in the market. For commodities.
example, lemon juice, sugarcane juice etc.
You should know :
But commodities having no close
Price
substitutes like salt the demand will be
Determinants Nature elasticity of
inelastic. demand
3) Number of uses : Single use goods have a 1) Availability a) Abundant a) Relatively
less elastic demand. Multi-use goods have of factors elastic
more elastic demand, For example, coal, b) Few b) Relatively
inelastic
electricity etc.
2) Nature of a) Necessary a) Relatively
4) Habits : Habits make demand for certain commodity goods inelastic
goods relatively inelastic. For example, b) Luxury b) Relatively
addicted goods, drugs etc. goods elastic
3) Habits a) Habituated a) Relatively
5) Durability : The demand for durable inelastic
goods is relatively elastic. For example, b) Not b) Relatively
furniture, washing machine etc. Demand Habituated elastic
for perishable goods is inelastic. For 4) Time period a) Short-run a) Relatively
inelastic
example, milk, vegetables etc.
b) Long-run b) Relatively
6) Complementary goods : The demand for elastic
a commodity which is used in conjunction 5) Postpone- a) Possibility a) Relatively
with other commodities to satisfy a single ment of of Postpone- elastic
consumption ment
want is relatively inelastic. For example,
b) Impossible b) Relatively
a fall in the price of mobile handsets may
to Postpone inelastic
lead to rise in the demand for sim cards. 6) Number a) Several a) Relatively
7) Income of the consumer : Demand for of uses of a elastic
goods is usually inelastic, if the consumer commodity b) Specific b) Relatively
inelastic
has high income. The demand pattern of a
very rich and an extremely poor person is
rarely affected by significant changes in
the price.

33
Importance of Elasticity of Demand : c) infinity d) greater than one
The concept of elasticity of demand is of 3) Demand curve is parallel to X axis, in case of
great importance to producers, farmers, workers ................
and the Government. Lord Keynes considered
this concept to be the most important
contribution of Alfred Marshall. Significance of
the concept becomes clear from the following
applications :
1) Importance to a Producer : Every
producer has to decide the price of his
product at which he has to sell it. For this
purpose, elasticity of demand becomes
important. If the demand for a product is
relatively inelastic, he will fix up a higher
price and vice-versa. The concept of
elasticity of demand is also useful to a
monopolist to practice price discrimination.
2) Importance to Government : Taxation
policy of the Government is based on the
concept of elasticity of demand. Those
commodities whose demand is relatively
inelastic will be taxed more because it will
not affect their demand much and vice-
versa.
3) Important in Factor Pricing : The
concept of elasticity of demand is useful
in determination of factor prices. The
factor of production for which demand is
relatively inelastic can command a higher

EXERCISE

Q. 1. Complete the following statements :

1) Price elasticity of demand on a linear demand
curve at the X axis is ...............
a) zero b) one
c) infinity d) less than one

2) Price elasticity of demand on a linear demand

curve at the Y-axis is equal to .................
a) zero b) one

34
 price as compared to those having elastic c) rectangular
demand. For example, workers can ask d) horizontal
for higher wages, if the demand for the 5) Ed = 0 in case of correlation :
................
product produced by them is relatively 1) Perfectly elastic
a) luxuries demand : Ed =  :::
inelastic.
b) normal goods Ed
4) Importance in Foreign Trade : The =0
c) necessities
concept of elasticity of demand is useful 2) Rectangular
d) comforts
to determine terms and conditions in hyperbola ::
foreign trade. The countries exporting Q. 2. Give economic Steeper demand
commodities for which demand is terms :
curve : Relatively
relatively inelastic can raise their prices. 1) Degree of
inelastic demand.
For example, Organization of Petroleum responsiveness of
3) Straight line
Exporting Countries (OPEC) have quantity demanded
demand curve :
increased the price of oil several times. to change in
Linear demand
The concept is also useful in formulating income only.
curve :: :
export and import policy of a country. 2) Degree of
non linear demand
5) Public Utilities : In case of public responsiveness of a
curve.
utilities like railways which have an change in quantity
demanded of one 4) Pen and ink :::
inelastic demand, Government can either
commodity due to Tea and Coffee:
subsidise or nationalise them to avoid
change in the price Substitutes.
consumers exploitation.
of another
6) Proportion of expenditure : If the commodity.
proportion of expenditure in a person's
3) Degree of
income is small, then demand for the
responsiveness of a
product is relatively inelastic. For
change of quantity
example, news papers. If the proportion
demanded of a
of expenditure is large, then demand for
good to a change
the product is relatively elastic.
in its price.
4) Elasticity resulting
from infinite
change in quantity
a) perfectly elastic demand demanded.
b) perfectly inelastic demand 5) Elasticity resulting
c) relatively elastic demand from a
d) relatively inelastic demand proportionate
4) When percentage change in quantity change in quantity
demanded is more than the percentage change demanded due to a
in price, the demand curve is ................ proportionate
a) flatter change in price.
b) steeper
Q. 3. Complete the
35
 2) (A) is False, (R) is the :: : 1) Relatively elastic
but (R) is True correct L and Relatively
3) Both (A) explanation o E
d inelastic demand.
and (R) are of (A) w
2) Perfectly elastic
True and 4) Both (A) and e = demand and
(R) is the (R) are True r Perfectly inelastic
correct and (R) is not
explanation s
the correct
of (A) e
explanation
g
4) Both (A) of (A)
m
and (R) are
3) Assertion (A) : e
True and
Degree of price n
(R) is not
elasticity is less t
the correct
than one in case
explanation U
of relatively
of (A) p
inelastic
2) Assertion (A) : p
demand.
e
A change in Reasoning (R) :
r
quantity Change in
demanded of demand is less s
one commodity then the change e
due to a change in price. g
in the price of
Options : 1) (A) is True, m
other but (R) is False e
commodity is n
2) (A) is False, but
cross elasticity. (R) is True t
Reasoning (R) Q. 4. Assertion and Options : 1) (A) is True,
3) Both (A) and
Reasoning type but (R) is False
: Changes in (R) are True questions :
consumers and (R) is
1) Assertion (A) :
income leads to the correct
Elasticity of
a change in the explanation
demand explains
quantity of (A)
that one variable is
demanded. 4) Both (A) and influenced by
Options : 1) (A) is (R) are True another variable.
True, but (R) is False
and (R) is not
Reasoning (R) :
2) (A) is False, the correct
but (R) is True The concept of
explanation
elasticity of
3) Both (A) of (A)
demand indicates
and (R) are
Q. 5. Distinguish the effect of price
True and
between : and changes in
%△Q
5) Ratio m ethod : Ed =
%△P other factors on
demand.
36
 demand. 2) Explain the total elastic
outlay method demand
Q. 6. Answer the .
following questions : of measuring
elasticity of 
1) Explain the
demand?
factors
influencing 3) Explain importance
of elasticity of
elasticity of demand.
demand.
Q. 7. Observe the 2) In the following
following figure and diagram AE is
answer the the linear
questions : demand curve of
1) Identify and a commodity. On
define the the basis of the
degrees of given diagram
elasticity of state whether the
demand from the following
following demand statements are
curves. True or False.
a) Give reasons to
Y D Y
your answer.
Price

Price

Y
D D A

B
Price

D
0 X 0 X D

C
Quanti Quanti E
ty ty 0 X
Dema Dema
nded Quantity
nded
Demand
c) ed
Y Y
1) Demand at point
Price
Price

D ‘C’
D is relatively
P P
elastic demand.
P1 D P2)
1 Demand at D point
‘B’ is unitary
0QQ1 X 0 elastic
Q demand.
Q1 X
Quanti Quanti
ty 3) Demand at
ty
Dema Dema point ‘D’ is
nded nded perfectly
inelastic
demand.
4) Demand at point
‘A’ is perfectly
37
 4 Supply Analysis

Introduction : Supply is a flow concept. It refers to the amount

The study of supply is as important as of a commodity that the firms produce and offer
the study of demand. Supply is a fundamental for sale in the market over a period of time, say
economic concept that describes the total a day, a week, a month or a year.
amount of a specific good or service that is Stock Supply
available to a seller. The total amount of goods
or services available for sale at any specified
price is known as supply.
Concept of Total Output, Stock and Supply
: Total Output :
Output is produced in the process of
production. “Total output can be defined as
the sum total of the quantity of the commodity
produced at a given period of time in the Fig. 4.1
economy.’’ Production leads to consumption. In Try this :
the process of production inputs are converted Distinguish between stock and supply.
into output or final goods.
Stock : Definition of Supply :
Stock is the total quantity of commodity According to Paul Samuelson, “Supply
available for sale with a seller at a particular refers to the relation between market prices and
point of time. It is the source of supply. It is the amount of goods that producers are willing
potential supply. By increasing production, to supply.’’
stock can be increased. Without stock, supply Supply refers to the quantity of a
is not possible. Normally, stock exceeds supply commodity that a seller is willing and able to
and it is fixed and inelastic. In case of offer for sale at a given price, during a certain
perishable goods such as milk, fish etc. stock period of time. For example, a farmer's total
may be equal to supply. On the other hand, for output of rice is
durable goods such as furniture, garments etc. 4000 kgs. This is the total stock. If the price is `
stock can exceed the supply. 40 per kg, he offers 1000 kgs for sale. This is the
actual supply.
Supply :
Supply is a relative term. It is always Supply schedule :
expressed in relation to price, time and quantity. Asupply schedule is a tabular
representation of the functional relationship
Meaning of Supply :
between price and quantity supplied of a
The word ‘supply’ implies the various particular commodity.
quantities of a commodity offered for sale
by producers during a given period of time at 1) Individual Supply Schedule : Individual
a given price. It is related to time and price. supply schedule refers to a tabular
 representation showing various producer is willing to
quantities of a commodity that a
sell at various prices, during a given period schedule refers to a tabular representation
of time. showing different quantities of commodity
Table 4.1 which all producers are prepared to sell at
Individual Supply Schedule different prices at a given period of time.
Price of a commodity Supply of a commodity
Table 4.2
x (in ` per kgs.) x (in kgs.)
Market Supply Schedule
10 100
Price of Quantity supplied Market
20 200 commodity (in kgs.) supply
30 300 (in `)
(in kgs.)
Seller Seller Seller (A+B+C)
40 400 A B C
50 500 10 100 200 300 600
20 200 300 400 900
Table 4.1 explains the functional
relationship between price and quantity 30 300 400 500 1200
supplied of a commodity. Lower the price, 40 400 500 600 1500
lower the quantity of a commodity supplied 50 500 600 700 1800
and vice In Table 4.2, market supply is obtained by
versa. At the lowest price of ` 10, supply is also
lowest at 100 kgs. At the highest price of ` 50, adding the supply of sellers A, B and C at different
quantity supplied is highest at 500 kgs. prices. At a highest price of ` 50, market supply
Individual Supply Curve : It is a graphical is the highest at 1800 kgs. At a lowest price of
presentation of individual supply schedule. ` 10 market supply is lowest at 600 kgs.
Individual Supply Curve Market Supply Curve : It is a graphical
SS = Individual Supply Curve presentation of market supply schedule.
Y Market Supply Curve

Y SS = Market
S
50 Supply Curve S
Price in `

40 50
Price in `

30 40
0
20 3

10 S 20

0 100 200 300 400 500X 10 S

Quantity Supplied in kgs supplied.

0
3 60 9 0 1 0 0 1 0 X
Fig. 4.2 2) Market Supply Schedule
0 0 0 : Market
2 1 0 8 0supply
In figure 4.2, quantity supplied is shown on 0 05
the X axis and price on the Y axis. Supply curve
SS slopes upwards from left to right, indicating
a direct relationship between price and quantity
 In figure 4.3, quantity supplied is shown on
the X axis and price on the Y axis. Supply curve
Quantity Supplied in SS slopes upwards from left to right, indicating
kgs
a direct relationship between price and market
Fig. 4.3
supply.
Try this : monsoon and favourable climatic condition
Draw a supply curve with the help of a will produce a good harvest, so the supply of
hypothetical supply schedule. agricultural products will increase and
unfavourable climatic conditions will lead to
Determinants of Supply : a decrease in supply.
1) Price of commodity : Price is an important 7) Future expectations about price : If the
factor influencing the supply of a prices are expected to rise in the near future,
commodity. More quantities are supplied the producer may withhold the stock. This
at a higher price and less quantities are
supplied at a lower price. Thus, there is
a direct relationship between price and
quantity supplied.
2) State of technology : Technological
improvements reduce the cost of
production which lead to an increase in
production and supply.
3) Cost of Production : If the factor price
increases, the cost of production also
increases, as a result, supply decreases.
4) Infrastructural facility : Infrastructure
in the form of transport, communication,
power, etc. influences the production
process as well as supply. Shortage of these
facilities decreases the supply and vice
versa.
5) Government policy : Favourable
Government policies may encourage
supply and unfavourable government
policies may discourage the supply.
Government policies like taxation,
subsidies, industrial policies, etc. may
encourage or discourage production and
supply, depending upon government policy
measures.
6) Natural conditions : The supply of
agricultural products depends on the
natural conditions. For example, a good
 will reduce the supply and vice versa supplied and lower the price of a commodity
8) Other factors : It includes, less is the quantity supplied”
• nature of the market, In simple words, “other factors remaining
• relative prices of other goods, constant, a rise in price results in a rise in the
• export and imports, quantity supplied and vice-versa. Thus, there is
• industrial relations, a direct relationship between price and quantity
• availability of factors of production supplied.
etc. If all factors are favourable, supply Symbolically,
of a commodity will be more and vice Sx = f (Px)
versa. S = Supply
x=
Law of
Commodity f =
Supply
Function
Introductio P = Price of commodity
n:
The law of supply is also a fundamental Assumptions of the law :
principle of economic theory like law of The law of supply is based on the
demand. It was introduced by Prof. Alfred following assumptions :
Marshall in his book, ‘Principles of 1) Constant cost of production : It is
Economics’ which was published in 1890. assumed that there is no change in the cost
The law explains the functional relationship of production .A change in cost of
between price and quantity supplied. production will affect the profits of the
seller. Therefore less quantity will be
Statement of the Law :
supplied at the same
“Other things being constant, higher the
price.
price of a commodity, more is the quantity
2) Constant technique of production : It is transport facility increases supply at the same
also assumed that technique of production price.
does not change. Improved technique of 6) Prices of other goods remain constant :
production may lead to an increase in Prices of other goods are assumed to remain
production. This in turn may lead to an constant. If they change, the law of supply
increase in the supply at the same price. may not hold true because producer may
3) No change in weather conditions : It is transfer resources to other products.
assumed that there is no change in the 7) No future expectations : The law also
weather conditions. Natural calamities assumes that the sellers do not expect future
like floods, earthquakes etc. may decrease changes in the price of the product.
supply. Law of supply is explained with the help of
4) No change in Government policy : It is the following schedule and diagram :
also assumed that government policies like Table 4.3
taxation policy, trade policy etc. remain Supply Schedule
unchanged. Price of commodity x Supply of commodity x
5) No change in transport cost : It is (in `) (in kgs.)
assumed that there is no change in the 10 100
20 200
condition of transport facilities and
30 300
transport cost. For example, better
 40 400 when price rises supply also rises and when
50 500 price falls supply also falls. Thus, there is direct
Table 4.3 explains the direct relationship relationship between price and quantity
between price and quantity of commodity supplied which is shown in following figure 4.4
supplied. When price rises from ` 10 to 20, 30,
40 and 50, the supply also rises from 100 to :
200, Supply Curve
300, 400 and 500 units respectively. It means,
Y
S
50

Price in `
40

30

20
10S

0100 200 300 400 500 X

Quantity Supplied in kgs

Fig. 4.4
In the figure 4.4, X axis represents quantity
supplied and Y axis represents the price of the
commodity. Supply curve 'SS' slopes upwards
from left to right which has a positive slope. It
indicates a direct relationship between price and
quantity supplied.
Exceptions to the Law of Supply :
Following are the exceptions to the law of supply:
1) Supply of labour : Labour supply is the
total number of hours that workers to work
at a given wage rate. It is represented
graphically by a supply curve. In case of
labour, as the wage rate rises the supply
of labour (hours of work) would increase.
So supply curve slopes upward. Supply of
labour (hours of work) falls with a further
rise in wage rate and supply curve of
labour bends backward. This is because the
worker would prefer leisure to work after
receiving higher amount of wages. Thus,
after a certain point when wage rate rises
the supply of labour tends to fall.
It can be explained with the help of a
backward bending supply curve. Table no.
4.4 and fig. no 4.5 explains the backward
 bending supply curve of labour.
Table. 4.4 production depends on weather conditions.
Labour Supply Schedule
Wage rate (`) Hours of work Total amount
per hour
per day of wages (`)
100 5 500
200 7 1400
300 6 1800

SAS1 = Backward bending

Wage rate (`) per hour

labour supply curve

Y SA = cre asi g ppl y rve
AS In
= isu n re su
tim cu
Le e
S1
300

200 A
100
S
0 567 X
Supply of Labour (hours of work)
Fig. 4.5
In fig. 4.5, supply of labour (hours of
work) is shown on X axis and wage rate
per hour is shown on the Y axis. The curve
SAS represents backward bending supply
curve of labour. Initially, when the wage
rate is ` 100 per hour, the hours of work is
5. The total amount of wages received is `
500. When wage rate rises from ` 100 to
` 200, hours of work will also rise from 5
hours to 7 hours and total amount of wages
would also rise from ` 500 to ` 1400. At
this point, labourer enjoys the highest
amount
i.e. ` 1400, and works for 7 hours. If wage
rate rises further from ` 200 to ` 300, total
amount of wages may rise, but the labourer
will prefer leisure time and denies to work
for extra hours. Thus, he is ready to work
only for 6 hours. At the point A, the supply
curve bends backward, which becomes an
exception to the law of supply.
2) Agricultural goods : The law of supply
does not apply to agricultural goods as they
are produced in a specific season and their
 Due to unfavourable changes in known as variations in supply. There are two
weather, if the agricultural production types of variations in supply :
is low, their supply cannot be increased 1) Expansion of supply : Expansion of
even at a higher price. supply refers to a rise in the quantity
3) Urgent need for cash : If the seller is supplied due to a rise in the price of a
in urgent need for hard cash, he may commodity, other factors remaining
sell his product at which may even be constant. Expansion in supply leads to an
below the market price. upward movement on the same supply
4) Perishable goods : In case of curve due to a rise in price. It is shown in
perishable goods, the supplier would figure 4.6
offer to sell more quantities at lower Expansion of supply
prices to avoid losses. For example, Y SS = Supply
vegetables, eggs etc. Curve
5) Rare goods : The supply of rare goods MN =
cannot be increased or decreased Extension of
according to its demand. Even if the supply S

Price
P1 N
price rises, supply remains unchanged.
For example, rare paintings, old coins, M
P
antique goods etc.
S
Variations in Supply :
0 Q Q1X
When quantity supplied of a
Quantity Supplied
commodity varies due to change in its price,
Fig. 4.6
other factors remaining constant, it is
In figure 4.6, quantity supplied is shown
on the X axis and price on the Y axis. Quantity
supplied rises from OQ to OQ1, with a rise in
price from OP to OP1, resulting in an upward
movement from M to N along the same supply
curve SS. It is known as Expansion of supply.
Quantity Supplied
2) Contraction of supply : Contraction of Fig. 4.7
supply refers to a fall in the quantity
In figure 4.7, quantity supplied is shown
supplied, due to fall in the price of a
on the X axis and price on the Y axis. Quantity
commodity, other factors remaining
supplied falls from OQ to OQ2 with a fall in price
constant. In case of contraction of supply,
from OP to OP2, resulting in a downward
there is a downward movement on the
movement from N to M on the same supply curve
same supply curve. It is shown in figure
SS. It is known as Contraction of supply.
4.7
Contraction of supply Changes in Supply :

SS = Supply Curve When other factors change and price remains

Y
constant, it is known as changes in supply. There
NM = Contraction of
Supply are two types of changes in supply :
1) Increase in supply : Increase in supply refers
S
Price

P N

P2 M
 0 Q2 QX

to rise in the supply of a given commodity shifts to the right of the original supply
due to favourable changes in other factors curve. It is shown in figure 4.8
such as fall in the price of inputs, fall in tax Increase in supply
rates, technological upgradation etc., while SS = Original
price remains constant. The supply curve Y supply curve
S1S1 = Shift in
supply curve
S

Price
S
P M N
1
S
S
1

0 Q Q1X
Quantity Supplied
Fig. 4.8
In figure 4.8, quantity supplied is shown on
the X axis and price on the Y axis. Supply rises
from OQ to OQ1 at the same price OP, resulting
in an outward shift of the original supply curve
to the right from SS to S1S1. It is known as
Increase in supply.
2) Decrease in supply : Decrease in supply
refers to a fall in the supply of a given
commodity due to unfavourable changes in
other factors such as increase in the prices
of inputs, increase in tax rate, outdated
technology, strikes by worker, while price
remains constant. The supply curve shifts
to the left of the original supply curve. It is
shown in figure 4.9
Decrease in supply
SS curv
Y O gials p
= e
ri n
S i u ly
S 2S y
2 =i n 2 pp
curv
S ft s l
P N uM S e
h
Price

p
S
2

0 Q Q X
Quantity Supplied
2
Fig. 4.9
 In figure 4.9, quantity supplied is shown on machinery etc.
the X axis and price on the Y axis. Supply falls Total Variable Cost (TVC) : Total
from OQ to OQ2 at the same price OP, resulting variable costs are those expenses of
in an inward shift of the original supply curve to production which are incurred on variable
the left from SS to S2S2. It is known as Decrease factors such as labour, raw material,
in supply. power, fuel etc.
2) Average Cost (AC) : Average cost refers
You should know : to cost of production per unit. It is
Supply : Supply is a micro-economic concept. calculated by dividing total cost by total
Supply refers to quantity of a commodity that a quantity of production.
seller is willing and able to offer for sale at a TC
AC = TQ
particular price, during a certain period of time. AC = Average cost
Aggregate supply : It is a macro-economic TC = Total cost
concept. It refers to the minimum amount of TQ = Total quantity
sales proceeds which entrepreneurs expect to For example, If the total cost of production
receive from the sale of output at a given level of of 40 units of commodity is ` 800 then the
average cost is :
employment.
TC
AC = TQ
Concepts of Cost and Revenue : 800
A) Cost Concepts : = 40
When an entrepreneur undertakes an act = ` 20 per unit
of production, he has to use various inputs like 3) Marginal cost (MC) : Marginal cost is the
raw material, labour, capital etc. He has to net addition made to total cost by
make payments for such inputs. The producing one more unit of output.
expenditure incurred on these inputs is known MCn = TCn – TCn-1
as the cost of production. Cost of production
n = Number of units produced
increases with an increase in need of output.
There are three types of costs which are as MCn = Marginal cost of the nth unit
follows : TCn = Total cost of n thunit
1) Total Cost (TC) : Total cost is the total TCn-1 = Total cost of previous units
expenditure incurred by a firm on the If previous total cost of producing 4 units
factors of production required for the is ` 200 and total cost of producing 5 units
production of goods and services. Total is ` 250, then :
cost is the sum of total fixed cost and total MCn = TCn – TCn-1
variable cost at various levels of output. = ` 250 – ` 200
TC = TFC + TVC = ` 50
TC = Total cost Find out :
TFC = Total Fixed Cost If a firm produces 600 units of a
TVC = Total Variable Cost commodity in a day and incurs a total cost
Total Fixed Cost (TFC) : Total fixed of ` 30,000. Calculate the Average Cost.
costs are those expenses of production
which are incurred on fixed factors such 43
as land,
B) Revenue Concepts : For example, if the total revenue of 15
units, is ` 3000, then average revenue is
The term ‘revenue’ refers to the receipts calculated as :
obtained by a firm from the sale of certain TR
quantities of a commodity at given price in the AR = TQ
market. The concept of revenue relates to total
3000
revenue, average revenue and marginal = 15
revenue. = ` 200
1) Total Revenue (TR) : Total revenue is the 3) Marginal Revenue : Marginal revenue is
total sales proceeds of a firm by selling a the net addition made to total revenue by
commodity at a given price. It is the total selling an extra unit of the commodity.
income of a firm. Total revenue is MRn = TRn – TRn-1
calculated as follows : MRn = Marginal revenue of n thunit
Total revenue = Price × Quantity TRn = Total revenue of n thunit
For example, if a firm sells 15 units of a
commodity at ` 200 per unit TR is TRn-1 = Total Revenue of previous units
calculated as : n = Number of units sold
TR = P × Q For example, if the previous total revenue
= ` 200 × 15 from the sale of 20 tables is ` 4000 and
that from the sale of 21 tables is ` 4200,
= ` 3000 marginal revenue is calculated as :
2) Average Revenue (AR) : Average revenue MRn = TRn – TRn-1
is the revenue per unit of output sold. It is = 4200 – 4000
obtained by dividing the total revenue by = ` 200 per table
the number of units sold.
TR Find out :
AR = TQ EXERCISE
If a firm sells 400 units of a
AR = Average Revenue commodity at ` 10 unit.
TR= Total Revenue Calculate the TRa)and
Q. 1. Complete the AR.
contraction of
TQ =Total Quantity following statements : supply
1) When supply curve
is upward sloping,
it’s slope
is ..............
a) positive
b) negative
c) first positive
then negative
d) zero
2) An upward
movement along
the same supply
curve shows
................

44
 b) decrease in a) contraction of Q. 5. Observe the 2) Draw the market
supply supply
following table and supply curve from
c) expansion of b) decrease in
answer the questions : the schedule and
supply supply
A) Supply schedule of explain it.
d) increase in c) expansion of
chocolates
supply supply
Q. 6. Answer the
d) increase in Price in ` Quantity following questions :
3) A rightward shift
in supply curve supply 10
1) Explain the
shows 15
4) Other factors concept of total
................ remaining constant, 20
when less 25 cost and total
30 revenue.
quantity is 3) Total cost : TFC
+ TVC :: Average 35 2) Explain determinants
supplied only due
cost : 40 of supply.
to a fall in price, it
shows ................ 1) Complete the above Q. 7. Answer in detail :
4) Demand curve ::: supply schedule.
a) contraction of 1) State and explain law
supply Supply curve : 2) Draw a diagram for of supply with
Upward the above supply exceptions.
b) decrease in schedule.
supply 5) : Change
3) State the 
c) expansion of in supply :: Other
supply relationship
factors constant :
d) increase in between price
Variation of supply
supply and quantity
Q. 3. Give economic supplied.
5) Net addition made
terms :
to the total B) Observe the
1) Cost incurred on
revenue by selling fixed factor. market supply
an extra unit of a schedule of
2) Cost incurred per
commodity is unit of output. potatoes and
.................. 3) Net addition made answer the
a) total Revenue to total cost of following
production. questions.
b) marginal
Revenue 4) Revenue per unit of Price Firms
output sold. in `
c) average
Revenue Q. 4. Distinguish
d) marginal Cost between : “A” “B”
1) Stock and Supply. 1 20
Q. 2. Complete the
Correlation : 2) Expansion of 2 37 30
Supply and Increase 3 40
1) Expansion of
in Supply. 4 44 50
supply : Price
3) Contraction of
rises :: 1) Complete the
Supply and
Contraction of Decrease in Supply. quantity of
supply : 4) Average Revenue potato supplied
2) Total revenue ::: and Average Cost. by the firms to
Average revenue the market in the
: TR/TQ above table.
45
 5 Forms of Market

Introduction : various criteria. This is shown in following

Market is generally understood as a fig. 5.1.
particular place or locality where goods are sold I) On the basis of place :
and purchased. But, in economics, market refers 1) Local market : Local market is a market
to an arrangement through which buyers and in which sellers sell and customers buy a
sellers come in contact with each other directly product in the region or area in which it is
or indirectly and exchange of goods and produced.
services takes place among them. 2) National market : National market is
Definition of Market : a domestic market in a given country.
According to Augustin Cournot, Each national market is governed by the
“Economists understand the term market, not regulation of its own country.
any particular market place in which things are 3) International market : International
bought and sold, but the whole of any region market is a worldwide market in which
in which buyers and sellers are in such a close buyers and sellers trade in goods and
contact with one another that the prices of the services across the national borders.
same goods tend to equality easily and II) On the basis of time :
quickly.” Thus, market is a network of 1) Very short period : Very short period is a
dealings between potential buyers and potential period in which supply is fixed and price is
sellers. At any point of time, a market will exist determined by the demand. The time
if there are : period is for a few days or weeks in which
the supply of commodity cannot be
1) Buyers and sellers
increased.
2) A product or service to be bought and sold
2) Short period : Short period is a period of
3) Price of the product
less than one year. In this period, firms can
4) Close contact between buyers and sellers
only make adjustments in inputs like labour
5) Knowledge about market to increase the supply of goods and
Classification of Market : services.
Market can be classified on the basis of 3) Long period : Long run is a period of time
in which all factors of production and costs
Classification of Market on the basis of
I) Place II) Time
III) Competition
A) Perfect A) Local A) Very
ii) Oligopoly

competition short period

B) National B) Short
period
C) International C) Long
period
D) Very long
period
competition
iii) Monopolistic

i) Monopoly
competi
B) Impe
 ect
on
Fig. 5.1
are variable. In the long run, firms are able The number of buyers is also large. The
to adjust all costs. It is for a few years, share of each buyer is so negligible that
generally up to five years.
4) Very long period : Very long period is
a production time that is so long that all
inputs are variable. It is of more than five
years.
III) On the basis of Competition :
Competition among the sellers and buyers
is the most important criteria for classification
of markets in economics. Let us study the
various types of markets on the basis of
competition among the sellers :
A) Perfect Competition :
Meaning and Definition : Perfect
competition is an ideal and imaginary
concept of market rather than an actual
market. According to Mrs. Joan Robinson,
“Perfect competition prevails when the
demand for the output of each producer is
perfectly elastic.”
A perfectly competitive market is
one in which the number of buyers and
sellers is very large. All the buyers and
sellers are engaged in buying and selling
a homogeneous product without any
restrictions. Moreover both buyers and
sellers possess perfect knowledge of
market conditions.
Following are the features of Perfect
Competition :
1) Large number of sellers and buyers :
Under perfect competitions, there are large
number of sellers and buyers. As
mentioned earlier, each seller forms a
negligible part in the total market. Hence,
none of them is in a position to influence
the price and supply in the market. Thus,
sellers are price takers under perfect
competition.
 none of them is in a position to influence buyers and sellers possess a perfect
the price in the market. knowledge about the market conditions.
2) Homogeneous product : An important Every seller and buyer has the knowledge
feature of a perfectly competitive about price, quality, source of supply of
market is that the product sold is products etc.
homogeneous or identical in respect of 6) Perfect mobility of factors of production
size, design, colour, taste etc. All the : There is perfect mobility of factors of
products are perfect substitutes to each production under perfect competition.
other. Labour and capital are mobile not only
3) Free entry and exit : There are no geographically but also occupationally.
barriers to the entry and exit of firms. 7) Absence of transport cost : In perfect
Any firm can enter or quit the industry at competition, price is uniform because we
its own will. If there is hope of profit, assume that transport cost does not exist.
the firm will enter the market and if This assumption will lead to uniformity in
there is possibility of loss the firm will price.
leave the market. 8) No government intervention : Laissez-
4) Single price : A single uniform price faire policy is an important feature of
prevails under perfect competition perfect competition. It means there is
which is determined by the interaction of absence of Government intervention in
demand and supply. economic activities.
5) Perfect knowledge of market : The Price determination under Perfect Competition:
The interaction of demand and supply
determine price of the commodity in perfect conclusions can be drawn :
competition. This is known as ‘equilibrium 1) When price rises from ` 100 to ` 200
price.’ Marshall has compared the process of quantity demanded falls from 5000 kgs. to
price determination to the cutting of cloth with 4000 kgs. whereas supply increases from
a pair of scissors. Just as both the blades of 1000 kgs. to 2000 kgs. This is because
scissors are required to cut the cloth, both the demand falls with rise in price and supply
forces of demand and supply are essential to rises with a rise in price. This is the stage
determine the equilibrium price in the market. where demand is greater than supply (DD >
This is explained with the help of the following
schedule and diagram.
Table no 5.1 Demand and Supply Schedule
Price per Quantity Quantity Relationship
Kg. of demanded supplied between DD
Apples (in `) (in Kg.) (in Kg.) and SS
100 5000 1000 DD > SS
200 4000 2000 DD > SS
300 3000 3000 DD = SS
400 2000 4000 DD < SS
500 1000 5000 DD < SS
From the table no 5.1, following
diagram, X axis represents quantity
demanded and quantity supplied, whereas Y Y Ex ce ss Su pl
axis represents the price. DD is the downward 500 D SS >
p y S
sloping demand curve which shows inverse D
400 D
relationship between price and quantity
00 E =
demanded. SS is the upward sloping supply 3
D SS
curve which shows direct relationship
200 D
between price and quantity supplied. E is the DD >
equilibrium point where DD and SS curve 100 S Ex ce ss SS
De m an D
intersect d
0 1000 20 00 30 00 40 0 00 X
each other. Accordingly ` 300 is the equilibrium
0 50
price and 3000 kgs. is the equilibrium quantity Quantity Demanded and Quantity Supplied (in
demanded and supplied. This equilibrium kgs.)
price is determined by market demand and Fig. 5.2
market supply. B) Imperfect Competition :

Price (in `) per kg

Imperfect competition is a type of market
SS). showing some but not all the features of a
2) When price rises to ` 300, quantity competitive market. Following are some of the
demanded and quantity supplied become types of imperfect market.
equal that is 3000 kg. This is the stage of
I) Monopoly :
equilibrium where demand and supply
Meaning and Definition : The term monopoly
become equal (DD = SS). Hence, ` 300
is derived from the Greek word ‘Mono’ which
becomes the equilibrium price.
means single and ‘poly’ which means seller.
3) When price further rises from ` 400 to `
Monopoly is a market in which there is only
500, demand falls from 2000 kgs. to 1000
one seller who controls the entire market supply
kgs. and supply rises from 4000 kgs. to
for a product which has no close substitute.
5000 kgs. Thus, supply is greater than
demand. (SS > DD). According to E. H. Chamberlin,
“Monopoly refers to a single firm which has
The process of price determination is
control over the supply of a product which has
explained in the following figure 5.2. In this
no close substitute.”
 Following are the main features of 2) Public monopoly : When the production
monopoly market : is solely owned, controlled and operated
1) Single seller : In monopoly, there is no by the Government, it is known as public
competition as there is only one single monopoly. It is usually welfare oriented.
producer or seller of the product. But, the For example, Indian Railways.
number of buyers is large. 3) Legal monopoly : This monopoly emerges
2) No close substitute : There are no close on account of legal provisions like patents,
substitutes for the product of the trade mark, copyrights etc. The law forbids
monopolist. Therefore, the buyers have no the potential competitors to imitate the
choice. They have to either buy the product design or form of the product registered
from the monopolist or go without it. The under given branded names. For example,
cross elasticity of demand for his product is Amul products.
either zero or negative. 4) Natural monopoly : The monopoly
3) Barriers to entry : Entry of the rivals is created on the basis of natural conditions
restricted due to legal, natural, like climate, rainfall, specific location etc.
technological barriers which do not allow is known as natural monopoly. For
the competitors to enter the market. example, wheat from Punjab.
4) Complete control over the market supply: 5) Simple monopoly : In simple monopoly,
The monopolist has complete hold over the seller or a firm charges a uniform price for
market. He is the sole producer or seller of its product to all the buyers.
the product. 6) Discriminating monopoly : In
5) Price maker : A monopolist can fix the discriminating monopoly, firm charges
price of his own product as he controls the different prices to different buyers for the
whole market supply. Monopolist is a price same product. For example, doctor charges
maker. different fees to different patients.
6) Price discrimination : Monopolist being a 7) Voluntary monopoly : To avoid cut
price maker, he can charge different prices throat competition, some monopolists
to different consumers for the same voluntarily come together and form a
product, on the basis of time, place etc. group of monopolists. This facilitates
Thus, price discrimination is an important them to maximise the profit. For example,
feature of monopoly market. For example, Organisation of Petroleum Exporting
students and senior citizens are provided Countries (OPEC).
railway tickets at concessional rates.
7) No distinction between firm and You should know :
Price descrimination under monopoly
industry: A monopolist is the sole seller
and producer of the product. A monopoly
firm itself is an industry. Personal Place wise Time wise f Use p
Following are m i k ri
Types of monopoly : r v
some of the types of o n
monopoly : n m o a
1) Private o w t
monopoly : p i n e
When an o t m
individual or l a o
private body i s n
y
controls a s o
poly. For
D Diff ST Ele
example, Tata oc eren bus ctri
Group. to ces fare city
rs in diffe cha
49 ch hou rs rge
ar se for s
ge rent over are
di in nigh diff
ff rura t and ere
er l day nt
en and time for
t urba trave do
fe n ls me
es area stic
to s and
di co
ff m
er me
en rcia
t l
pa use
tie s
nt
s
 4) Entry barriers : The firm can easily
Find out :
exit from the industry whenever it wants.
Types of monopoly for the following But has to face certain entry barriers
products/services : such as Government licence, patents etc.
Tea in Assam
5) Lack of uniformity : There is a lack of
Atomic energy uniformity among the firms in terms of
Logo of a commercial bank their size. Some firms may be small while
others may be of bigger size.
Do you know? 6) Uncertainty : There is a considerable
Monopsony is the converse of element of uncertainty in this type of
monopoly. It exists when there are many market due to different behaviour patterns.
sellers but only one buyer. Buyer’s Rivals may join hands and co-operate or
monopoly is rarely found. A monopsonist may try to fight each other.
can exploit the sellers just as a
III) Monopolistic competition :
monopolist may exploit the buyers. In
Different brands of liquid cleaners :
the labour market, a particular kind of
labour is used by one employer only.
II) Oligopoly : large part of market.
The term oligopoly is derived from the
Greek words ‘Oligo’ which means few and
‘poly’ which means sellers. It is that market
where there are a few firms (sellers) in the
market producing either a homogeneous
product or a differentiated product. For
example, mobile service providers, cement
companies etc.
Features of oligopoly :
1) Few firms or sellers : Under oligopoly
market, there are few firms or sellers.
These few firms dominate the market and
enjoy a considerable control over the price
of a product.
2) Interdependence : The seller has to be
cautious with respect to any action taken
by the competing firms. Since there are
few sellers in the market, if any firm makes
the change in the price, all other firms in
the industry also try to follow the same to
remain in the competition.
3) Advertising : Advertising is a powerful
instrument in the hands of oligopolist. A
firm under oligopoly can start an
aggressive and attractive advertising
campaign with the intention of capturing a
50
 coined this concept in his book “Theory of
Monopolistic Competition” which was
published in 1933.
According to Chamberlin, “Monopolistic
competition refers to competition among a large
number of sellers producing close but not
perfect substitutes.”
Following are the main features of
Fig. 5.3
monopolistic competition :
Meaning and Definition : Monopolistic
1) Fairly large number of sellers : In
competition is very realistic in nature. In this
monopolistic competition, the number of
market there are some features of perfect
sellers is large but comparatively it is less
competition and some features of monopoly
than that of perfect competition. Due to this
acting together. Prof. E. H. Chamberlin
reason sellers’ behaviour is like monopoly.
2) Fairly large number of buyers : In this demand for its product and thus increase
market there are fairly large number of the volume of sales. It includes expenditure
buyers. Consequently, no single buyer on advertisements, readio and television
can influence the price of the product by broadcasts, hoardings, exhibitions, window
changing his individual demand. display, free gifts, free samples etc.
3) Product differentiation : Product 6) Close substitutes : In monopolistic
differentiation is the main feature of competition, goods have close substitutes
monopolistic competition. In this market, to each other. For example, different
there are many firms producing a particular brands of soaps, toothpastes etc.
product, but the product of each firm is in
some way differentiated from the product 7) Concept of group : Under monopolistic
of every other firm in the market. This is competition, Chamberlin introduced the
known as product differentiation. Product concept of ‘Group’ in place of industry.
differentiation may take the form of brand Industry means the number of firms
names, trade marks, peculiarity of package producing identical products. A ‘Group’
or container, shape, quality, cover, design, means a number of firms producing
colour etc. This means that the product of differentiated products which are closely
a firm may find close substitutes and its related. For example, group of firms
cross elasticity of demand is very high. For producing medicines, automobiles etc.
example, mobile handsets, cold drinks etc.
4) Free entry and exit : Under monopolistic
competition there is freedom of entry and
exit, that is new firms are free to enter the Find out :
market if there is profit. Similarly, they can Closesubstitutesforthefollowing
leave the market, if they find it difficult to products.
survive.
5) Selling Cost : Selling cost are peculiar to
monopolistic competition only. It refers to
the cost incurred by the firm to create more
51
 Products Substitutes
1) Gemini Oil
2) Colgate Toothpaste
3) Red Label Tea
4) Bru Caffee
5) Activa Two-wheeler

EXERCISE

Q. 1. A) Choose the correct option : Options :1) a and b 2) b and c

1) In economic sense, market includes following 3) a, b and c 4) only d
activities 2) Classification of markets on the basis of place
a) The place where goods are sold and a) Local market, National market,
purchased. International market
b) An arrangement through which buyers and b) Very short period market, Local market,
sellers come in close contact with each National market.
other directly or indirectly. c) Short period market, National market,
c) A shop where goods are sold. International market.
d) All of the above. d) Local market, National market, Short period
market.
Options :1) a, b and c 2) b, c and d 5) Charging different prices to different consumers
3) only a 4) a and d for the same product or services.
3) Homogeneous product is a feature of this Q. 3. Complete the Correlation :
market. 1) Perfect competition : Free entry and exit ::
a) Monopoly : Barriers to entry.
b) Monopolistic competition
2) Price taker : :: Price maker :: Monopoly.
c) Perfect competition
d) Oligopoly 3) Single price : Perfect competition ::
Options :1) c and d 2) a, b and c Discriminated prices :
3) a, c and d 4) only c
4) Under Perfect competition, sellers are
a) Price makers b) Price takers
c) Price discriminators d) None of these
Options :1) a, b and c 2) only b
3) only c 4) a and c
Q. 2. Give economic terms :
1) The market where there are few sellers.
2) The point where demand and supply curve
intersect.
3) The cost incurred by the firm to promote sales.
4) Number of firms producing identical product.

52
Q. 4. Find the odd word out :
Price of Demand (in Supply Relation
1) Selling cost : Free gifts, banana dozen) (in between DD
Advertisement hoardings, Window displas, (per dozen) and SS
Patents. dozon) in `
10 500 100 DD > SS
2) Market sructure on the basis of competition 20 400 DD > SS
: Monopoly, Oligopoly, Very Short Period 30 300 DD = SS
market, Perfect competition. 40 200 DD < SS
3) Features of monopoly : Price maker, Entry 50 500 DD < SS
barriers, Many sellers, Lack of substitutes. 1) Fill in the blanks in the above schedule.
4) Legal monopoly : Patent, OPEC, Copyright,
2) Derive the equilibrium price from the above
Trade mark.
schedule with the help of a sutiable diagram.
Q. 5. Answer the following :
Q. 7. Answer in detail :
1) Explain the features of Oligopoly.
1) Explain the meaning of Monopolistic
2) Explain the types of Monopoly. competition with its features.
Q. 6. Observe the table and answer the questions 2) Explain the meaning of Perfect competition
: with its features.



53
 6 Index Numbers

Introduction :
Index numbers are one of the most used 53
statistical tools in economics. An index number
is a device to measure changes in an economic
variable (or group of variables) over a period of
time. Index numbers were originally developed
to measure changes in the price level. In the
present context, it is also used to measure trends
in a wide variety of areas that includes stock
market prices, cost of living, industrial and
agricultural production, changes in exports and
imports etc. Index numbers are not directly
measurable, but represent relative changes.

Do you know?
Origin of Index Numbers : During the
17th century, Rice Vaughan, an Englishman
and eminent writer was concerned with the
rise in prices which had occurred in his
native land over the preceding century. The
first study using Index Numbers was done
in the early 18th century. In 1707, William
Fleetwood made a comparison of the prices
of certain commodities such as wheat, oats,
beans, cloth, meat etc. for the periods
1440-1460 and 1686-1706. The results of
this study are presented in his work,
‘Chronicon Preciosum’ (1707). In 1738,
Charles de Ferrare Dutot of France
constructed a simple aggregative index for
two periods 1508 and 1735 and compared
the costs for an identical list of
commodities. However, the first recorded
index number appeared in the work of G.R.
Carli, an Italian who used a modified form
of the simple average of price relatives in
1764.

Definitions of Index Numbers :

1) Spiegel : “An index number is a statistical
measure designed to show changes in a
variable or a group of related variables
with
 reference to time, geographical location and
other characteristics such as income,
profession etc.”
2) Croxton and Cowden : “Index Numbers are
devices for measuring differences in the
magnitude of a group of related variables.”
Features of Index Numbers :
1) Index numbers are statistical devices.
2) Index numbers are specialized averages
which are capable of being expressed in
percentages.
3) Index numbers measure the net change in one
or more related variables over a period of
time or between two different time periods or
two different localities.
4) Index number which is computed from a
single variable is called a ‘univariate index’,
whereas an index which is constructed from a
group of variables is called a ‘composite
index’.
5) The year for which the index number is
prepared is the current year.
6) The year with which the changes are
measured is called the base year.
7) The base year’s index is assumed as 100 and
accordingly the value of the current year is
calculated.
8) Index numbers are also referred to as
‘barometers of economic activity’, since it
is used to measure the trends and changes in
the economy.

You should know :

Terminologies used in index numbers -
Base Year : The year with respect to which
comparisons are made is the base year. It is
denoted by the suffix ‘o’.
Current Year : The year for which
comparisons are required to be made is the
 current period. It is denoted by the suffix ‘1’. Consumer Price Index
Notations Wholesale Price Index
p0 = Price of the commodity in the base year Index of Agricultural Production
Index of Industrial Production
p1 = Price of the commodity in the current year
Index of Service Production
q0 = Quantity of the commodity consumed or Index of Export/Import
purchased in the base year
Human Development Index
q1 = Quantity of the commodity consumed or
purchased in the current year
Significance of Index Numbers in Economics :
Index numbers are indispensable tools of
economic analysis. Following points explain the
Types of Index numbers :
significance of index numbers :
PRICE INDEX NUMBER
1) Framing suitable policies : Index
QUANTITY INDEX NUMBER
INDEX numbers provide guidelines to policy
NUMBERS VALUE INDEX NUMBER makers in framing suitable economic
SPECIAL PURPOSE INDEX NUMBER policies such as agricultural policy,
industrial policy, fixation of wages and
1) Price Index Number : It measures the
dearness allowances in accordance with the
general changes in the prices of goods. It
cost of living etc.
compares the level of prices between two
different time periods. 2) Studies trends and tendencies : Index
numbers are widely used to measure
2) Quantity Index Number : It is also called
changes in economic variables such as
volume index number. It measures changes
production, prices, exports, imports etc.
in the level of output or physical volume of
over a period of time. For example, by
production in the economy. For example,
examining the index of industrial
changes in agricultural production,
production for the last five years, we can
industrial production etc. over a period of
draw important conclusions about the trend
time.
of industrial production whether it shows
3) Value Index Number : The value of a an upward tendency or a downward
commodity is the product of its price and tendency.
quantity (p × q). Value index number
3) Forecasting about future economic
measures the changes in the value of a
activity : Index numbers are useful for
variable in terms of rupee. It is a more
making predictions for the future based on
informative index as it combines both,
the analysis of the past and present trends
changes in the price as well as quantity.
in the economic activities. For example,
4) Special Purpose Index Number : They based on the available data pertaining to
are constructed with some specific imports and exports, future predictions can
purpose. For example, import-export index be made. Thus, forecasting guides in
numbers, labour productivity index proper decision making.
numbers, share price index numbers etc.
4) Measurement of inflation : Index
Do you know? numbers are also used to measure changes
Some of the widely used index numbers in the price level from time to time. It
by the Government of India : enables the government to undertake
appropriate anti-inflationary measures.
54 There is a legal provision to pay the
D.A. (dearness
 allowance) to the employees in organised number. For example, in the construction
sector on the basis of changes in Dearness of price index numbers it is impossible to
Index. include each and every commodity. The
5) Useful to present financial data in commodities to be selected should
real terms : Deflating means to make represent the tastes, habits and customs of
adjustments in the original data. Index the people. Besides this, only standardized
numbers are used to adjust price changes, or graded items should be included to give
wage changes etc. Thus, deflating helps better results.
to present financial data in real terms (at 4) Selection of price quotations : Prices of
constant prices). the selected commodities may vary from
Construction of Index Numbers : place to place and shop to shop in the same
Following steps are involved in the market. Therefore, it is desirable that price
construction of index numbers : quotations should be obtained from an
1) Purpose of index number : The purpose unbiased price reporting agency. To
for constructing the index number, its achieve accuracy, proper selection of
scope as well as which variable is representative places and persons is
intended to be measured should be clearly required.
decided to achieve fruitful results. 5) Choice of a suitable average :
2) Selection of the base year : Base year is Construction of index numbers requires
also called the reference year. It is the year choice of a suitable average. Generally,
against which comparisons are made. The Arithmetic mean is used in the construction
base year should be normal i.e. it should be of index numbers because it is simple to
free from natural calamities. It should not compute compared to other averages.
be too distant in the past. 6) Assigning proper weights : Weight
refers to the relative importance of the
different items in the construction of an
index number. Weights are of two types
Do you know? i.e. quantity weights (q) and value weights
In 2015, the Central Statistical Organisation (p x q). Since all items are not of equal
importance, by assigning specific weights,
(CSO) under the Ministry of Statistics changed
better results can be achieved.
the base year for tabulating Gross Domestic
7) Selection of an appropriate formula :
Product from 2004-05 to 2011-12. Periodic
Various formulae are devised for the
rebasing of GDP series every seven to ten years
construction of index numbers. Choice of a
is carried out to account for the changing suitable formula depends upon the purpose
economic structure and relative prices. Besides of index number and availability of data.
this, the base year of Index of Industrial
Methods of Constructing Index Numbers :
Production (IIP) and the base year of
There are two methods of constructing
Wholesale Price Index (WPI) has also been index numbers:
changed from 2004-05 to 2011-12. At present, a) Simple Index Number
3) Selection of items : It is necessary to
the process of further rebasing the base year is
select a sample of the number of items to b) Weighted Index Number
underway.
be included in the construction of a The following chart explains the methods
particular index
55
 of constructing index numbers : p = sum total of the prices of the base year
0
where, q = sum total of Ex 1 : Construct a
SIMPLE INDEX
the NUMBER
quantities of Price index1 number
the using the simple q
1
current year method from the given Quantity
= q ×
CONSTRUCTION OF
INDEX NUMBERS data : Index
: In WEIGHTED Number Q01 1
this INDEX NUMBER Steps : 1) Add the 0
prices of the different 0
A) Simple method, q = sum total of the
0

Index quantities of the base commodities

0
of the
Numbe year base year to derive p
r
0
2
2) Add the prices of Q 8 × 100 = 133.33
Ex 2 : Construct a 0
the different
= 0
Quantity index 1 2
commodities of
number using the the current year to 1
derive p 0
simple method from
the given data : 3) Apply Q01 =133.33
1

every the formula


commodity is Steps : 1) Add the : p 3) Value Index
given equal quantities of the = 1 Number : It is
importance. 
different commodities Price
× measured as :
It is the easiest of the p Index 100 p q
base year to
method of derive q Number 0

P01 0
constructing Value Index Number V01 = 1 1
Commodities Prices in 2) Add Prices
2010 the in 2015 
index numbers.(in `) Base (in `)
p0q0
quantities of(Current
the w
This method can year) p0 year) p1 1
different h
be applied to e
A 20 commodities30 of the r
determine e
B 60 current year to
80
1) Price Index ,
C 100 derive q 130 
Number p
D 40 60
2)Total
Quantity p =3) p = 300
Apply the
220 q
Index
0
formula :
1 q
1
= ×  =
Number 100
Quantity q
3) Value Index
0
s
Index u
Number m
Number Q01
t
Some Solved o
Examples : t
a
1) Price index l
number : It is Commodities Qty. in 2000 Qty. in 2001 o
f
measured as: (Base year) q0 (Current year) q1 t
p h
Price = 1
× 100 
A 30 45 e
Index 0 p
p B 55 70 r
Number o
C 90 105 d
P01
D 35 60 u
where, p1 = sum total of the prices of the current c
year Total q = 210 q = 280 t
0 1
o
56
 f
the
1 1
prices and quantities
of the current year.
p q = sum total of 0 0
the product of the
prices and quantities
 of the base year.
Price p Ex 3 : Construct
1
Index =
Number × aValue index
100 p
P01 0
number using the
300 simple method
from the given
data :
Steps : 1) Find the
product of prices
and their respective
quantities of the
different
commodities
P for the base year
22
0 to derive p q .
0 × Take the sum
10
1 0 =
= 13
6.3
6
0 0
P01 =136.36 total of the products to 0 0

2) Quantity index derive p q .

number : It is 2) Find the product of
measured as : prices and their
respective

Quantity  quantities of the

Index q different 1
Number Q01 × = q
10 commodities for the
0
0

57
current year to derive p1q1. Take sum total of Ex. 1 : Construct Laaspeyre’s Index for the given
the products to derive p q . data : 1 1
3)Commodities
Apply Base year Current year
the p 0q
p q0 p1 q1
1 1
p A : = 20 × 1004
formula 30 6
q B 10 5 20 8
Value C 40 8 60 5
Index D 30 4 40 4
Number
V01
0 0

Commodities Base year Current year

p0 q0 p0q0 p1 q1 p1q1
P 5 4 20 20 10 200
Q 10 3 30 30 8 240 Solution :
Commodities Base Current
R 15 2 30 40 6 240 year year
S 20 1 20 50 4 200 p0 q0 p1 q1 p1 q0 p0 q0
Total p0q0 = 100 p1q1 = 880 A 20 4 30 6 120 80
B 10 5 20 8 100 50
C 40 8 60 5 480 320
Value D p30× 100
4 40 4 160 120
IndexTotal 860 570
Number q
1 1
=  V01 p
0
q
0

V 8
×
8
0 1 Steps : 1) p1q0 of
0
1
0 Find out the
0
V 1 the
=
0 08 product
=
1 08 different
=0 commodit
88 ies.
0
B) Weighted Index 2) Find out the
Number : In this product p0q0 of the
method, suitable different
commodities.
weights are
assigned to
various
commodities. It 3) Add all obtained
gives relative the to derive
importance
to the commodity products
in the group. In p1q0
most of p q .
1 0
 the cases 4) Add all obtained Thus, Laaspeyre’s Sensex, also
‘quantities’ are to derive index P01 = 150.87 called BSE 30,
the
used as weights.
products is the market
There are Do you know?
various methods p0q0 index consisting
of constructing p q . Sensex and
0 0 of 30 well-
Nifty are stock
weighted index 5) Apply the given established and
number such as market indices
formula : financially
Laaspeyre’s p q which
Price Index, sound
represent
Paasche’s Price companies listed
Index etc. 1P
Bombay Stock
on Bombay
Exchange
× 100 Stock Exchange
S p0q0 (BSE) and
(BSE). The
o National Stock
base
m Exchange
year of Sensex is
e (NSE) 1978-79.
S respectively.
ol P
Nifty,
called also
NIFTY
=1
01 50, is the
market
v
0
e
d ×
E 1
x 0
0
a p
m 0

pl q
0
es
: 57

Étienne Laspeyres : GermanP01 economist

8 Étienne
× 100 = 150.87 =
6
Laspeyres (1834–1913) formulated an index for
0
measuring current prices or quantities in
relation to those of a selected 5base period.
7
The distinctive feature of the Laspeyres index is
0
that it uses a group of commodities purchased
weights.
in the base period as the basis for comparison.
Laaspeyre’s price
index is calculated
as :
p q

1) Laaspeyre’s
Price Index
Number : In
this technique,
‘base year’
quantities are
considered as
 index consisting of 50 well-established and 5) Apply the given formula :
financially sound companies listed on p q
P01 = 1 1
× 100
National Stock Exchange of India (NSE). The p 0 1
q
base year of Nifty is taken as 1995. 134
P01 = × 100 = 212.69
63
Hermann Paasche : German economist Thus, Paasche’s index P01 = 212.69
Hermann
Paasche (1851-1925) developed an index Find out :
for measuring current price or quantity List of crops included in the
levels relative to those of a selected base Index of Agricultural Production
period. Paasche’s index uses current- in India.
period weighting.
List of products included in the
2) Paasche’s Price Index Number : In this
Index of Industrial Production in
technique, quantities of the ‘current year’ Limitations of index
are considered as weights. Paasche’s Price India.numbers :
Index numbers are useful in practice.
Index is calculated as : However they suffer from certain limitations.
p q
P01 = 1 1 Therefore, they are not completely reliable.
 × 100 1) Based on samples : Index numbers are
p0q1
Ex. 2 : Construct Paasche’s Index for the given generally based on samples. We cannot
data : include all the items in the construction of
Commodities Base year Current year the index numbers. Hence they are not free
p0 q0 p1 q1 from sampling errors.
M 2 10 5 8 2) Bias in the data : Index numbers are
N 4 5 8 3
O 1 7 2 10 constructed on the basis of various types of
P 5 8 10 5 data which may be incomplete. There may
be bias in the data collected. This is bound
Solution :
to affect the results of the index numbers.
Commodities Base Current
year year 3) Misuse of Index Numbers : Index
p0 q0 p1 q1 p1 q1 p0 q1 numbers can be misused. They compare a
M 2 10 5 8 40 16
situation in the current year with a situation
N 4 5 8 3 24 12
O 1 7 2 10 20 10 in the base year. Hence a person may
P 5 8 10 5 50 25 choose a base year which will be suitable
Total 134 63 for his purpose. For example, a
Steps : 1) Find out the product p1q1 of the businessman may choose a year in which
different commodities. his profit is high as the base year and show
that his profit is falling in the current years.
2) Find out the product p0q1 of the different
commodities. 4) Defects in formulae : There is no perfect
formula for the construction of an index
3) Add all the products p1q1 obtained to derive
p q . number. It is only an average and so it has
all the limitations of an average.
1 1

4) Add all the products p0q1 obtained to derive 5) Changes in the economy : The habits,
p q .
58
 tastes and expectations of the people in
0 1

a country are always changing and all 8) Limited scope : An index number has
these changes cannot be included in the limited scope because if it is constructed
estimation of index numbers. for one purpose then it cannot be used for
6) Qualitative changes : The price or any other purpose.
quantity index numbers may ignore the
changes in qualities of the products. At any Find out :
given time, a better quality commodity Newspaperheadlinesrelatedtoth
will have a higher production cost and a
e following types of index
higher price than an ordinary commodity
numbers :
which is a substitute for the better product.
Price Index
7) Arbitrary weights : The weights assigned Agricultural Productivity Index
to different commodities may be arbitrary.
Index of Industrial Production
Equity Share Price Index
EXERCISE

Q. 1. Choose the correct option : c) In most of the cases, quantities are used as
1) Statements that are incorrect in relation to weights.
index numbers. d) Laaspeyre's and Paasche's method is used in
a) Index number is a geographical tool. the calculation of weighted index numbers.
b) Index numbers measure changes in the air Options :1) b, c and d 2) a, c and d
pressure. 3) a, b and d 4) a, b, c and d
c) Index numbers measure relative changes in 4) Statements related to limitations of index
an economic variable. numbers.
d) Index numbers are specialized averages. a) Index numbers are not completely reliable.
Options :1) c and d 2) a and b b) There may be a bias in the data collected.
3) b and c 4) a and d c) Every formula has some kind of defect.
2) Statements that highlight the significance of d) Index numbers ignore changes in the
index numbers. qualities of products.
a) Index numbers are useful for making future Options :1) a, c and d 2) a, b, c and d
predictions. 3) a, b and d 4) b, c and d
b) Index numbers help in the measurement of 5) Choose the correct pair :
inflation. Group A Group B
c) Index numbers help to frame suitable p q
1 1 × 100
policies. 1) Price Index a)
p0q0
d) Index numbers can be misused. q
2) Value Index b)
1 × 100
Options :1) b, c and d 2) a, c and d q0
3) a, b and d 4) a, b and c p q
1 1
3) Quantity Index c) × 100
p0 1
3) Statements that apply to weighted index q
numbers. 4) Paasche's Index d) p 1 × 100

a) Every commodity is given equal b) It assigns suitable 'weights' to various
importance. commodities.
59
 p0 Options :1) 1-d, 2-c, 3-a, 4-b 2) 1-d, 2-a, 3-b, 4-c
3) 1-b, 2-c, 3-d, 4-a 4) 1-c, 2-d, 3-a, 4-b
Q. 2. Complete the Correlation : 4) Calculate Laaspeyre's and Paasche's index from the
1) Price Index : Inflation :: : Agricultural given data :
production
Base Year Current Year
2) : Base year prices :: p1 : Current year Commodity
Price Quantity Price Quantity
prices X 8 30 12 25
3) Laaspeyre's index : :: Paasche's index
Y 10 42 20 16
: Current year quantities
4) : Single variable :: Composite index : Q. 4. Distinguish between :
Group of variables 1) Simple Index Numbers and Weighted Index
Q. 3. Solve the following : Numbers.
1) Calculate Price Index number from the given 2) Price Index and Quantity Index.
data : 3) Laaspeyre's Index and Paasche's Index.
Commodity A B C D Q. 5. State with resons whether you agree or
Price in 2005 (`) 6 16 24 4
disagree with the following statements :
Price in 2010 (`) 8 18 28 6
1) Index numbers measure changes in the price
2) Calculate Quantity Index number from the level only.
given data :
2) Index numbers are free from limitations.
Commodity P Q R S T
Base year quantities 170 150 100 195 205 3) Index numbers can be constructed without the
Current year quantities 90 70 75 150 95 base year.
3) Calculate Value Index number from the given Q. 6. Answer the following :
data : 1) Explain the features of index numbers.
Base Year Current Year
Commodity Price Quantity Price Quantity 2) Explain the significance of index numbers in
A 40 15 70 20 economics
B 10 12 60 22
C 50 10 90 18 Q. 7. Answer in detail :
D 20 14 100 16 1) Explain the steps involved in the construction
E 30 13 40 15 of index numbers.



60
 7 National Income

Definitions of National Income :

Following are some of the important
definitions of national income :
1) National Income Committee (NIC) : The
National Income Commitee was appointed
by the Government of India in August
1949 with Prof. P. C. Mahalanobis as
Chairman and Prof. D. R. Gadgil and Dr.
V. K. R. V. Rao as the members.

Fig. 7.1
Introduction :
National Income is one of the important
subject matter of macroeconomics. The national
P.C.Mahalanobis V. K. R. V. Rao D. R. Gadgil
economy comprises of all the firms and
According to NIC “A national estimate
factories, shops and markets, banks and
financial institutions, various departments and measures the volume of commodities and
services turned out during a given period
their offices etc. National income is a
counted without duplication.”
composite measure of all economic activities
such as production, distribution, exchange and 2) Prof. A.C. Pigou : “National dividend is
consumption, but is also an objective indicator that part of objective income
of economic welfare of the people in a country. of the community including of
course income derived from
In India, establishment of the National
abroad which can be measured
Income Committee (NIC) in 1949 marked the
in money.”
beginning of Government efforts for regular
compilation of National Income estimates. At 5) Prof. Irving Fisher : “National dividend
present, Central Statistical Organisation (CSO) or income consists solely of
compiles and publishes data on national income services as received by
ultimate consumers, whether
and allied aggregates every year.
from their material or from
Meaning : their human environments.”
Modern economy is a money economy. Features of National Income :
Hence, national income of a country is 1) Macro Economic concept : National
expressed in terms of money. income represents income of the economy
The total income of the nation is called as a whole rather than that of an individual.
national income. Hence it is a macro economic concept.
In real terms, national income is the flow 2) Value of only final goods and services :
of goods and services produced in an economy In order to avoid double counting in
during a year. national income, the value of only final
 goods and
services produced in the economy are Y=C+I+G
considered. The value of intermediate 3) Four Sector Economy(Households, Business
goods or raw materials is not considered.
For example, while estimating the
production of shirts, there is no need to
take the value of cotton, as it is already
included in the price of the shirts.
3) Net aggregate value : National income
includes net value of goods and services
produced and does not include depreciation
cost. (i.e. wear and tear of capital assets)
4) Net income from abroad : National
income includes net income from abroad
i.e. difference between export value and
import value (X-M) and net difference
between receipts from abroad and
payments made abroad (R-P).
5) Financial year : National income is
always expressed with reference to a time
period. In India, it is from 1st April to 31st
March.
6) Flow concept : National income is a flow
concept as it shows flow of goods and
services produced in the economy during a
year.
7) Money value : National income is always
expressed in monetary terms. It represents
only those goods and services which are
exchanged for money.
Circular Flow of National Income :
Circular flow of income is the basic
concept in macro economics. The circular flow
of income refers to the process whereby an
economy's money receipts and payments flow
in a circular manner continuously through time.
Circular flow of income can be determined
for the following :
1) Two sector Economy (Households and
Business Firms.) Y = C + I
2) Three sector Economy (Households,
Business Firms and Government sector)
 Firms, Government and Foreign sector)
Y = C + I + G + (X-M)
The circular flow of goods and money in
a two sector model is explained below :
Two sector model of Circular flow of
National Income :
There are two sectors, households and
firms. It divides the diagram into two parts.
The upper half represents the factor market
and the lower half represents the commodity
market.
Fig. no. 7.2 explaines circular flow of
income and expenditure in a two sector
model. Land, Labour, Capital and Enterprise

Consumption Expenditure on
Goods and Services

Fig. 7.2 Households Firms

In the above figure 7.2, the factors of
production flow from the households to the Factor Income, Rent, Wages,
Interest, Profit
firms. The firms use these factors to produce
goods and services required by the
Flow of Goods and Services
households. Thus, goods flow from the
households to the firms and from the firms
back to the households. It is called product
flows.
In the same way, money flows from the
firms to the households in the form of factor
payments such as rent, wages, interest and
profit. Households use this income to
purchase goods and services. Thus, money
flows from the firms to the households and
from the households back to the firms. It is
called money flows.
In the circular flow of income,
production generates factor income, which is
converted into expenditure. This flow of
income continues as production is a
continuous activity due to never ending
human wants. It makes the flow of
income circular
 3
Do you know?
I) Three Sector Model of Circular Flow
of National Income : Under a three sector
model, the government sector is added to
the existing two sectors i.e. households and
business firms.
II) Four Sector Model of Circular
Income : In an four sector model,
foreign sector is added to the existing
three sectors
i.e. households, business firms and
government sector.

Different Concepts of National Income :

Following are some of the important
concepts related to national income.
1) Gross Domestic Product (GDP) : Gross
Domestic Product is the gross market value
of all final goods and services produced
within the domestic territory of a country,
during a period of one year.
 GDP = C + I + G + (X-M) ,
Where C = Private consumption expenditure
I = Domestic Private Investment
G = Government's consumption and Investment
Expenditures
X - M = Net export value (Value of Exports -
Value of imports
2) Net Domestic Product (NDP) : Net
Domestic Product is the net market value
of all final goods and services produced,
within the territorial boundaries of a
country, during a period of one year.
 NDP = GDP – Depreciation.
3) Gross National Product (GNP) : Gross
National Product means the gross value of
final goods and services produced annually
in a country, which is estimated according
to the price prevailing in the market.
 GNP = C + I + G + (X-M) + (R-P).
(R = receipts from abroad and P =
payments made abroad)
6
4) Net National Product (NNP) : Net National
Product is the net market value of all final
goods and services produced by the residents
of a country, during a period of one year.
 NNP = GNP – Depreciation.

Find out :
India’s GDP data.

You should know :

Concept of Green GNP :
It is defined as, “Green GNP is an
indicator of sustainable use of natural
environment and equitable distribution of
benefits of development.”
Gross National product does not take into
consideration the cost in terms of (i)
Environmental pollution, (ii) Depletion of
natural resources caused by production of
output. Mere increase in GNP will not reflect
improvement in quality of life, when it
increases environmental pollution or reduce
available resources for future generations. So
Green GNP has been introduced while
measuring economic welfare.
Following are the characteristics of Green
GNP :
1) Sustainable economic development, i.e.
development which should not cause
environmental degradation (pollution) and
depletion of natural resources.
2) Equitable distribution of benefits of its
development.
3) Promotes economic welfare for a long
period of time.
Measurement :
Green GNP = GNP - (Net fall in stock of
natural capital + pollution load.)
 process of producing final goods, that is, the
final flow of output purchased by

Methods of Measurment of National Income :

There are three methods of measuring
national income.
1) Output Method/Product Method
2) Income Method
3) Expenditure Method
Output Method
Methods of Measurement of Income Method
National Income
Expenditure Method
1) Output Method :
This method of measuring national income
is also known as product method or inventory
method.
This method approaches national income
from the output side. According to this method,
the economy is divided into different sectors,
such as agriculture, mining, manufacturing,
small enterprises, commerce, transport,
communication and other services. The output
or product method is followed either by valuing
all the final goods and services, produced
during a year, at their market price or by adding
up all the values at each higher stage of
production, until these products are turned into
final products.
While using this method utmost care must
be taken to avoid multiple or double counting.
To avoid double counting this method suggests
two alternative approaches for the measurement
of GNP.
i) Final Goods Approach / The Final
Product Approach : Final goods are those
goods which are ready for final
consumption. According to this approach,
value of all final goods and services
produced in primary, secondary and
tertiary sector are included and the value of
all intermediate transactions are ignored.
Intermediate goods are involved in the

64
 value added at each stage of production is also `
consumers. Hence, the value of final 500. Thus the total value added is equal to the
Findoutput
out : includes the value of intermediate value of
products.
Names of five countries making use of the final goods. (150 + 100 + 150 + 100 = 500)
conceptForof example,
Green GNP.the price of bread Precautions : account.
includes, the cost of wheat, making of While estimating 5) Value of exports
flour, etc., wheat and flour are both national income by should be added
intermediate goods. Their values are paid output method, and value of
up during the process of production. In following precautions imports should be
the final product i.e. bread, the values of should be taken: deducted.
intermediate goods are already included. 1) To avoid double 6) Depreciation of
Thus, a separate accounting of the counting, only the capital assets
values of intermediate goods, along value of final should be
with the accounting of the value of final goods and deducted.
product, would mean double counting. services must be 7) Sale and purchase
To avoid this, the value of only the final taken into of second hand
product or goods must be computed. account. goods should be
ii) Value Added Approach / The Value 2) Goods used for ignored as it is not
Added Method : In order to avoid self consumption a part of current
double counting value added approach is by farmers should production.
used. According to this approach, the be estimated by a Output method
value added at each stage of the guess work. is widely used in
production process is included. The Imputed value of the
difference between the value of final goods produced underdeveloped
outputs and inputs, at each stage of for self countries.
production is called the value added. consumption is However, it is
Thus, GNP is obtained as the sum total included in less reliable
of the values added by all the different, national income. because of the
stages of the production process, till the 3) Indirect taxes margin of error. In
final output is reached in the hands of included in the India, this method
consumers, to meet the final demand. market prices are is applied to
This can be illustrated with the help of to be deducted agriculture, mining
the following table. and subsidies and manufacturers,
Table No. 7.1 - Value Added Method given by the including
Production stage Value of Value of Value government to handicrafts. But it
output ` input ` added ` certain products is not applied for
Cotton 150 0 150 should be added transport,
Yarn 250 150 100 for accurate commerce and
Cloth 400 250 150
estimation of communication
Shirt (final goods) 500 400 100
Total value 500 national income. sectors in India.
Value added at each stage is calculated 4) While evaluating 2) Income Method :
by deducting the value of inputs from the output, changes in This method of
value of output produced. The sum total the price level measuring national
added at different stages make GNP. In the between different income is also known
above table the value of years must be as factor cost method.
final good (Shirt) is ` 500. The sum total of taken into This method estimates
65
national income from all added together, income by income should be
the distribution side. but income received method, the ignored, as they
According to in the form of following do not add
this method, the transfer payments precautions should anything to the
income payments are ignored. The be taken. real national
received by all data pertaining to 1) Transfer income.
citizens of a country, income are obtained incomes or 5) Revenue
in a particular year, from different transfer received by the
are added up, that is, sources, for payments like government
incomes that accrue instance, from scholarships, through direct
to all factors of income tax returns, gifts, taxes, should be
production by way of reports, books of donations, ignored, as it is
rents, wages, interest accounts, as well as charity, old age only a transfer
and profits are estimates for small pensions, of income.
income. unemployment 6) Undistributed
GNP can be allowance etc., profits of
treated as the sum should be companies,
of factor incomes, ignored. income from
earned as a result of 2) All unpaid government
undertaking services like property and
economic activity, services of a profits from
on the part of housewife, public
resource owners and teacher enterprise, such
reflected in the teaching her/his as water supply,
production of the child, should be should be
total output of ignored. included.
goods and services 3) Any income 7) Imputed value of
during any given from sale of production kept
time period. second hand for self-
Thus, GNP, goods like car, consumption and
according to income house etc., imputed rent of
method, is should be owner occupied
calculated as ignored. houses should be
follows: 4) Income from included.
NI = Rent + sale of shares In India, the
Wages + Interest + and bonds National Income
Profit + Mixed Committee
Income + Net of the Central professional and
income from Statistical liberal arts, public
abroad. Organization, administration and
NI = R + W + I + P + uses the income domestic services.
MI + (X–M) method for 3) Expenditure
Precautions : adding up the Method :
While income arising This method of
estimating national from trade, measuring national
transport,
66
income is also known washing machine government, on business sector
as Outlay Method. etc., which are creating for production of
According to generally used for infrastructural goods and
this method, the total a longer period of facilities like services in any
expenditure incurred time; and construction of economy (G).
by the society, in a expenditure on roads, railways, 4) Net Foreign
particular year, is services like bridges, dams, Investment/Net
added together. transport services, canals, which are Exports : It
Income can be spent medical services, used by the refers to the
either on consumer etc.
difference
goods or on capital 2) Gross Domestic between exports
goods. Thus, we can Private and imports of a
get national income Investment country during a
by summing up all Expenditure (I) : period of one
consumption It refers to year.
expenditure and expenditure made
investment 5) Net Receipts
by private (R-P) : The
expenditure made by businesses on
all individuals, firms difference
replacement, between
as well as the renewals and new
government of a expenditure
investment (I). incurred by
country during a
3) Government foreigners on
year.
Final domestic goods
Thus, gross national
Consumption and services (R)
product is found by
and Investment and expenditure
adding up NI = C + I
Expenditure incurred abroad
+ G + (X–M) + (R–
(G) : by residents on
P)
i) Government's foreign goods
1) Private Final final consumption and services (P).
Consumption
expenditure refers Precautions:
Expenditure
to the expenditure While estimating
(C) : Private Final
Consumption incurred by national income by
Expenditure government on Expenditure Method,
(C) by various the following
households on administrative precautions should be
non-durable services like, law taken.
goods, such as and order, 1) Expenditure on
food, which are defence, all intermediate
used education, health goods and
immediately; etc. services should
expenditure on ii) Government's be ignored, in
durable goods investment order to avoid
such as car, expenditure refers double counting.
computer, to the expenditure 2) Expenditure on
television set, incurred by the repurchase of
67
 second hand and services Conceptual which are not
goods, should should be Difficulties : accounted for in
be ignored, as included. 1) Transfer the calculation of
it is not 7) Subsidies should payments : national income.
incurred on be included. Individuals get For example,
currently Out of these pension, services of
produced methods, the unemployment housewives and
goods. Output Method allowance etc. but the services
3) Expenditure and Income whether these provided out of
on transfer Method are transfer love, affection,
payments like extensively payments should mercy, sympathy,
scholarships, used. In be included in charity etc. are not
old age advanced national income included in
pensions, countries like or not, is a major national income.
unemploymen U.S.A. and problem. On one 4) Production for
t allowance U.K. the hand they are a self consumption :
etc., should be Income Method part of individual The products kept
ignored. is popular. income and on for self
4) Expenditure Expenditure the other hand, consumption by
on repurchase Method is they are part of the farmers and
of financial rarely used by Government other allied
assets such as any country expenditure. producers do not
shares, bonds, because of Hence, these enter the market.
debentures practical transfer payments Hence, it is not
etc., should difficulties. In are not included accounted for in
not be India, the in national the national
included, as Central income. Income.
such Statistical 2) Illegal income : 5) Income of foreign
transactions Organization Illegal incomes firms : According
do not add to (CSO) adopts a like income from to IMF, income of
the flow of combination of gambling, black a foreign firm,
goods and both output marketing, theft, should be included
services. method and smuggling etc. in the national
5) Indirect taxes income method are not included income of the
should be to estimate in national country, where the
deducted. national income. firm actually
6) Expenditure income of
3) Unpaid services : undertakes the
on final goods India.
For the purpose production work.
Measurement of of calculating
National Income : national income,
There are various only paid goods
difficulties in the and services are
measurement of considered.
national income. However, there
A) Theoretical are a number of
Difficulties in the
Difficulties or unpaid services
68
6) Valuation of national failure to the nature of
Government income may distinguish subsistence
Services : show an properly, farming, a major
Government increase even between a final part of
provides a though the and an production is
number of production may intermediate partly exchanged
public have decreased. product. For for other goods
services such Also, when the example, flour and services. It
as law and price level used by a is excluded
order, falls, the bakery is an while counting
defence, national intermediate national income.
public income may product and 3) Inadequate and
administration show a that by a unreliable data
, education, decrease even household is : Adequate and
health though there final product. correct data on
services etc. may be an 2) Existence of production and
The increase in non-monetized cost data relating
calculation of production. sector : In to crops,
these services B) Practical India, fisheries, animal
at market Difficulties or especially in husbandry,
price is Statistical rural areas, forestry,
difficult, as Difficulties : there exists the construction
Youthe
should
real know
value : non-monetized workers, small
In practice, a
of income
Mixed these
refers to the incomes of self sector. enterprises etc.,
number of
servicespersons
employed is not who use their own land, Agriculture, are not
difficulties arise in
known.capital and entrepreneurship to
labour, still being in available in
the collection of
Therefore,
produce various itgoods and services.
statistical data a developing tear of capital
is difficult to country. Besides assets, due to
required for
calculate this, data on their use in the
estimation of
national unearned process of
national income.
Income. incomes, production. There
Some of the
7) Changing practical difficulties consumption and are no uniform,
price level : are as follows : investment common or
Difficulties in expenditure of accepted standard
1) Problem of
calculating rural and urban rates of
double
national population are depreciation
counting : The
income also also not applicable to the
greatest various capital
arise due to available. This
difficulty in assets. Thus, it is
changes in does not reveal
calculating difficult to make
price levels. the actual size of
national correct deductions
For example, national income.
income is of for depreciation.
when the 4) Depreciation :
double
price level Depreciation 5) Capital gains or
counting. It losses : Capital
rises, the refers to wear and
arises from the
69
 gains or capital Obviously, in the 1) For the which the
losses, which off season, they Economy : industrial output,
accrue to the engage National income investment and
property owners themselves in data are saving etc.,
by increase or alternative important for change. National
decrease in the occupations. In the economy of Income also
market value of such a case, it is a country. In helps to generate
their capital very difficult to present times, economic
assets or identify their the national models like
changes in incomes from a income data are growth model,
demand, are not particular regarded as investment
included in the occupation. accounts of the models etc.
national income 8) Valuation of economy, which Thus, proper
because these inventories : are known as measures can be
changes do not Raw materials, ‘Social adopted to bring
result from intermediate Accounts’. It the economy to
current goods, semi- tells us how the the right path.
economic finished and aggregates of a 3) Economic
activities. finished products nation's income, planning : For
6) Illiteracy and in the stock of output and economic
ignorance : Due the producers are product result planning, data
to ignorance and known as from the income pertaining to
illiteracy, small inventories. Any of different national income
producers do not mistake in individuals, is very essential.
keep an account measuring the products of This includes
of their value of industries and data related to a
production. So inventory, will transactions of country's gross
they cannot give distort the value international income, output,
information of the final trade. savings,
about the production of the 2) National investment and
quantity or producer. policies : consumption
value of their Therefore, National income which can be
output. valuation of data forms the obtained from
7) Difficulties in inventories basis of different sources.
the requires careful national 4) Economic
classification of assessment. policies such as Research :
working Importance of employment National income
population : In National Income : policy, data are also
India, working The following industrial used by the
population is not points explain the policy, research scholars
clearly defined. importance of the agricultural of economics.
For instance, National Income : policy etc. They make use
farmers in India These figures of various data
are not engaged enable us to of the country's
in agriculture know the input, output,
round the year. direction in
70
 income,
savings,
consumption,
investment
employment
etc., which are
obtained from
social
accounts.
5) Comparison
of Standard of
Living :
National
income data
helps us to
compare the
standards of
living of
people in
different
countries and
of people
living in the
same country
at different
times.
6) Distribution
of Income :
National
income
statistics
enables us to
know about the
distribution of
income in the
country from
the data related
to wages, rent,
interest and
profits. We
understand the
disparities in
the incomes of
different
sections of the
society.
71
 EXERCISE

Q. 1. Complete the following statements : Income from abroad

1) While estimating national income, we include
only value of final goods and services in order
to .........
a) make computation easier
b) avoid double counting
c) maximize national welfare of the people
d) evaluate the total economic performance of
a nation
2) NDP is obtained by .........
a) deducting depreciation from GNP
b) deducting depreciation from GDP
c) including depreciation in GDP
d) including depreciation in GNP
3) In India, national income is estimated using
.........
a) output method
b) income method
c) expenditure method
d) combination of output and income method

Q. 2. Complete the Correlation :

1) : C + I + G + (X-M) :: GNP : C + I +
G
+ (X-M) + (R-P).
2) Output method : :: Income method :
Factor cost method
3) Theoretical difficulty : Transfer payments ::
: Valuation of Inventories

Q. 3. Choose the correct option :

1) Wrongly matched pair :
a) National Income Committee – 1949
b) Financial year – 1st April to 31st March
c) Income method – National Income = Rent
+Wages+Interest+ Profit
+ Mixed income + Net
d) Expenditure method – National Income = Rent
+ Wages + Interest + Profit
Options : 1) a 2) b 3) c 4) d

Q. 4. Identify and Explain the following concepts

:
1) Vrinda receives monthly pension of
Rs.5,000/- from the State Government.
2) Viru kept aside 100 kgs. out of 500 kgs. of
wheat produced in his farm for his family.
3) Sheetal purchased wheat flour for her bakery
from the flour mill.
4) Shobha collected data regarding the money
value of all final goods and services
produced in the country for the financial
year 2018-2019.
5) Rajendra has a total stock of 500 gel pens in
his shop which includes the 200 gel pens
produced in the previous financial year.

Q. 5. Answer the following :

1) Explain the two sector model of circular
flow of national income.
2) Explain the importance of national income.
3) Explain the features of national income.
4) Explain the concept of Green GNP.

Q. 6. State with reasons, whether you agree or

disagree with the following statements :
1) There are many theoretical difficulties in
the measurement of national income.
2) Under output method, value added
approach is used to avoid double counting.

Q. 7. Answer in detail :
1) Explain the practical difficulties involved in
the measurement of national income.
2) Explain the income method and expenditure
method of measuring national income.


 8 Public Finance in India

Find out :
Moreexamplesofobligatoryand optional functions of the government.

Meaning and Nature of Public Finance :

To perform the above mentioned functions,
adequately and efficiently, any government
needs funds which can be received from various
sources. The concept of public finance is a
combination of two words ‘public’ and
‘finance, ‘Public’ is a collective for the
individuals living within an administrative
territory. In economics, it is used to signify the
government which represents the public.
‘Finance’ simply means income and
Fig. 8.1 expenditure. Thus, ‘public finance’ is nothing
Introduction : but a study of the principles of income and
expenditure of the government at central,
Public finance is one of the old branches of welfare measures etc. are optional functions
economics which highlights the role and of the government.
functions of the government in an economy.
Government is a formal or informal institution
created by the people in a specific region to
perform various functions such as protection
from external attacks, protection of private
property of the people, generation of
employment, maintaining internal law and
order, provision of social needs like education,
health, etc.
These functions of the government can be
classified as :
1) Obligatory functions : Protection from
external attacks, maintaining internal law
and order etc. are obligatory functions of
the government.
2) Optional functions : Provision of
education and health services, provision of
social security like pensions and other
state and local levels. This study is done
under the public finance branch in
economics.
Definitions of Public Finance :
Different economists have defined
public finance in their own ways. Let us
study some of these definitions :
1) According to Hugh Dalton : “Public
finance is one of those subjects which
are on the borderline between economics
and politics. It is concerned with the
income and expenditure of public
authorities and with the adjustment of
one with the other.” Since we study the
activities of the governments in political
science too, public finance also
constitutes a part of the study of political
science.
2) According to Prof. Findlay Shirras :
“Public finance is the study of the
principles underlying the spending and
raising of funds by public authorities.”
Differences Between Public Finance and Private Finance :

Points of difference Public finance Private finance

1) Objectives To offer maximum social To fulfil private interests
advantage to the society
2) Determination of Government first determines the An individual considers his
expenditure volume and different ways of its income and then determines the
expenditure volume of expenditure
3) Credit status High degree of credit in the Credit of a private individual is
market limited
4) Right to print The Government can print notes Private individual does not enjoy
currency through Reserve Bank of India such right
5) Elasticity of finance Public finance is more elastic There is not much scope for
changes in private finance
6) Effect on economy Tremendous impact on the Marginal effect on the national
economy of country economy

Structure of Public Finance : Ext

A
TheDcomponents
irec ) Tax or scope of public
ern finance can be shown as below :
t al
Ind
irec Structure of Public Finance at a Glance
t

c
I) Public II) Publi IV) Fiscal V) Financial
Expenditure e Policy Administration
Revenu
nal
Inter

B) Non-
Debt
Public
III)

Tax

(Revenue expenditure
and debit policy for
1) Proportionate
Goods and overall growth)
2) Progressive Services Tax
1) Fees
3) Regressive (GST)
2) Prices of public good and service
1) Public expenditure
3) Special Assessment
2) Public revenue
A) Revenue expenditure 4) Fines and penalties
3) Public debt
B) Capital expenditure 5) Gifts, grants and donations
C) Developmental expenditure 6) Special levy
D) Non- Developmental expenditure 7) Borrowings

Fig. 8.2
On the basis of figure 8.2, the explanation is as follows :
I) Public Expenditure : in nature. The expenditure which results
Public expenditure is that expenditure
which is incurred by the public authority
[Central, State and Local Bodies] for protection
of their citizens, for satisfying their collective
needs and for promoting their economic and
social welfare.
Till 20th century, the majority of the
governments had adopted a policy of laissez
faire. Under this policy, the functions of
government were restricted to the obligatory
functions. But, the modern governments not
only perform the obligatory functions such
as defence and civil administration, but also
perform optional functions for promoting social
and economic development of their countries.
Therefore, study of public expenditure is an
important part of study of public finance.
Classification of Public Expenditure :
Different economists have classified public
expenditure on different bases. We shall now
study some of the important classification of
public expenditure.
A) Revenue Expenditure : Revenue
expenditure of the government is for
incurred carrying out day-to-day functions
of the government departments and
various services. It is incurred regularly.
For example, administration costs of the
government, salaries, allowances and
pensions of government employees,
medical and public health services etc.
B) Capital Expenditure : Capital expenditure
of the government is expenditure for
progress and development of the country.
For example, huge investments in different
development projects, loans granted to
the state governments and government
companies, repayment of government
loans etc.
C) Developmental Expenditure :
Developmental expenditure is productive
 in generation of employment, increase in 3 2005-06 5,06,123
production, price stability etc. is known 4 2009-10 10,24,487
as developmental expenditure. For 5 2015-16 11,95,025
example, expenditure on health, 6 2016-17 13,74,203
education, industrial development, social 7 2017-18 14,35,233
welfare, Research and Development (R 8 2018-19 17,29,682
& D) etc.
D) Non-Developmental Expenditure : On
the other hand, that government
expenditure which does not yield any
direct productive impact on the country
is called non- developmental
expenditure. For example, administration
costs, war expenditure etc. These are
Reasons for Growth in Public Expenditure :
unproductive in nature.
It is observed that there is a continous
growth in public expenditure in a developing
country like India.
Let us study some ofDothe
youimportant
know? reasuns :
Sr. No. Year Total Expenditure (` Cr.) 1) Increase in Trendsthe inActivities
Public of the
1 1991-92 72,317 Expenditure in India
Government : As mentioned earlier, since
Independenceperforms many
the modern government
2 2001-02 3,62,450
functions for the social and economic
development of the country. These government expenditure on water supply,
functions include spread of education, roads, energy, schools and colleges, public
public health, public works, public transport, sanitation etc.
recreation, social welfare schemes etc. It is
4) Increasing Defence Expenditure : In modern
observed that new functions are
times, defence expenditure of the
continuously being undertaken and old
government isSource
increasing
- Economiceven
Survey,in the peace
functions are being performed more Government of India- 2018-19
time due to unstable and hostile international
efficiently on a large scale by the
government. This leads to increase in relationships. Given table shows trends in
public expenditure in India
public expenditure. 5) Spread of Democracy
since 1991-92 : Majority
for selectof the
2) Rapid Increase in Population : countries in years.
the world are be
It can democratic
clearly in
Population of developing countries like nature. A democratic
observedformthat of government
there is is
India is increasing fast. In 2011 Census, it expensive duetremendous
to regular elections
growth in andtheother
was such activities.total
Thispublic
resultsexpenditure
in the increaseof in
121.02 crores. As a result, the government total expenditure
theofcountry
the government.
over the period.
has to incur greater expenditure to fulfil the 6) Inflation : Just like a private individual, the
needs of the increasing population. government has to buy goods and services
3) Growing Urbanization : Spread of from the market for the spread of economic
urbanization is a global phenomenon and social development. Normally, prices
of the day. This leads to increase in the show a rising trend. Due to this, the
 government has to incur increasing costs. production, employment and overall
7) Industrial Development : Industrial growth in the economy. Hence, the
development leads to an increase in government makes huge efforts for
implementing various schemes and
programmes for industrial development.
This results in increase in government
expenditure.
8) Disaster Management : Many natural and
man-made calamities like earthquakes,
floods, cyclones, social unrest etc. are
occurring more frequently. The
government has to spend a huge amount
for the disaster management which
increases total expenditure.
Modern governments are working for
‘welfare state’. Hence, there is a
continuous increase in the public
expenditure.

Find out :
Reasons for growth in public
expenditure other than
given above.
Find out :
Important social welfare
schemes by the Govt.

II) Public Revenue :

Public revenue means the aggregate
collection of income with the government
through various sources. Public revenue holds
the permanent position in the study of public
finance which is part of study of economics.
Thus, the necessity of public revenue arises due
to public expenditure.
The main sources of public revenue are as
follows.
Sources of Public Revenue :
A) Taxes B) Non-tax Revenue :
A) Taxes :
1) According to Prof. Taussig : “The essence
of a tax as distinguished from other
charges by government is the absence
of a direct
 quid pro quo between the tax payer and the this canon, every tax should be levied in such a
public authority.” manner and at such a time that it becomes
2) According to Prof. Seligman, “A tax is a convenient to the tax payer.
compulsory contribution from the person to 4) Canon of Economy : According to this canon,
the government without reference to the cost of tax collection should be the minimum.
special benefits conferred.” If a major portion of the tax proceeds is spent on
A tax possesses following essential the tax collection itself, then such a tax cannot be
characteristics :
considered as a good tax.
1)It is a compulsory contribution to the
government and every citizen of the
country is legally bound to pay the tax Types of Taxes :
imposed upon him. It is a major source of There are two main types of taxes. They are :
revenue to the government. If any person 1) Direct Tax and 2) Indirect Tax.
does not pay a tax, he can be punished by
Let us study in details :
the government.
1) Direct Tax : It is paid by the taxpayer on
2)Tax is paid by a taxpayer to enable
his income and property. The burden of tax
government to incur expenses in the
is borne by the person on whom it is levied.
common interests of the society.
As he cannot transfer the burden of the tax
3)The payment of a tax by a person does
to others, impact and incidence of direct
not entitle him to receive any direct and
tax falls on the same person. For example-
proportionate benefits or services from the
personal income tax, wealth tax etc.
government in return for the tax.
2) Indirect Tax : It is levied on goods or
4)Tax is imposed on income, property or
services. It is paid at the time of production
commodities and services.
or sale and purchase of a commodity or a
You should know : service. The burden of an indirect tax can
Canons (Principles) of Taxation : be shifted by the taxpayer (producers) to
Adam Smith, the founder of Modern other person/s. Hence, impact and
economics propounded the following four incidence of tax are on different heads. For
canons of taxation : example, newly implemented Goods and
Services Tax [GST] in India has replaced
1) Canon of Equity or Equality : Smith
almost all indirect taxes, custom duty.
suggested that every person will pay the
taxes to the government in proportion to Do you know?
his ‘ability to pay’. It means rich people Direct taxes are further classified into
should pay more tax compared to the three categories depending upon the rate of
poor. tax. These are :
2) Canon of Certainty : According to 1) Proportionate tax : When a tax is
Smith, the taxpayer should know in levied at the same and constant rate on
advance how much tax he has to pay, all incomes, it is called proportional tax.
at what time he has to pay the tax and 2) Progressive tax : A tax, the rate of
in what form the tax is to be paid to the which increases with every increase in
government. income
3) Canon of Convenience : According to
74
is called progressive tax. In India we have violating traffic rules. However, the
progressive tax rate system. income from this source is small.
3) Regressive tax : In regressive taxation, the 5) Gifts, Grants and Donations : The
larger the income of a tax-payer, the smaller is government may also earn some income
the proportion of the tax levied on him. in the form of gifts by the citizens and
others. The government may also receive
grants from the foreign governments and
B) Non-Tax Revenue Sources : institutions for general and specific
purposes. Foreign aid has become an
Public revenue received by the government
important source of development finance
administration, public enterprises, gifts and
for a developing country like India.
grants etc. are called as non-tax revenue. These
However, this source of revenue is
sources are different than the taxes. A brief
uncertain in nature.
information about these sources are as follows :
6) Special levies : This is levied on those
1) Fees : A tax is paid compulsorily without
commodities, the consumption of which
any return service whereas, fee is paid in
is harmful to the health and well-being
return for certain specific services rendered
of the citizens. Like fines and penalties,
by the government. For example-
the objective is not to earn income, but to
education fee, registration fee, etc.
discourage the consumption of harmful
2) Prices of public goods and services : commodities by the citizens. For example-
Modern governments sell various types of duties levied on wine, opium and other
commodities and services to the citizens. A intoxicants.
price is a payment made by the citizens to 7) Borrowings : The government can borrow
the government for the goods and services from the people in the form of deposits,
sold to them. For example- railway fares, bonds etc. It also gets loans from foreign
postal charges etc. governments and organizations such as
3) Special Assessment : The payment made IMF, World Bank etc. Loans are becoming
by the citizens of a particular locality more and more popular source of revenue
in exchange for certain special facilities for the governments in the modern times.
given to them by the authorities is known
Do you know?
as ‘special assessment.’ For example-
Goods and Services Tax [GST]
local bodies can levy a special tax on the
The Goods and Services Tax [GST]
residents of a particular area where extra/
came into effect in India on July 1, 2017. It
special facilities of roads, energy, water
was proposed by the Kelkar Task Force on
supply etc. are provided.
Implementation of the Fiscal
4) Fines and Penalties : The government Responsibility and Budget Management
imposes fines and penalties on those who [FRBM] Act in July, 2004. The 101st
violate the laws of the country. The Amendment in the Constitution Act,
objective of the imposition of fines and 2016 provided for the constitution of the
penalties is not to earn income, but to Goods and Services Tax Council[GSTC]
discourage the citizens from violating the comprising the Union Finance Minister,
laws framed by the Government. For the Minister of State[Revenue] and the
example, fines for Finance Ministers of each state,
empowering the Council to
75
make recommendations on the GST rates,  Reducing final price of goods.
exemptions, thresholds of the tax etc.
 Boost to the industrial sector.
GST is different from an excise or sales
 Poverty Eradication by generating
tax imposed as a single-stage levy on the
more employment and more financial
manufacture or sale of a product. It is a
resources.
comprehensive tax base with nationwide
Sample showing GST voucher
coverage of goods and service. GST would
replace the following taxes levied and
collected by the Centre and States such as
Central Excise Duty, Service tax,
Additional Duties of Customs, State Value
Added Tax, Entry Tax, Entertainment Tax
etc.
Central Goods and Services Tax [CGST]
- It is a tax levied on interstate supplies
of both goods and services by the central
government which will be governed by the
CGST Act.
State Goods and Services Tax [SGST]-
This tax is received by the state in which
the goods or services are consumed and III) Public Debt :
not by the state in which these goods are Like a private individual, the government
manufactured. also needs to raise loans. In fact, raising debt is
Integrated Goods and Services Tax the most common activity of any government,
[IGST]- It is a tax levied on all interstate because government expenditure generally
supplies of goods and services which will exceeds government revenue. Public debt policy
be governed by the IGST Act. of the government plays an important role in
Compensation Part - It is for the loss of public finance.
expected income on the part of the State There are mainly two types of public debt.
Governments. They are :
Expected Benefits of GST : 1) Internal Debt and 2) External Debt
 Creation of a unified common national 1) Internal Debt : When a government
market for India. borrows from its citizens, banks, central
bank, financial institutions, business houses
 Boost to foreign investments and ‘Make
etc. within the country, it is known as
in India’, campaign.
internal debt.
 Harmonization of laws, procedures and
2) External Debt : When a government
rates of tax.
borrows from foreign governments,
 Boost export and manufacturing activity.
foreign banks or institutions, international
 Improvement in the overall investment organizations like International Monetary
climate in the country. Fund, World Bank etc., it is known as
 Simplifying the tax system in the external debt.
country.
76
 Table no. 8.1 shows the difference Government Budget :
between Internal debt and External debt. Budget is an important instrument of
Table 8.1 financial administration through which all the
financial affairs of the state are regulated.
Differences between Internal and External Debt
Budget is a financial statement showing the
Sr. No. Internal Debt External Debt expected receipts and proposed expenditures of
1 Raised within the Raised outside the government in the coming financial year. In
economy the economy India, a financial year is from 1st April to 31st
2 Voluntary or Voluntary in March. Article 112 of the Constitution of India
compulsory in nature
has a provision for annual financial statement.
nature
3 Use of domestic Use of In every budget, a set of seven budget
currency foreign documents describe the details of Government
currency finance in India.
4 Less complex for More The word ‘Budget’ is derived from the
management complex for French word ‘Bougette’,which means a bag
management or a wallet containing the financial proposals.
These financial proposals are in the form of the
Try this : Government expenditure and revenue.
Classify the following activities into Internal and
External Debt :
Government selling bonds to its citizens.
Government of India borrowing funds from the
World Bank for provision of water supply.
Government of India takes loans from Government.
Nationalized Banks for developing infrastructure V) Financial
facilities in the country. Administration :
Government of India takes loans from World A smooth and
Bank for Mumbai Metro Train. efficient
implementation of
IV) Fiscal Policy : revenue, expenditure
Fiscal policy is and debt policy of the
the means by which a Government, is referred
government adjusts to as financial
its spending levels administration. This
and tax rates to includes preparation
monitor and influence and implementation of
a nation's economy. It the Government
deals with the public budgets along with
expenditure, public overall growth of the
revenue and public country.
debt. In short, it is
the financial policy
implemented by the

77

Do you know?
 the Constitution of India. It
refers to the ‘Annual Financial
Revenue and to the state Types of Budget :
Statement’ of the However,
Government.
Capital Budgets : governments. The budgetary modern economists
Central Budget 2) Capital provisions of public believe that the
provisions are policy of balanced
Budget : The expenditure and
divided into- budget may not
capital budget revenue need to be at
1) Revenue Budget
consists of different levels as per always be suitable
and
capital receipts the changing needs of for the economy.
2) Capital Budget.
and capital the economy. The modern
1) Revenue payments. Accordingly, Governments are
Budget : It Capital receipts Government budget is welfare entities and
consists of are hence, they cannot
of three types :
revenue Government keep their
1) Balanced Budget
receipts and loans raised expenditure at the
revenue 2) Surplus Budget
from the public level of their
expenditure of 3) Deficit Budget
and the receipts.
the Reserve Bank 1) Balanced
government. 2) Surplus Budget :
of India, Budget :
Revenue Government
divestment of Government
receipts are budget is said to be
equity holding budget is said to
divided into surplus, when
in the public be balanced,
tax and non- estimated
sector when estimated
tax revenue. enterprises, Government
revenue and
Revenue loans received receipts are more
expenditure of the
expenditure from the than the estimated
government are
comprises of foreign Government
equal. That is,
interest paid Governments expenditure.
Government
on and other i.e. anticipated
Receipts =
Government foreign bodies, Government
Government
borrowings, State deposit Receipts >
subsidies and Expenditure.
funds, special estimated
grants given The concept of
deposits etc. Government
a balanced budget
Capital and Government Expenditure.
was advocated by
payments refer companies, A surplus budget
the classical
to the capital corporations and may prove useful
economists like
expenditures on other parties. during the period
Adam Smith. It
various Besides, it of inflation. In the
was considered
development includes period
as neutral in its
projects, expenditure on
effect on the
investments by social and
working of the
the Government, community
loans given to development, economy and
the state defence and hence, they
Governments, general services. regarded it as the
best.
78
of inflation, pressures can low level modern times,
there is a be controlled. which results in deficit budget is
tendency for However, a unemployment. the most
prices to rise surplus budget This can be commonly
should not be
rapidly. This checked by implemented
used in the
needs to be increasing policy of any
situations other
checked, Government Government.
than inflation
particularly in expenditure, by Developing
as it may lead
the interest of borrowing countries like
to
those who money and India have
unemployment
have more or through deficit consistently
and low levels
less a fixed financing. This resorted to
of output in an
income. The will increase deficit budget
economy.
rise in prices employment technique for
3) Deficit and aggregate economic
can be
Budget : effective development.
checked by
Government demand for
lowering the Importance of
budget is said goods and Budget :
level of
to be deficit, services which Union Budget is
effective
when would important because it
demand in the
anticipated encourage affects people and
economy.
Government further economy in general
This can be receipts are less investment. In in a
done by than the
increasing number of ways. Also, budget is
estimated Taxes are the most important
taxes which Government interesting part of any
would expenditure. budget. Taxes
increase the That is determine the fate of
revenue of the anticipated businesses and
government Government individuals. The level
and reduce the Receipts < of disposable income
purchasing estimated of the taxpayers
power of the Government depends on the tax
people. As a expenditure. rates presented in the
result, the A deficit budget. Government
aggregate budget may expenditure on various
demand will prove useful heads such as defence,
fall leading to during the administration,
downward period of infrastructure,
movement in depression. In education and health
the price the period of care etc. affects the
level. Thus, depression, all lives of the citizens
inflationary economic and overall economy.
activities are at
79
because utilization of human b) Direct Tax and c) Fees
Governments use and material Fees
d) Special Levy
it as a medium for resources of the Options : 1) b
implementing country. and c 2) a an
economic policies Thus, the scope 3) a, b, c and d 4)
in the country. and importance of c and d
Budgetary actions public finance in a 5) Trends shown by
of the Government modern economy Public
affect production, has undergone an expenditure of
size and immense change any Government
distribution of since last 100 years. shows following
income and trend.
a) Constant b)
EXERCISE Increasing
c) Decreasing d)
Fluctuating
Q. 1. A) Choose the services
Options : 1)
correct option : Options : 1) c and d only a 2) only
1) Optional functions and b
3) only c 4) only
of Government : 3) only b d
a) Protection from c and d
external attack 6) Identify the right
3) "Definition - Public
b) Provision of group of pairs
finance is one of
education and from the given
those subjects
health services options.
which are on the
c) Provision of i) Direct taxa) Non-tax
social security borderline between
revenue
measures economics and
ii) Indirect taxb)
d) Collection of politics."...................................
Inflation
tax a) Adam Smith iii) Fees and Finesc)
Options : 1) b and c b) Alfred Marshall GST
a, b and c
c) Prof. Hugh iv) Surplus budgetd)
3) b, c and d Personal income tax
Dalton
above d) Prof. Findlay Options : a) i-d ii-c iii-b
Shirras iv-a
2) Obligatory
functions of the Options : 1) b) i-c ii-d iii-
Government : only a a iv-b
a) Provision of 3) only c c) i-d ii-c iii-
employment 4) only a iv-b
b) Maintaining d) i-a ii-b iii-
d
internal law c iv-d
and order 4) Non-tax sources of
Q. 2. Distingwish
c) Welfare revenue :
between following
measures a) Direct and concepts :
d) Exporting Indirect Tax
1) Public finance and
goods and
80
 Private finance. developmental population was of social security
2) Internal debt and expenditure. numerals enough and from the rich
External debt. 4) Special assessment earning enough to world?
3) Developmental and Special levy.
generate the taxes to 4) Which features of
expenditure and 5) Direct Tax and pay for the care of
Indirect tax. India make the
Non- those not working. traditional model
Q. 3. State with people in their old age, This model is ill- of social security
reasons whether you ill-health, disability and suited for less, well- ill-suited for the
agree or disagree poverty. This idea off India with economy?
with the following should itself change growing life
statement : from writing a cheque Q. 5. Answer the
expectancy, following :
1) Obligatory for the beneficiary to increasing
institutional 1) State the types
function is the urbanization and
only function of arrangements to care for and importance of
resultant migration.
the Govenment. beneficiaries, including Government
Social security under
by enabling them to look budget.
2) Fines and urbanization will be
penalties are a after themselves, to a different from social 2) Explain the
large extent. principles of
major source of security in a static taxation.
revenue for the The write-a-cheque society.
model of social security 3) Explain non-tax
Government.
1) State the sources of
3) The goods and is a legacy from the conventional notion
rich world at the of social security. revenue of the
services tax
optimal phase of its Government.
(GST) has 2) What kind of
replaced almost demographic transition, conceptual Q. 6. Answer in detail :
all indirect taxes when the working change is 1) Explain various
in India. suggested in the reasons for the
4) Democratic given paragraph. growth of public
Governments do 3) What is a legacy expenditure.
not lead to
increase in public 
expenditure.
5) Public finance is
more elastic than
private finance.

Q. 4. Read the given

passage and answer
the questions :
“The conventional
notion of social
security is that the
government would
make periodic
payments to look after

81
 9 Money Market and Capital Market in India

Introduction :
Finance is the backbone of an economy. Try this :
Finance, basically refers to the management of From the given examples,
money. It includes funds needed by individuals, identify the type of finance
business houses and the Government for involved (Personal finance/
various purposes. Thus, finance is categorized Corporate finance /Public
as personal finance, corporate finance and finance) :
public finance. The financial system of the Building a retirement corpus
country is responsible for the mobilization and Raising share capital through sale
allocation of funds. It helps in creation of of equity shares
wealth which is vital for the economic Collection of tax revenue
development of the country. The financial
ClearinghomeloanthroughEMI
system in India comprises of financial
(Equated Monthly Instalment)
institutions, financial markets, financial
Expenditure on social
instruments and financial services.
FINANCIAL INSTITUTIONS
A) Money infrastructure
Market in such as health and
education
India : Meaning :
INDIAN FINANCIAL MARKETS
Managing working
Money market is a market forcapital
lendingneeds
and
FINANCIAL
SYSTEM borrowing of short term funds. It is a market for
FINANCIAL INSTRUMENTS “near money” i.e. short term instruments such
as trade bills, government securities, promissory
FINANCIAL SERVICES notes etc. Such instruments are highly liquid,
This chapter deals exclusively with less risky and easily marketable with a maturity
financial markets in India. Financial markets period of one year or less than one year.
are an important component of the financial
Do you know?
system.
Some Financial Instruments :
Meaning of Financial Market :
 Bonds refer to debt instruments issued
Financial market refers to a market where
by companies or the government as a
sale and purchase of financial assets such
means of borrowing long term funds.
as bonds, stocks, derivatives, government
 Equity shares refer to shares of a
securities, foreign currency etc. is undertaken.
company held by an individual or a group.
Financial markets operate through banks, non-
 Derivatives refer to a financial security
banking financial institutions, brokers, mutual
which derives its value/price from the
funds, discount houses etc. Financial markets
underlying assets such as bonds, stocks,
include two distinct markets i.e. the Money
currency, interest rates, commodities etc.
market and Capital market.
 Government securities refer to debt
FINANCIAL MARKETS instruments issued by a government with a
promise of repayment at maturity.
MONEY MARKET CAPITAL MARKET

81
 Trade bills refer to bills of exchange drawn on 1) Organized Sector : The organised sector
and accepted by a trader (trade acceptance) in of the money market consists of the
payment of goods. Reserve Bank of India, commercial banks,
Promissory note is a financial instrument that co-operative banks, regulated financial
contains a written promise by one party to pay intermediaries etc. Let us now discuss the
organized sector of the money market in
another party a definite sum of money, either
India.
on demand or at a specified future date.
a) Reserve Bank of India (RBI): Every
country in the world has a Central Bank
which is at the apex of the banking system.
Structure of Money Market in India :
It is entrusted with the responsibility of
The money market in India is dichotomous
regulating the money market in the
by nature. It comprises of both, the organized country. Reserve Bank of India is the
sector as well as the unorganized sector. The central bank of our country. RBI was set up
organized sector includes the Reserve Bank of on the basis of the recommendations of the
India (RBI), commercial banks, co-operative Hilton Young Commission. The RBI Act
banks, development financial institutions, of 1934 provides the statutory basis of the
investment institutions and the Discount and functions of the bank. RBI commenced its
Finance House of India (DFHI). The operations on 1st April, 1935 as a private
unorganized sector on the other hand, comprises shareholders’ bank. RBI was nationalized
of indigenous bankers, money lenders and on 1st January, 1949. It is the most
unregulated non- bank financial intermediaries. important constituent of the money market.
Money market centres in India are located Popular Definitions of Central Bank :
at Mumbai, Delhi and Kolkata. However,
Dr. M. H. de Kock : “Central bank is one
Mumbai is the only active money market centre which constitutes the apex of the monetary and
in India with money flowing in from all parts of banking structure of the country.”
the country.
Prof. W. A. Shaw : “Central bank is a bank
The following chart explains the structure
which controls credit.”
of money market in India :

RBI

COMMERCIAL BANKS
ORGANIZED Functions of
SECTOR CO-OPERATIVE BANKS
Reserve
DEVELOPMENT FINANCIAL Bank of India
INSTITUTIONS 1) Issue
DISCOUNT AND FINANCE of
HOUSE OF INDIA
Curre
ncy
INDIGENOUS BANKERS Fig. 9.1 Notes
UNORGANIZED : RBI
SECTOR MONEY LENDERS
82
UNREGULATED NON-BANK
FINANCIAL INTERMEDIARIES
 m’ of over the (IMF).
1957, commercial 5) Controller of
RBI banks. All Credit : As a
is scheduled banks supreme banking
requi are compulsorily authority of the
red to required to country, RBI has
maint maintain a certain the power to
ain minimum of cash influence the
mini reserves with the volume of credit
mum RBI against their created by
gold demand and time commercial banks.
and liabilities. RBI It also monitors
forei provides financial the purpose or use
gn assistance to of credit.
exch banks in the form Quantitative
ange of discounting of methods such as
reser eligible bills. bank rate, open
ves Loans and market operations,
of advances are also variable reserve
Rs provided against ratios such as
200 approved Cash Reserve
crore securities. Ratio (CRR),
s, 4) Custodian of Statutory Liquid
out Foreign Ratio (SLR) etc.
of Exchange control the volume
whic Reserves : RBI of credit created.
h at acts as a Qualitative
least ` 115 Governments. It custodian of the methods such as
crores should be
in gold and the accepts money as country’s foreign fixing margin
remaining ` 85 well as makes requirements,
crores should be exchange
in terms of payments on reserves. It has to credit rationing,
foreign currency behalf these moral suasion etc.
and government maintain the
securities. Governments. It official rate of regulate the
also undertakes exchange of rupee purpose or use of
2) Banker to the
the management as well as ensure credit.
Government :
of public debt. It its stability. RBI
RBI acts as a
advises the also undertakes
banker, agent
Government on a to buy and sell
and advisor to
wide range of the currencies of
the Government.
economic issues. all the members
It transacts the
business of both, 3) Banker’s Bank : of the
the Central and RBI exercises International
State statutory control Monetary Fund

83
6) Collection for settling the banks. banks.
and accounts Commercial Scheduled
Publication between its banks play an commercial
of Data : RBI member banks. important role banks are those
collects and As a lender of in mobilizing included in the
compiles last resort, it savings and second schedule
statistical also provides allocating them of the Reserve
information liquidity to to various Bank of India
related to banks sectors of the Act, 1934. In
banking and experiencing economy. It terms of
other financial financial includes both ownership and
sectors of the difficulty. scheduled function,
economy. commercial commercial
7) Promotional banks and non- banks in India
and scheduled can be
Development commercial
al Functions : classified into in loans and debts.”
RBI also four categories:
Functions of
performs  Public sector Commercial Banks :
certain banks
1) Acceptance of
promotional  Private sector
banks deposits :
and
Deposits
developmental b) Commercial  Regional rural
banks constitute the
functions such banks :
main source of
as extending Commercial  Foreign banks
funds for
banking banks act as
Popular Definitions commercial
services to intermediaries of Commercial banks. Savings
semi- urban in the country’s Bank :
lead to the
and rural financial Banking Regulation creation of
areas, system to bring Act of 1949 : deposits. Deposits
providing the savers and “Banking means the are categorized as
security to investors accepting, for the (i) Demand
depositors, together. They purpose of lending or deposits and (ii)
development are profit investment, of Time deposits.
of specialized seeking deposits of money
financial i) Demand Deposits
institutions for from the public,
institutions. : Deposits that are
agricultural repayable on demand
Acceptance of withdrawable on
credit, or otherwise, and
deposits and demand are
industrial withdrawable by
granting loans known as demand
finance etc. cheque, demand draft,
and advances deposits. They
8) Other order or otherwise.”
are the primary are in the form
Functions : Prof. Cairncross : “A of Current
functions of
RBI acts as a bank is a financial account and
commercial
clearing house intermediary, a dealer Savings account
84
 Find out :
Names of the Central Banks of
the following countries :
deposits. deposits a fixed at regular of exchange.
USA UK (United Kingdom)
 Current account amount intervals for a
CANADA 3) Ancillary
SWEDEN
is usually specified period functions :
opened by RU SSIA  FRANCE
of time. Commercial
businessmen, GERMANY JAPAN
 Fixed deposits banks also
corporations, refer to CHINA
a AUSTRALIA
provide a range
industrial lumpsum of ancillary
houses, trusts amount services such as
etc. They are deposited by a transfer of funds,
provided with customer for a collection of
overdraft specified period money, making
facility. of time. periodical
Overdraft means Compared to all payments on
withdrawal in other deposits, behalf of the
excess of the fixed deposits customer,
balance in the carry a high rate merchant
account. of interest. banking, foreign
 Savings account 2) Providing loans exchange, safe
are operated by and advances : deposit lockers,
a large number Commercial D-mat facility,
of people, banks mobilize internet banking,
particularly the savings and lend mobile banking
salaried class, these funds to etc.
small traders institutions and 4) Credit Creation
etc. who wish to individuals for : Credit creation
save a part of various is an important
their income purposes. Based function of
with the bank. on the tenure, commercial
ii) Time deposits : loans include banks.
Deposits that are call loans, short Commercial
repayable after term, medium banks are
a certain period term and long creators of
of time are term loans. credit. Demand
known as time Longer the and time
deposits. They duration of the deposits
are in the form loans, greater constitute the
of recurring will be the rate primary deposits
deposits and of interest. of banks. After
time deposits Besides this, meeting the
 Recurring banks also reserve
deposit refers to provide cash requirements out
a deposit credit, overdraft of the net
wherein a facility as well demand and time
customer as discount bills liabilities, the
85
balance the bank y Co-operative credit Fig. 9.3
amount is used account of the Societie
Try this :
for giving customer. The
loans. Thus, bank that Collect
secondary receives the operating
deposits or loan amount as
‘derivative a deposit, keeps
deposits’ are aside a certain d) Development
created out of portion in the Financial
F
the loans given form of Institutions
i
by the banks. reserves. After g (DFIs) :
For meeting the . Development
instance, when reserve financial
the bank requirements, 9 institutions are
provides loan the bank lends .
agencies that
2
to its customer, the remaining provide
the loan amount. This medium and
amount is procedure is long-term
credited into followed by the
financial
entire banking co-operative assistance.
system in the banks and state They help in
country, leading co-operative the
to creation of banks. development
credit. In short, Fig. 9.3 of industry,
commercial explains the agriculture
banks create structure of co- and other key
deposits out of operative banks in sectors.
the loans given India : Industrial
thereby leading Finance
Three Tier Co-
to crediton. Corporation of
operative Credit
Structure India (IFCI)
Try this : was the first
development
Pair the logos given with their respective
State Co-
operative
financial
banks as given in the bracket below:
Bank institution to
(State Bank of India, HSBC Bank, Union Bank
(Apex be established
of India, Axis Bank, Standard Chartered
Bank) Bank,
in 1948.
HDFC Bank)
District
Central
Co-
operative c) Co-operative existence with
Bank Banks : Co- the enactment of
operative banks the Co-operative
Primar
came into Credit Societies
86
 Let's recall :
You have already studied in
class XI about NABARD which is
Act of 1904.
the apex institution in the rural
Co-operative
banks credit structure. It provides
supplement the credit for promotion of
efforts of agriculture, small-scale
commercial industries, cottage and village
banks by Development industries, handicrafts etc.
meeting the financial
credit needs of institutions have
the local diversified their
population. It operations with
fulfills the the advent of
banking needs liberalization
of small and and
medium income globalization.
groups. The co- They have set
operative credit up subsidiaries
sector to offer a wide
comprises of range of new
co-operative products and
credit services
institutions
such as primary
co- operative
credit societies,
district central

87
 such as commercial banking, consumer labourers, small and marginal farmers,
finance, broking, venture capital finance, artisans, small traders etc. usually borrow
infrastructural financing, e-commerce etc. money from the money lenders. At present,
Thus, development financial institutions the activities of the money lenders have
are in the process of converting themselves been restricted by RBI due to their
into universal banks. RBI has issued exploitative tendencies.
guidelines for development financial iii) Unregulated Non-Bank Financial
institutions to become commercial banks. Intermediaries : They include Chit funds,
For e.g. ICICI (Industrial Credit and Nidhi, loan companies etc. Under Chit
Investment Corporation of India) has funds, members make regular contribution
become a universal bank by a reverse to the fund. Bids or draws are made on the
merger with its subsidiary ICICI Bank. basis of a criteria mutually agreed upon by
e) Discount and Finance House of India the members. Accordingly, the collected
(DFHI) : The Discount and Finance House fund is given to the chosen member. Chit
of India (DFHI) was set up in 1988 as a funds mostly operate in Kerala and Tamil
money market institution based on the Nadu. Nidhi is also a type of mutual
recommendations of the Vaghul benefit fund thriving on the contribution
Committee. It is jointly owned by the RBI, of its members. Loans are provided to
public sector banks and financial members at reasonable rates of interest.
institutions to impart liquidity to the money Loan companies are finance companies.
market instruments. They provide loans to traders, small-scale
2) Unorganized Sector : The unorganized industries and self-employed persons.
money market in India comprises of Being unregulated, they charge a high rate
indigenous bankers, money lenders of interest on loans.
and unregulated non-bank financial UNREGULATED NON-
NIDHI
intermediaries. The activities of the BANK FINANCIAL CHIT FUNDS
unorganized money market are largely INTERMEDIARIES
confined to the rural areas. LOAN COMPANIES
i) Indigenous bankers : They are financial
intermediaries that function similar to Do you know?
banks. They mostly deal in indigenous Money market instruments :
short-term credit instruments such as The following instruments are traded in
hundi. The rate of interest differs from one the money market :
market to another. Indigenous bankers are
 Call / Notice Money Market : When
mostly confined to certain social strata.
money is borrowed or lent for a day, it is
They are an important source of funds in
known as call (overnight) money. When
unbanked areas and provide loans directly
money is borrowed or lent for more than
to agriculture, trade and industry.
a day up to 14 days, it is known as notice
ii) Money lenders : They mostly operate in money.
the villages. Money lenders usually charge  Treasury Bills (TBs) : They are short
a high rate of interest. The loans provided term instruments issued by the RBI on
by money lenders are for both productive
and unproductive purpose. Agricultural

86
 behalf of the government to meet temporary Government to fulfil its short term
liquidity shortfalls. financial requirements on the basis of
Commercial Papers (CPs) : It is an unsecured Treasury Bills.
promissory note, negotiable and transferable 6) Implementation of Monetary policy :
by endorsement and delivery with a fixed Monetary policy is implemented by the
maturity period. central bank. It aims at managing the
quantity of money in order to meet the
Certificate of Deposits (CDs) : They are
requirements of different sectors of the
unsecured, negotiable instruments in bearer
economy and to increase the pace of
form issued by commercial banks and
economic growth. A well-developed money
development finance institutions.
market ensures successful implementation
Commercial Bills (CBs) : They are short term, of the monetary policy. It guides the central
negotiable and self-liquidating instruments bank in developing an appropriate interest
with low risk. policy.

Role of Money Market in India : 7) Economizes the use of cash : Money market
The following points outline the role of the deals with various financial instruments
money market in India : that are close substitutes of money and not
actual money. Thus, it economizes the use
1) Short-term requirements of borrowers :
of cash.
Money market provides reasonable access
8) Growth of Commerce, Industry and
for meeting the short-term financial needs
of the borrowers at realistic prices. Trade: Money market facilitates
discounting bills of exchange to local and
2) Liquidity Management : Money market
international traders who are in urgent need
is a dynamic market. It facilitates better
of short-term funds. It also provides
management of liquidity and money in the
working capital for agriculture and small
economy by the monetary authorities. This,
scale industries.
in turn, leads to economic stability and
development of the country. Problems of the Indian Money Market :
3) Portfolio Management : Money market Compared to advanced countries, the
deals with different types of financial Indian money market is less developed in terms
instruments that are designed to suit the of volume and liquidity. Following points
risk and return preferences of the investors. explain the problems of the Indian Money
This enables the investors to hold a Market :
portfolio of different financial assets which 1) Dual Structure of the Money Market :
in turn, helps in minimizing risk and Presence of both, the organized and
maximizing returns. unorganized sector in the money market
4) Equilibrating mechanism : Through leads to disintegration, lack of transparency
rational allocation of resources and and increased volatility. The unorganized
mobilization of savings into investment markets lack co-ordination and do not
channels, money market helps to establish come under the direct control and
equilibrium between the demand for and supervision of the RBI.
supply of short-term funds. 2) Lack of uniformity in the rates of
5) Financial requirements of the interest : The money market comprises
Government : Money market helps the of various entities such as commercial
banks, co-operative banks, non-bank
finance companies, development finance
87
 institutions, investment companies etc. The 4) National Electronic Fund Transfer (NEFT)
category of borrowers is also different. and Real Time Gross Settlement (RTGS)
3) Shortage of funds : Money market faces were introduced as an improved payment
shortage of funds due to inadequate infrastructure.
savings. Low per capita income, poor 5) Electronic dealing system was introduced
banking habits among the people, to bring about technological upgradation.
indulgence in wasteful consumption,
inadequate banking facilities in the rural Do you know?
areas etc. have also been responsible for Recent developments in banking sector :
the paucity of funds in the money market.  Small Finance Banks : Small finance
4) Seasonal fluctuations : Demand for funds banks aim to promote financial inclusion
varies as per the seasons. During the peak through supply of credit to small business
season, from October to June, finance units, small and marginal farmers, micro
is required on a large scale for various and small industries and other unorganized
purposes such as trading in agricultural sector entities through high technology but
produce, investment in business activities low cost operations.
etc. This results in wide fluctuations in the  Payments Banks : Apayments bank is
money market. like any other bank, but operating on a
5) Lack of financial inclusion : Banking smaller scale without involving any credit
facilities in the country are still inadequate risk. In simple words, it can carry out most
and inaccessible to the vulnerable groups banking operations but can’t advance loans
such as the weaker sections and the low or issue credit cards. It can accept demand
income groups. This shows lack of deposits
financial inclusion. (up to ` 1 lakh), offer remittance services,
mobile payments / transfers / purchases and
6) Delays in technological upgradation :
other banking services like ATM/debit cards,
Use of advanced technology is a pre-
net banking and third party fund transfers.
requisite for the development and smooth
functioning of financial markets. Delays  Universal Banks : Universal banks refer
in upgradation of technology hampers the to those banks that offer a wide range of
working of the money market. financial services, such as, commercial
banking and investment banking and other
Reforms introduced in the Money Market : activities especially insurance. It is a multi-
Following are some of the important purpose and multi-functional financial
reforms introduced in the money market : supermarket providing both banking and
1) Introduction of new instruments such as financial services through a single window.
Treasury bills of varying maturity periods,
 Local Area Banks : Local area bank
Commercial Papers (CPs), Certificate of
scheme was introduced in August, 1996 to
Deposits (CDs) and Money Market Mutual enable mobilization of rural savings by
Mutual Funds (MMMFs). local institutions especially private local
2) RBI Repos and Reverse Repos were banks and make them available for
introduced under the Liquidity Adjustment investments in the local areas. This helps to
Facility (LAF). bridge the gap in credit availability and
3) Interest rates to be largely determined by strengthen the institutional credit from
market forces. work in the rural and semi-urban areas.
88
B) Capital Market in India : 1) Government Securities Market : It is
Meaning : also known as the gilt-edged market. It
Capital market is a market for long term funds deals in government and semi-government
both equity and debt raised within and outside securities. Such securities carry a fixed rate
the country. It is also an important constituent of interest.
of the financial system. Development of an 2) Industrial Securities Market : It deals
effective capital market is necessary for with the shares and debentures issued by
promoting more investments as well as old and new companies. It is further
achieving economic growth. The demand for divided into Primary Market (New Issues)
long term funds comes from agriculture, trade and Secondary Market (Old Issues).
and industry. Individual savers, corporate Primary market helps to raise fresh capital
savings, banks, insurance companies, through sale of shares and debentures.
specialized financial institutions are the Secondary market deals with securities
suppliers of long term funds. already issued by companies. Secondary
markets function through stock exchanges.
Stock exchange is an important
constituent of the capital market. It is an
association or organization in which stocks,
bonds, commodities etc are traded.
Bombay Stock Exchange (BSE) and
National Stock Exchange (NSE) are the
Securities
Government

premier stock exchanges in the country.

3) Development Financial Institutions
(DFIs) : They provide medium term and
Fig. 9.4 long term financial assistance to the private
sector. They include Industrial Finance
Structure of Capital Market in India :
Corporation of India (IFCI), Industrial
The capital market in India comprises of
Investment Bank of India (IIBI), EXIM
the Gilt-Edged or the Government Securities
Bank etc.
Market, Industrial Securities Market,
Development Financial Institutions and 4) Financial Intermediaries : Financial
Financial Intermediaries. intermediary is an organization which
Indian Capital Market

Fig. 9.5, explains the structure of India’s acts as a link between the investor and the
Capital Market.
Institutions
Development Financial

Industria
l Securiti
Market es

89
Intermedia
Financial
 s
Merchant Banks
the population leads to
through the sale integration among
of securities. real and financial
2) Provides equity sectors, equity and
capital : Capital debt instruments,
Mutual Funds

market provides government and

equity capital or private sector,
share capital to domestic and
entrepreneurs external funds etc.
Leasing Companies

which could be Problems of the

used to purchase Capital Market :
IFCI
assets as well as Following points
fund business explain the problems
operations. faced by the Indian
New Issues Market 3) Operational Capital Market :
ICICI
Venture Capital Companies

efficiency : 1) Financial Scams :

Capital market Increasing number
helps to achieve of financial frauds
SFCs

operational have resulted in

efficiency by irreparable loss for
Old Issues Market

lowering the the capital market.

IDBI

transaction costs, Besides this, it has

simplifying also lead to public
Others

transaction distrust and loss of

IIBI

procedures, confidence among

Fig. 9.5 lowering the individual
borrower to increasing settlement investors.
meet the demand for timings in
UTI

financial investment funds purchase and sale

objectives of by industrial of stocks.
both the parties. organizations 4) Quick
They consist of and the valuation :
merchant banks, government. But Capital market
mutual funds, the availability of helps to
leasing financial determine a fair
companies, resources is and quick value
venture capital insufficient to of both equity
companies etc. meet this growing (shares) and debt
Role of Capital demand. Capital (bonds,
Market in India : market helps to debentures)
mobilize long instruments.
1) Mobilizes long
term savings from
term savings 5) Integration :
various section of
: There is an Capital market
90
2) Insider instruments prices. important reforms
trading and include bonds, However, the introduced in the
price debentures etc. stock market capital market :
manipulation There is not in India lacks 1) Securities and
: Insider much trading in informational Exchange
trading means the debt efficiency Board of India
buying or securities due compared to (SEBI) was
selling of a to narrow advanced established in
security by investor base, countries. 1988 but given
someone who high cost of statutory
has access to issuance, lack powers in 1992
non-public of accessibility to protect the
information or to small and interest of the
Reforms introduced
‘unpublished medium in the Capital investors and
information’ enterprises. Market : promote the
for personal 4) Decline in the Following are development of
benefit. Price volume of the securities
some of the
manipulation trade : market.
or price Regional stock 2) National Stock 5) Increased access
rigging on the exchanges have Exchange (NSE), to global funds
other hand witnessed a the leading stock by Indian
means to sharp decline in exchange in companies was
simply raise the volume of India was permitted through
the prices of trade because established in American
shares through investors prefer 1992. Depository
buying and to trade in 3) Computerized Receipts (ADRs)
selling of securities listed Screen Based and Global
shares within in premier you know? Depository
Trading Do
System
certain stock was PolicyReceipts
(SBTS) Economic (GDRs).
in an Economy
individuals exchanges like introduced as a
themselves for BSE, NSE etc. part of
personal
5) Lack of modernization.
gains. Such
informational 4) Demat account
illegal
efficiency : A has been
practices have
market is said introduced since
also affected
to be 1996 to
the smooth
informationally facilitate easy
functioning of
efficient if a purchase and
capital
company’s sale of shares by
market.
stock prices the investors
3) Inadequate incorporate all through Find the out :
debt the available electronic List of regional stock exchanges
instruments : information method. in India.
Debt into the current
91
6) Investor
Education and Implemented by Implemented by
Protection Central Bank Central government
Fund (IEPF) Deals with Deals with
Money Supply taxes,
was
expenditure etc.
established in Aims at financial Aims at economic and
2001 to stability social development
promote Quantitative in nature Qualitative in nature
investors’
awareness and EXERCISE
protecting the
interest of the
investors. Q. 1. Complete the investors have lost
following statements : confidence in the
1) Development capital market due
financial to ...........
institutions a) lack of financial
were established to instruments.
............. b) high transaction
a) provide short costs.
term funds. c) low returns.
b) develop d) financial scams.
industry,
4) Commercial banks
agriculture and
act as
other key
intermediaries in
sectors.
the financial system
c) regulate the
to ...........
money market.
a) make profits
d) regulate the
capital market.
2) Money market
faces shortage of
funds due to
...........
a) inadequate
savings.
b) growing
demand for
cash.
c) presence of
unorganized
sector.
d) financial
mismanagement
.
3) Individual
92
 b) accelerate the 4) Primary market ::: (R) is not the Options : 1) (A) is True,
country's Secondary market correct but (R) is False
economic : Old issues explanation of 2) (A) is False, but
growth.
(A) (R) is True
c) mobilise the Q. 3. Find the odd word
: 3) Both (A) and
savings and 2) Assertion (A) :
1) Types of Bank (R) are True
allocating Regional stock
Accounts : and (R) is the
them to exchanges have
Saving a/c, D- correct
various witnessed a sharp
mat a/c, explanation of
sectors of decline in the
Recurring a/c, (A)
the volume of trade.
Current a/c Reasoning (R) : 4) Both (A) and (R)
economy.
2) Unregulated Investors prefer to are True and (R)
d) control the
credit. Financial trade in securities is not the correct
intermediates : listed in premier explanation of
Q. 2. Complete the
Mutual fund, stock exchanges (A)
correlation :
Nidhi, Chit fund, like BSE, NSE etc. 4) Assertion (A) :
1) Money market
Loan Companies Options : 1) (A) is Foreign exchange
: Short term
3) Financial Assets True, but (R) is False management and
funds :: : Long
term funds : Bonds, Land, 2) (A) is False, but control is
Govt. Securities, (R) is True undertaken by
2) :
Derivatives 3) Both (A) and commercial banks.
Central Bank ::
4) Quantitative (R) are True
SBI :
Tools : Bank and (R) is the
Commercial
rate, Open correct
Bank
market explanation of
3) Co-operative
operations, (A)
banks :
Foreign 4) Both (A) and
Organized
Exchange rate, (R) are True
sector ::
Variable reserve and (R) is not
Indigenous
ratios the correct
bankers :
explanation of
Q. 4. Assertion and money
Reasoning : (A)
Options : 1) (A) is True,
1) Assertion (A) : but (R) is False 3) Assertion (A) :
Money market 2) (A) is False, but The unorganized
economizes use of (R) is True sector of the
cash 3) Both (A) and money market
Reasoning (R) : (R) are True and lacks transparency.
Money market (R) is the Reasoning (R) :
deals with correct Activities of the
financial explanation of unorganized sector
instruments that (A) are largely
are close 4) Both (A) and confined to rural
substitutes of (R) are True and areas.

93
 Reasoning (R) is then given to a 2) Explain the functions of RBI.
: RBI has to chosen member 
maintain the through lucky
official rate of draw.
exchange of 3) Tina deposited a
rupee and lumpsum
amount of `
ensure its 50,000 in the
stability. bank for a period
of one year.
Options : 1) (A) is
True, but (R) is False 4) ABC bank
2) (A) is False, provides d-mat
but (R) is True facility, safe
3) Both (A) deposit lockers,
and (R) are internet banking
True and facilities to its
(R) is the customers.
correct Q. 6. Distinguish
explanation between :
of (A) 1) Money market and
Capital market.
4) Both (A)
and (R) are 2) Demand deposit
and Time deposit.
True and
3) Organized sector
(R) is not
and Unorganized
the correct
sector of money
explanation
market.
of (A)
Q. 7. Answer the
Q. 5. Identify and
following :
explain the
1) Explain the
concepts from the
problems faced
given illustrations :
by the money
1) Raghu’s father
market in India.
regularly
2) Explain the
invests his functions of
money in commercial bank.
stocks and 3) Explain the role of
bonds. capital market in
India.
2) Sara makes a
monthly 4) Explain the
problems of capital
contribution to market in India.
a fund jointly
Q. 8. Answer in detail :
created by her
friends. The 1) Explain the role of
money market in
collected fund India.

94
 10 Foreign Trade of India

Introduction : Types of foreign trade :

Before 1947, the pattern of India's foreign Foreign trade is divided into the following
trade was typically colonial. India was a three types.
supplier of raw materials to the industrialized 1) Import Trade, 2) Export Trade, 3) Entrepot Trade
nations, particularly England and importer of
1) Import Trade : Import trade refers to
manufactured goods. This dependence on
purchase of goods and services by one
foreign trade did not permit industrialization at
country from another country or inflow of
home. As a result the indigenous handicrafts
goods and services from foreign country
suffered a severe blow. However, many
to home country. For example, India
underdeveloped countries that won
independence in the post World War II period, imports petroleum from Iraq, Kuwait,
viewed foreign trade as an investment. Saudi Arabia, etc.
2) Export Trade : Export trade refers to the
Meaning of Internal Trade :
sale of goods by one country to another
Buying and selling of goods and services
country or outflow of goods from one
within the boundaries of a nation are referred
country to foreign country. For example,
to as ‘Internal Trade’ or ‘Domestic Trade’ or
India exports tea, rice, jute to China, Hong
‘Home Trade’. For example, if goods produced
Kong, Singapore etc.
in Maharashtra are sold to states like West
Bengal, Uttar Pradesh, Tamil Nadu etc, then it 3) Entrepot Trade : Entrepot trade refers to
is known as internal trade. purchase of goods and services from one
country and then selling them to another
country after some processing operations.
For example, Japan imports raw material
required to make electronic goods like,
radio, washing machine, television etc.
from England, Germany, France etc. and
sells them to various countries in the world
after processing them.
Role of Foreign Trade :
Fig. 10.1 Trade is an engine of growth of an
economy, because it plays an important role for
Meaning of Foreign Trade :
economic development. In developed countries
Foreign Trade is trade between the
different countries of the world. It is called as it represents a significant share of Gross
International Trade or External Trade. Domestic Product.
Role of foreign trade can be justitied on the
Definition : basis of the following points :
According to Wasserman and Hultman,
1) To earn foreign exchange : Foreign trade
“International Trade consists of transaction
provides foreign exchange which can be
between residents of different countries”.
 used for very productive purposes. expanding
Foreign trade is a remarkable factor in
the market and encouraging the production Germany, Switzerland etc. have earned a lot
of goods. of goodwill and reputation in foreign market
2) Encourages Investment : Foreign trade for their qualitative production of electronic
creates an opportunity for the producers goods.
to reach beyond the domestic markets. It Try this :
encourages them to produce more goods Name the goods exported to and imported from
for export. This leads to an increase in total India to China and Japan in recent years by India.
investment in an economy.
3) Division of labour and specialization :
Foreign trade leads to division of labour Composition and Direction of India’s foreign
and specialization at world level. Some trade :
countries have abundant natural resources, Over the last 70 years, India’s foreign trade
they should export raw material and import has undergone a complete change in terms of
finished goods from countries which are composition and direction. Main feature of
advanced in skilled manpower. Thus, composition of India’s foreign trade are as
foreign trade gives benefits to all countries follows :
thereby leading to division of labour and 1) Increasing share of Gross National
specialization. Income : In 1990-91, share of India’s
4) Optimum allocation and utilization of foreign trade (import-export) in gross
resources : Due to specialization, national income was 17.55%. It increased
resources are channelized for the to 25% during 2006-07 and to 48.8% during
production of only those goods which 2016-17
would give highest returns. Thus, there is 2) Increase in volume and value of trade :
rational allocation and specialization of Since 1990-91, the volume and value of
resources at the international level due to India’s foreign trade has gone up. India
foreign trade.
now exports and imports goods which are
5) Stability in price level : Foreign trade several times more in value and volume.
helps to keep the demand and supply
3) Change in the composition of exports :
position stable which in turn stabilizes the
Since Independence, the composition of
price level in the economy.
export trade of India has undergone a
6) Availability of multiple choices : Foreign change. Prior to Independence, India used
trade provides multiple choices of imported to export primary products like jute, cotton,
commodities. As foreign trade is highly tea, oil-seeds, leather, foodgrains, cashew
competitive it also ensures a good quality nuts and mineral products. With the
and standard products. This raises the passage of time, manufactured items like
standard of living of people. readymade garments, gems and jewellery,
7) Brings reputation and helps earn electronic goods, especially computer
goodwill : Exporting country can earn hardware and software occupy a prime
reputation and goodwill in the international place in India’s exports.
market. For example, countries like Japan,
4) Change in the composition of imports :
Prior to independence, India used to
import consumer goods like medicines,
cloth, motor vehicles, electrical goods
etc. A part from petrol and petroleum,
India is now importing mainly capital
goods like high-tech machinery
chemicals, fertilizers, steel etc.
5) Oceanic trade : Most of India’s trade these ports were overburdened. Recently,
is by sea. India has trade relations with India has developed new ports at Kandla,
its neighbouring countries like Nepal, Cochin, Vishakhapatnam, Nhava Sheva
Afghanistan, Myanmar, Sri Lanka etc. The etc. to reduce the burden on the exsiting
share of India’s oceanic trade is around ports.
68%.
6) Development of new ports : For its D Find out :
foreign trade, India depended mostly on o Recent share of India’s foreign
Mumbai, Kolkata and Chennai ports. trade in Gross National Income.
Therefore, y
o
u

k
n
o
w
?
Composition of India’s Imports

Commodities 2015-16

Sr. Expenditure Perc

No. (in million $)
Petroleum, oil and
1 82,944 2
lubricants
2 Electronic goods 40,032 1
Pearls and precious
3 20,070 5
stones
4 Edible oils 10,492 2
5 Fertilizers 8,072 2
6 Foodgrains 276 0

Composition of India’s Exports

Commodities 2015-16

Sr. Expenditure
(in million $) Perc
No.
Readymade
1 16,964 6
Garments
2 Iron ore 191 0
3 Cotton yarn 8,874 3
4 Petroleum products 31,209 1
Leather
5 5,554 2
manufactures
6 Engineering goods 7,220 2
Source : 1) Reserve Bank of India, Handbook of
Statistics on Indian Economy 2016-17,
2) Government of India, Economic Survey
2017-18.

95
Direction of India’s foreign trade :
Direction of foreign trade means the
countries to which India exports its goods
and services and the countries from which it
imports the goods and services. Thus, direction
consists of destination of exports and sources
of our imports. Prior to Independence, much of
India’s trade was done with Britain. Therefore
Britain used to hold the first position in India’s
foreign trade. However, after Independence, Fig. 10.2
new trade relations with many other countries
Recent Trends in Exports :
were established. Now USA has emerged as the
leading trading partner followed by Germany, 1) Engineering goods : According to
Japan and United Kingdom. Engineering Goods Export Promotion
Council (EGEPC) Report, the share of
engineering goods was 25% in India’s total
exports in 2017-18. Within this category
Year some of the prominent exported items are
Countries/Organisation
2016-17 transport equipment including automobiles
Sr. no. (Percentage) and auto components, machinery and
Do you know?
1 OECD 28.1 instruments. During the period 2010-11 to
Direction of India's Imports
2 OPEC 24.1 2014-15, exports of transport equipment
3 Eastern Europe 2.4 have grown from 16 billion dollars to to
4 Developing Nations 43.2 24.8 billion dollars.
5 Others 2.2
2) Petroleum products : India’s petroleum
capacity increased significantly since 2001-
Year 02, due to which India turned as a net
Countries/Organisation exporter of petroleum refinery products.
2016-17
Sr. no. Direction of India's Exports
(Percentage) Petroleum product had a share of 4.3% in
1 OECD 37.9
India’s total exports in 2000-01, which rose
2 OPEC 16.4
steadily to 20.1% in 2013-14.
3 Eastern Europe 1.0 3) Chemicals and chemical products : An
4 Developing Nations 43.5 important export item that has performed
5 Others 1.2 reasonably well over the last few years
is chemicals and chemical products. The
share of this item was 10.4% in 2014-15.
Source : Reserve Bank of India, Handbook of
Trends in India’s foreign trade since 2001 : 4) Gems and Jewellery : Gems and jewellery
Statistics on Indian Economy.
is one of the major contributors to export
Since liberalisation, India’s foreign trade
earnings in India, having a share of 13.3%
has expanded manifold and has shown a
in India’s merchandise export in 2014-15.
significant structured shift in imported and
exported products, and also in its geographical 5) Textiles and readymade garments :
composition. Textiles and garment exports together
accounted for 11.3% of India’s exports
96
 in 2014-15. In fact, India is one of the etc. is included in balance of payments.
leading exporting countries of textiles and
readymade garments in the world.
Trends in Imports :
1) Petroleum : Petroleum has always
remained the most important item of
imports in India’s trade in the pre as well
as post reform period. It had a share of
27% in total imports in 1990-92 which Fig. 10.3
currently stands at around 31%. Balance of Trade :
2) Gold : After petroleum, the second most Balance of trade is the difference between
imported item is gold. It has been observed the value of a country’s exports and imports for
that there is a significant drop in gold a given period. Balance of trade is also referred
imports during 2013-14. The gold imports to as the international trade balance.
declined from 53.3 billion dollars in 2011- According to Bentham, “Balance of trade
12 to 27.5 billion dollars in 2013-14. This of a country is the relation over a period
was primarily due to fall in international between the values of her exports and imports
gold prices and various policy measures of physical goods.”
taken by the government to curb gold According to Samuelson, “if export value
imports. is greater than the import value it is called as
3) Fertilizers : The share of fertilizers in trade surplus and if import value is greater than
import expenditure declined from 4.1% in export value, then it is called as trade deficit.”
1990-91 to only 1.3% in 2016-17. It is clear from the above definitions that
4) Iron and Steel : The share of iron and balance of trade includes the value of imports
steel in import expenditure declined from and exports of visible goods and invisible
4.9% to 2.1% in 2016-17. goods.

Concept of Balance of payments :

The Balance of payments of a country is a
systematic record of all international economic
transactions of that country during a given
period, usually a year.
According to Ellsworth, “Balance of
payments is a summary statement of all the
transactions between the residents of one
country and the rest of the world.
According to Walter Krause, “The balance
of payments of a country is a systematic record
of all economic transactions completed between
its residents and the rest of the world during a
Fig. 10.4
given period of time usually a concept of year.
From the above definitions, it is clear that the Find out :
value of exchange of goods and services among List of countries coming under OPEC
the citizens, businessmen, firms, government and OECD.

97
 EXERCISE

Q. 1. Choose the correct option : 2) Explain any four features of composition of

1) Types of foreign trade India's foreign trade.
a) Import trade b) Export trade 3) Explain the trend in India's imports.
c) Entrepot trade d) Internal trade
Q. 5. State with reasons whether you agree or
Options : 1) a and b 2) a, b and c
disagree with the following statements :
3) a, b, c and d 4) None of these
1) During British rule, indigenous handicrafts
2) Export trends of India’s foreign trade includes suffered a severe blow.
a) Engineering goods 2) Trade is an engine of growth for an economy.
b) Gems and Jewellery
3) Foreign trade leads to division of labour and
c) Textiles and ready-made garments
specialization at world level.
d) Gold
Q. 6. Observe the following table and answer the
Options : 1) a and c 2) a, b and c
questions given below it.
3) b, c and d 4) None of these
 Direction of India’s imports
3) Role of foreign trade is Years
Countries /
a) To earn foreign exchange Organisations 1990-91 2015-16
b) To encourage investment
Sr.
c) Lead to division of labour No. Percentage Percentage
d) Bring change in composition of exports
1 OECD 54.0 28.8
Options : 1) a and b 2) a, b and c 2 OPEC 16.3 23.6
3) b and d 4) None of these 3 Eastern Europe 7.8 1.9
Q. 2. Identify and explain the concepts from the 4 Developing Nations 18.6 43.2
given illustrations : 5 Others 1.4 2.5
1) India purchased petroleum from Iran. Questions :
2) Maharashtra purchased wheat from Punjab. 1) Which organisation has the least share in the
3) England imported cotton from India, made direction of India's imports in 2015-16?
readymade garments from it and sold them to 2) Which organisation has maximum share in
Malaysia. India's direction of imports in 1990-91?
4) Japan sells smart phones to Myanmar. 3) Expand the abbreviations of OECD and OPEC

Q. 3. Distinguish between the following : 4) State your opinion regarding the direction of
India's imports.
1) Internal trade and International trade.
5) How much is the percentage of increase in the
2) Trends in imports and Trends in exports of
imports of developing nations in 2015-16 as
foreign trade.
compared to 1990-91?
3) Balance of payments and Balance of trade.
Q. 7. Answer in detail :
Q. 4.Answer the following : 1) Explain the meaning and role of foreign trade.
1) Explain the concept of foreign trade and its
2) Explain the recent trends in India’s exports.
types.


98
 GLOSSARY OF ECONOMIC TERMS

 Advertising : Business of persuading people to based on multiple data items.

buy products or services.
 Antique goods : Something made in an earlier
period that is collected and considered to have
value because it is beautiful, rare and old or of
a high quality.
 Arbitrary weights : Based on or determined
by individual preference, rather than intrinsic
nature of something.
 Bank rate : The rate of interest set by a central
bank in a country. This is the lowest rate
at which central bank lends money against
approved securities.
 Branded products : A branded product is one
which is the made by a well-known
manufacturer and has the manufacturer's label
on it.
 Canons of taxation : Canons of taxation
define numerous rules and principles upon
which a good taxation system should be built.
 Capital gains : A capital gain is a rise in the
value of a capital asset (investment or real
estate) that gives it a higher worth than the
purchase price.
 Capital losses : A capital loss is essentially the
difference between the purchase price and the
price at which the asset is sold, where the sale
price is lower than the purchase price.
 Cardinal measurement : The exponents of
cardinal utility analysis regard utility to be a
cardinal concept and hypothetically hold that
utility is a measurable and quantifiable entity.
 Cash reserve ratio (CRR) : As per RBI Act
of 1934, every commercial bank has to keep
certain minimum cash reserves with RBI. It
varies between 3- 15% of the total demand and
time deposits.
 Ceteris paribus : It is a Latin phrase and a
dominant assumption in mainstream economic
thinking when translated into English refers to
“other things being equal or constant.”
 Composite measure : In Statistics, composite
measures of variables refers to measurements
 Composition of foreign trade : the purpose of credit.
Composition of trade means a study of the  Cross elasticity : Cross elasticity of demand
goods and services imported and exported is an economic concept that measures the
by a country. responsiveness in the quantity demanded of
 Consumer equilibrium : It is a state of one good when the price for another good
balance that can be achieved by a consumer (substitute or complementary product) changes.
from the purchase of goods and services,  Deficit financing : It is a practice in which
given their present level of income and the a government spends more money than it
current level of prices. receives as revenue. The difference is made up
 Copyrights : Copyright is a form of by borrowing or minting new funds.
protection provided by the laws of a country  Deflating : Deflating in statistics means
to the creators of original works that counteracting the effect of inflation over a set
includes literary, dramatic, musical, artistic of data to unravel their true values and make
and certain other creative works. A them comparable.
copyright holder can prevent others from  Dearness Allowances : It is a cost of living
copying, performing or otherwise using the adjustment allowance paid to government
work without his or her consent. employees, public sector employees and
 Cost of living : It is the average amount of pensioners. It is calculated as a percentage of
money that people in a particular place need basic salary to mitigate the impact of inflation.
to afford basic food, housing and clothing.
 Direction of foreign trade : Direction of
 Credit rationing : RBI imposes a ceiling on foreign trade means the countries to which a
the loans and advances offered by particular country exports its goods and the
commercial banks to regulate and control countries from which it imports.
 Disparities in income : It refers to a measurement that helps to determine how an
significant disparity or inequality in the economy functions. Population, poverty,
distribution of income between individuals, unemployment, inflation etc. are examples of
groups, populations, social classes or countries. economic variables.
 Division of labour : It means separation of a  Economic welfare : It is the overall level of
work process into a number of tasks, with each financial satisfaction and prosperity experienced
task performed by a separate person or group by participants in an economic system.
of persons.  Effective demand : In Keynesian
 Double counting : It occurs when the costs macroeconomic theory, effective demand is the
of intermediate goods used by a business to point of equilibrium where aggregate demand =
produce a finished good are included in the aggregate supply.
computation of a nation's gross domestic  Engineering goods : Engineering goods include
product. metal products, industrial machinery and
 Economic efficiency : Economic efficiency equipment, auto and its components and transport
is achieved when all goods and factors of equipments.
production in an economy are distributed or  Financial proposal : A financial proposal is a
allocated to their most valuable uses and waste written report that provides details of the future of
is eliminated or minimized. a business by addressing its monetary needs and
 Economic model : It is a simplified budget.
representation of economic reality showing the  Forecasting : It is a planning tool that helps
inter-relationships between selected economic management in its attempts to cope with the
variables. uncertainty of the future, relying mainly on
 Economic variable : It refers to any
 data from the past and present and analysis  Indivisible goods : A good is indivisible when
of trends. the utility one derives from it depends on the
 General price level : It is an index that number of users or individuals using it. This
measures the change in price of goods in an concept is used in public finance.
economy over time and hence the  Intermediate goods : An intermediate good is
purchasing power of the currency of the a good or service purchased by a manufacturer
country. to be used as an input in another product.
 Illegal incomes : Income derived from  Laissez-faire : It is a policy of minimum
illegal activities such as bookie/betting governmental interference in the economic
operations, theft, embezzlement and from affairs of individuals and society.
other illegal resources.  Leasing Companies : They provide finance
 Imputed value : Imputed value is an for acquiring plant and machinery especially
assumed value given to an item when the for small and medium sized enterprises.
actual value is not known or available.  Liquidity Adjustment facility (LAF) : It is a
 Impact of tax : Effect of a tax on monetary policy tool used by RBI which
production or consumption of a product. allows commercial banks to borrow money
 Incidence of tax: The incidence of a tax through repurchase agreements. It consists of
refers to the extent to which an Repo and Reverse Repo operations.
individual or organisation suffers from the  Marginalism : Marginalism is concerned with
imposition of a tax. how much extra use is gained from incremental
 Income tax returns : A tax return is increases in the number of goods created, sold,
documentation filed with a taxing authority etc. and how these measures relate to consumer
that reports income, expenses and other choice and demand.
relevant financial information.
 Margin Requirements : It is used by RBI to in stock market securities.
determine the loan value of a collateral security  National Electronic Fund Transfer (NEFT) : It
offered by a borrower. It is used to control is an electronic fund transfer process, through
speculative activities. which money can be sent from one bank account
 Merchant Banks : Merchant banks in India to another within the country in a safe and hassle
manage and underwrite new issues, advise free manner.
corporate clients on fund raising and other  Oceanic trade : It refers to expansion of trade
financial aspects. network of coastal countries beyond their land
 Mixed income : Remuneration of a self territories.
employed person is treated as mixed income.  Open market operations : Open market
It is defined as the income that is received, operations is the sale and purchase of government
over a given reference period, by individuals, securities and treasury bills by RBI or the central
for themselves or in respect of their family bank of the country. It is undertaken to regulate
members, as a result of their current or former the money supply in the economy.
involvement in self employment jobs.
 Optimum allocation : It refers to the allocation
 Moral Suasion : It is a psychological of resources in the best possible manner to
instrument of credit control which is used by achieve economic efficiency. It prevents misuse
RBI to persuade commercial banks to co- and avoids wastage of resources.
operate with it in following a proper credit
 Paradox of values : It is an observation that
policy more rigorously.
articles or goods critical to life (such as water) are
 Mutual Funds : Mutual funds mobilize the very cheap, whereas others which have no
savings of the general public and invest them bearing on human existence (such as diamonds)
 are very expensive. or sell an invention for a particular number of
 Patents : It is an official legal right to make years.
 Perishable goods : They are a type of good
especially food products with limited shelf life.
 Point of satiety : Point of satiety is defined
as “the point where marginal utility of any
commodity is zero.”
 Potential supply : Stock is the basis of supply.
It constitutes the potential or total supply of
a commodity that can be offered for sale at a
favourable time.
 Prestige goods : They are high end or luxury
goods that increases the status of the
consumers who own or use them e.g. jewellery,
luxury cars etc.
 Price discrimination : It is the act of of selling
the same product at different prices to different
buyers, in order to maximize sales and profits.
 Price illusion : It is also called money illusion.
It refers to the tendency of consumers to think
in terms of nominal rather than real monetary
values when making economic decisions. It is
likely to occur when inflation is unanticipated.
 Price quotations : Price quotation is a
document (generally written) which a seller
provides to the buyer for offering goods and
services at a stated price, subject to terms and
conditions specified therein.
 Principle of rationality : It is an economic
principle that assumes that individuals always
make prudent and logical decisions that
provide them with the highest amount of
personal utility. These decisions provide
people with the greatest benefit or satisfaction,
given the choices available.
 Public utilities : Public utilities are services
provided by the government or state, such as
the supply of electricity and gas, or the train
network.
 Quid pro quo : Quid pro quo is a Latin phrase
which means a gift or a advantage that is given
to someone in return for something that they
have done.
 Rational consumer : A consumer who makes
his choices after considering all the other
alternative goods and services available in the
market is called a rational consumer.
 Rare goods : They are artistic or precious securities equal to not less than 25% of their
goods that have a limited supply. The supply
of these goods cannot be increased according
to their demand or rising prices.
 Real Time Gross Settlement (RTGS) : 'Real
Time' means the processing of instructions at
the time they are received 'Gross settlement'
means that settlement of funds transfer
instructions occurs individually.
 Rectangular hyperbola : Rectangular
hyperbola is a curve under which all
rectangular areas are equal.
 Repo Rate : Rate at which RBI repurchases
government securities from commercial banks
for a short period when a liquidity shortage is
experienced. It injects liquidity into the
banking system.
 Reverse Repo Rate : Rate at which RBI sells
dated government securities in the market
through auction at fixed cut-off rate of interest.
It absorbs liquidity and also provides short
term avenue to banks to park their surplus
funds.
 Sales proceeds : It refers to the amount of
money received from a particular event or
activity or when something is sold.
 Samples: It is a subset containing the
characteristics of a larger population.
 Self-consumption : Producers themselves
consume the entire or a part of the output they
produce is self-consumption.
 Social accounts : It is the process of
measuring, monitoring, and reporting to
stakeholders the social and environmental
effects of an organization’s actions.
 Speculation : Speculation involves trading in
a financial instrument involving high risk, in
expectation of significant returns. The motive
is to take maximum advantage from
fluctuations in the market.
 Standardized items : It means products of the
same type, having the same basic features.
 Statutory Liquidity Ratio (SLR) : Under
Section 24 of Bankng Regulation Act, 1949,
commercial banks have to maintain liquid
assets in the form of cash, gold and approved


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 total demand and time liabilities. It has been strategy in which a systematic arrangement of
revised by RBI from time to time. articles is done in such a way that they attract
the attention of those who pass-by.
 Subsidies : It is a sum of money granted
by the state or a public body to help an
industry or business to keep the price of a
commodity or service low.
 Tariff : Tariffs are used to restrict
imports by increasing the price of goods and
services purchased from another country,
making them less attractive to domestic
consumers.
 Trademarks : It is a symbol, word or words
legally registered or established by use as
representing a company or product.
 Transfer payments : It is a one-way
payment of money for which no money,
good or service is received in exchange.
Governments use such payments as means
of income redistribution by giving out
money under social welfare programs such
as social security, old age or disability
pensions, student grants, unemployment
compensation, etc.
 Trends and Tendencies : A pattern of
gradual change in a condition, output or
process or an average or general tendency of
a series of data represented by a line or
curve on a graph.
 Uncertainty : In economics, uncertainty
implies that the future outlook for the
economy is unpredictable. There is a high
likelihood of negative economic events to
occur.
 Undistributed profits of companies :
Undistributed profits are those earnings
of a corporation that have not been paid out
to investors in the form of dividends.
 Venture Capital Companies : They
provide commercial support to new ideas
and for the introduction and adaptation of
new technologies.
 Welfare economics : It is that branch of
economics that seeks to evaluate economic
policies in terms of their effects on the well-
being of the community.
 Window Display : It is a marketing
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105
 LIST OF ABBREVIATIONS

 ADR American Depository Receipts

 BSE Bombay Stock Exchange
 CGST Central Goods and Service Tax
 CRR Cash Reserve Ratio
 CSO Central Statistical Organisation
 DFHI Discount and Finance House of India
 DFI Development Financial Institution
 EGEPC Engineering Goods Export Promotion Council
 GDP Gross Domestic Product
 GDR Global Depository Receipts
 GNP Gross National Product
 GST Goods and Service Tax
 ICICI Industrial Credit and Investment Corporation of India
 IDBI Industrial Development Bank of India
 IEPF Investor Education and Protection Fund
 IFCI Industrial Finance Corporation of India
 IGST Integrated Goods and Service Tax
 IIBI Industrial Investment Bank of India
 LAF Liquidity Adjustment Facility
 MMMF Money Market Mutual Funds
 NDP Net Domestic Product
 NEFT National Electronic Fund Transfer
 NNP Net National Product
 NSE National Stock Exchange
 OECD Organisation for Economic Co-operation and Development
 OPEC Organisation of Petroleum Exporting Countries
 RTGS Real Time Gross Settlement
 SBTS Screen Based Trading System
 SEBI Securities and Exchange Board of India
 SFC State Finance Corporation
 SGST State Goods and Service Tax
 SLR Statutory Liquidity Ratio
 UTI Unit Trust of India
 

107