Back to Main Page

Web Notes

Gist of XII Class Economy NCERT(Microeconomics & Macroeconomics)

Download PDF

Chapter 1 :Introduction

3 CENTRAL PROBLEMS OF AN ECONOMY

Production Possibility Frontier

ORGANISATION OF ECONOMIC ACTIVITIES

Chapter 2
Theory of Consumer Behaviour

Chapter 3
Production and Costs

PRODUCTION FUNCTION

Chapter 4
The Theory of the Firm under Perfect Competition

Chapter 5
Market Equilibrium

In a perfectly competitive market, equilibrium occurs where market demand equals market supply.
The equilibrium price and quantity are determined at the intersection of the market demand and market supply curves when there are fixed number of firms.
Imposition of price ceiling below the equilibrium price leads to an excess demand.
Imposition of price floor above the equilibrium price leads to an excess supply

Chapter 6
Non-competitive Markets

The market structure called monopoly exists where there is exactly one seller in any market.
A commodity market has a monopoly structure, if there is one seller of the commodity, the commodity has no substitute, and entry into the industry by another firm is prevented.
The market price of the commodity depends on the amount supplied by the monopoly firm. The market demand curve is the average revenue curve for the monopoly firm.

Class XII

Introductory Macroeconomics

Chapter1

Introduction

Macroeconomics tries to address situations facing the economy as a whole.

Adam Smith-

The founding father of modern economics, had suggested that if the buyers and sellers in each market take their decisions following only their own self-interest, economists will not need to think of the wealth and welfare of the country as a whole separately.
But economists gradually discovered that they had to look further.
Economists found that first, in some cases, the markets did not or could not exist.
Secondly, in some other cases, the markets existed but failed to produce equilibrium of demand and supply.
Thirdly, and most importantly, in a large number of situations society (or the State, or the people as a whole) had decided to pursue certain important social goals unselfishly (in areas like employment, administration, defence, education and health) for which some of the aggregate effects of the microeconomic decisions made by the individual economic agents needed to be modified.

John Maynard Keynes-

Published his celebrated book The General Theory of Employment, Interest and Money in 1936.
The dominant thinking in economics before Keynes was that all the labourers who are ready to work will find employment and all the factories will be working at their full capacity.
This school of thought is known as the classical tradition.

Great Depression- 1929

Output and employment levels in the countries of Europe and North America fall by huge amounts.
Demand for goods in the market was low, many factories were lying idle, workers were thrown out of jobs.
In USA, from 1929 to 1933, unemployment rate rose from 3 per cent to 25 per cent (unemployment rate may be defined as the number of people who are not working and are looking for jobs divided by the total number of people who are working or looking for jobs).
Over the same period aggregate output in USA fell by about 33 per cent.
The domestic country may sell goods to the rest of the world. These are called exports.
The economy may also buy goods from the rest of the world. These are called imports.
Besides exports and imports, the rest of the world affects the domestic economy in other ways as well.

Chapter- 2
National Income Accounting

Net Investment = Gross investment – Depreciation

(Depreciation does not take into account unexpected or sudden destruction or disuse of capital as can happen with accidents, natural calamities or other such extraneous circumstances)

Depreciation is an annual allowance for wear and tear of a capital good.

If we deduct depreciation from GNP the measure of aggregate income that we obtain is called Net National Product (NNP).

Thus NNP = GNP – Depreciation

Expenditure Method

An alternative way to calculate the GDP is by looking at the demand side of the products.

This method is referred to as the expenditure method.

Income Method

The sum of final expenditures in the economy must be equal to the incomes received by all the factors of production taken together (final expenditure is the spending on final goods, it does not include spending on intermediate goods).
This follows from the simple idea that the revenues earned by all the firms put together must be distributed among the factors of production as salaries, wages, profits, interest earnings and rents.

GVA at factor costs + Net production taxes = GVA at basic prices

GVA at basic prices + Net product taxes = GVA at market prices

Factor Cost, Basic Prices and Market Prices

In India, the most highlighted measure of national income has been the GDP at factor cost.
The Central Statistics Office (CSO) of the Government of India has been reporting the GDP at factor cost and at market prices.
In its revision in January 2015 the CSO replaced GDP at factor cost with the GVA at basic prices, and the GDP at market prices, which is now called only GDP, is now the most highlighted measure.

Gross National Product (GNP)

GNP = GDP + Factor income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic economy
Hence, GNP = GDP + Net factor income from abroad
(Net factor income from abroad = Factor income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic economy).
NNP = GNP – Depreciation

NNP at factor cost = National Income (NI ) = NNP at market prices – (Indirect taxes – Subsidies) = NNP at market prices – Net indirect taxes (Net indirect taxes = Indirect taxes – Subsidies)

Personal Income (PI) = NI – Undistributed profits – Net interest payments made by households – Corporate tax + Transfer payments to the households from the government and firms

Personal Disposable Income (PDI ) =PI – Personal tax payments – Non-tax payments.

National Disposable Income = Net National Product at market prices + Other current transfers from the rest of the world

Private Income = Factor income from net domestic product accruing to the private sector + National debt interest + Net factor income from abroad + Current transfers from government + Other net transfers from the rest of the world.

WPI vs. CPI

Chapter- 3
Money and Banking

Commercial Banks

They accept deposits from the public and lend out part of these funds to those who want to borrow.
The interest rate paid by the banks to depositors is lower than the rate charged from the borrowers.
This difference between these two types of interest rates, called the ‘spread’ is the profit appropriated by the bank.
Commercial banks mediate between individuals or firms with excess funds and lend to those who need funds.

MONEY CREATION BY BANKING SYSTEM

Assets are things a firm owns or what a firm can claim from others.
In case of a bank, apart from buildings, furniture, etc., its assets are loans given to public.
Commercial banks like State Bank of India (SBI) keep their deposits with RBI and these are called Reserves.

Assets = Reserves + Loans

Liabilities for any firm are its debts or what it owes to others. For a bank, the main liability is the deposits which people keep with it.

Liabilities = Deposits

The accounting rule states that both sides of the account must balance. Hence if assets are greater than liabilities, they are recorded on the right hand side as Net Worth.

Net Worth = Assets – Liabilities

POLICY TOOLS TO CONTROL MONEY SUPPLY

Reserve Bank is the only institution which can issue currency
Central bank- lender of last resort
The RBI controls the money supply in the economy in various ways.
The tools used by the Central bank to control money supply can be quantitative or qualitative.
The quantitative or general measures influence the total volume of the credit while the qualitative measures influence the selective or particular use of credit.

Quantitative measures

Bank Rate Policy: The bank rate is the Official interest rate at which RBI rediscounts the approved bills held by commercial banks.
For controlling the credit, inflation and money supply, RBI will increase the Bank Rate. Current Bank Rate is 6%.
Open Market Operations: OMO The Open market Operations refer to direct sales and purchase of securities and bills in the open market by Reserve bank of India. The aim is to control volume of credit.
Cash Reserve Ratio- Percentage of deposits which a bank must keep as cash reserves with itself.
Statutory Liquidity Ratio- Apart from the CRR, banks are also required to keep some reserves in liquid form in the short term. This ratio is called Statutory Liquidity Ratio or SLR.

Qualitative measures

Margin requirements: This refers to difference between the securities offered and amount borrowed by the banks.
Consumer Credit Regulation: This refers to issuing rules regarding down payments and maximum maturities of instalment credit for purchase of goods.
Guidelines: RBI issues oral, written statements, appeals, guidelines, and warnings etc. to the banks.
Rationing of credit: The RBI controls the Credit granted / allocated by commercial banks.
Moral Suasion: psychological means and informal means of selective credit control.
Direct Action: This step is taken by the RBI against banks that don’t fulfil conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.

Narrow and Broad Money

RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are defined as follows

M1 = CU + DD

M2 = M1 + Savings deposits with Post Office savings banks

M3 = M1 + Net time deposits of commercial banks

M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)

Where, CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks.
M1 and M2 are known as narrow money. M3 and M4 are known as broad money.
These measures are in decreasing order of liquidity.
M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.
M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources

Demonetisation

Demonetisation was a new initiative taken by the Government of India in November 2016 to tackle the problem of corruption, black money, terrorism and circulation of fake currency in the economy.
Old currency notes of Rs 500, and Rs 1000 were no longer legal tender.
New currency notes in the denomination of Rs 500 and Rs 2000 were launched.

Positive impact-

Improved tax compliance
Banks have more resources at their disposal which can be used to provide more loans at lower interest rates.
Help tax administration in another way, by shifting transactions out of the cash economy into the formal payment system.
Households and firms have begun to shift from cash to electronic payment technologies.

Chapter- 4
Determination of Income and Employment

Investment

Investment is defined as addition to the stock of physical capital (such as machines, buildings, roads etc., i.e. anything that adds to the future productive capacity of the economy) and changes in the inventory (or the stock of finished goods) of a producer.

Paradox of Thrift

If all the people of the economy increase the proportion of income they save (i.e. if the mps of the economy increases) the total value of savings in the economy will not increase – it will either decline or remain unchanged.
This result is known as the Paradox of Thrift – which states that as people become more thrifty they end up saving less or same as before.
This result, though sounds apparently impossible, is actually a simple application of the model we have learnt.

Chapter- 5
Government Budget and the Economy

BALANCED, SURPLUS AND DEFICIT BUDGET

Measures of Government Deficit

Revenue Deficit:

The revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts
Revenue deficit = Revenue expenditure – Revenue receipts

Fiscal Deficit:

Fiscal deficit is the difference between the government’s total expenditure and its total receipts excluding borrowing
Gross fiscal deficit = Total expenditure – (Revenue receipts + Non-debt creating capital receipts)

Gross fiscal deficit = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
Fiscal Deficit = Revenue Deficit + Capital Expenditure - non-debt creating capital receipts
Gross primary deficit = Gross fiscal deficit – Net interest liabilities

Debt

Budgetary deficits must be financed by taxation, borrowing or printing money.
Governments have mostly relied on borrowing, giving rise to what is called government debt.
The concepts of deficits and debt are closely related.
Deficits can be thought of as a flow which adds to the stock of debt.
If the government continues to borrow year after year, it leads to the accumulation of debt and the government has to pay more and more

Fiscal Responsibility and Budget Management Act, 2003 (FRBMA)

The enactment of the FRBMA, in August 2003, marked a turning point in fiscal reforms, binding the government through an institutional framework to pursue a prudent fiscal policy.
The central government must ensure intergenerational equity and long-term macro-economic stability by achieving sufficient revenue surplus, removing fiscal obstacles to monetary policy and effective debt management by limiting deficits and borrowing.

The rules under the Act were notified with effect from July, 2004.

Main Features

The Act mandates the central government to take appropriate measures to reduce fiscal deficit to not more than 3 percent of GDP and to eliminate the revenue deficit by March 31, 20098 and thereafter build up adequate revenue surplus.

It requires the reduction in fiscal deficit by 0.3 per cent of GDP each year and the revenue deficit by 0.5 per cent. If this is not achieved through tax revenues, the necessary adjustment has to come from a reduction in expenditure.

The actual deficits may exceed the targets specified only on grounds of national security or natural calamity or such other exceptional grounds as the central government may specify.

The central government shall not borrow from the Reserve Bank of India except by way of advances to meet temporary excess of cash disbursements over cash receipts.

The Reserve Bank of India must not subscribe to the primary issues of central government securities from the year 2006-07.

Measures to be taken to ensure greater transparency in fiscal operations.

The central government to lay before both Houses of Parliament three statements – Medium-term Fiscal Policy Statement, The Fiscal Policy Strategy Statement, The Macroeconomic Framework Statement along with the Annual Financial Statement.

Quarterly review of the trends in receipts and expenditure in relation to the budget be placed before both Houses of Parliament.

GST: One Nation, One Tax, One Market

Single comprehensive indirect tax, operational from 1 July 2017, on supply of goods and services, right from the manufacturer/ service provider to the consumer.
It is a destination based consumption tax with facility of Input Tax Credit in the supply chain.
It has amalgamated a large number of Central and State taxes and cesses.
As there have been a number of intermediate goods/services, which were manufactured/provided in the economy, the pre GST tax regime imposed taxes not on the value added at each stage but on the total value of the commodity/service with minimal facility of utilisation of Input Tax Credit (ITC).
The total value included taxes paid on intermediate goods/services.
This amounted to cascading of tax. Under GST, the tax is discharged at every stage of supply and the credit of tax paid at the previous stage is available for set off at the next stage of supply of goods and/or services.
In view of our large and fast growing economy, it addresses to establish parity in taxation across the country, and extend principles of ‘value- added taxation’ to all goods and services.
It has replaced various types of taxes/cesses, levied by the Central and State/UT Governments.
Some of the major taxes that were levied by Centre were Central Excise Duty, Service Tax, Central Sales Tax, Cesses like KKC and SBC.
The major State taxes were VAT/Sales Tax, Entry Tax, Luxury Tax, Octroi, Entertainment Tax, Taxes on Advertisements, Taxes on Lottery /Betting/ Gambling, State Cesses on goods etc. These have been subsumed in GST.
Five petroleum products have been kept out of GST for the time being but with passage of time, they will get subsumed in GST.
State Governments will continue to levy VAT on alcoholic liquor for human consumption.
Tobacco and tobacco products will attract both GST and Central Excise Duty.
Under GST, there are 6 (six) standard rates applied i.e. 0%, 3%,5%, 12%,18% and 28% on supply of all goods and/or services across the country.
GST is the biggest tax reform in the country since independence and was rolled out on the mid-night of 30 June/1 July, 2017 during a special midnight session of the Parliament.
The 101th Constitution Amendment Act received assent of the President of India on 8 September, 2016. The amendment introduced Article 246A in the Constitution cross empowering Parliament and Legislatures of States to make laws with reference to Goods and Service Tax imposed by the Union and the States.
Thereafter CGST Act, UTGST Act and SGST Acts were enacted for GST.
It will also result into higher economic growth as GDP is expected to rise by about 2%.

Advantages-

Expanded the tax base
Introduced higher transparency in the taxation system,
Reduced human interface between Taxpayer and Government

Chapter- 6
Open Economy Macroeconomics

THE BALANCE OF PAYMENTS

The balance of payments (BoP) records the transactions in goods, services and assets between residents of a country with the rest of the world for a specified time period typically a year.
There are two main accounts in the BoP — the current account and the capital account.

Current Account

Current Account is the record of trade in goods and services and transfer payments.

Capital Account

Capital Account records all international transactions of assets. An asset is any one of the forms in which wealth can be held, for example: money, stocks, bonds, Government debt, etc.

Purchase of assets is a debit item on the capital account.

Foreign Exchange Rate

Foreign Exchange Rate (also called Forex Rate) is the price of one currency in terms of another.

Demand for Foreign Exchange

People demand foreign exchange because: they want to purchase goods and services from other countries; they want to send gifts abroad; and, they want to purchase financial assets of a certain country.
A rise in price of foreign exchange will increase the cost (in terms of rupees) of purchasing a foreign good.
This reduces demand for imports and hence demand for foreign exchange also decreases, other things remaining constant.

Supply of Foreign Exchange

Foreign currency flows into the home country due to the following reasons: exports by a country lead to the purchase of its domestic goods and services by the foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by the foreigners.
A rise in price of foreign exchange will reduce the foreigner’s cost (in terms of USD) while purchasing products from India, other things remaining constant.

Depreciation

Increase in exchange rate implies that the price of foreign currency (dollar) in terms of domestic currency (rupees) has increased.

This is called Depreciation of domestic currency (rupees) in terms of foreign currency (dollars).

Appreciation

When the price of domestic currency (rupees) in terms of foreign currency (dollars) increases, it is called Appreciation of the domestic currency (rupees) in terms of foreign currency (dollars).

Income and the Exchange Rate

When income increases, consumer spending increases.
Spending on imported goods is also likely to increase.
When imports increase, the demand curve for foreign exchange shifts to the right.
There is a depreciation of the domestic currency.
On balance, the domestic currency may or may not depreciate.

Devaluation-

In a fixed exchange rate system, when some government action increases the exchange rate (thereby, making domestic currency cheaper) is called Devaluation.

Revaluation-

When the Government decreases the exchange rate (thereby, making domestic currency costlier) in a fixed exchange rate system.

The Bretton Woods System

The Bretton Woods Conference held in 1944 set up the International Monetary Fund (IMF) and the World Bank and re-established a system of fixed exchange rates.

A two-tier system of convertibility was established at the centre of which was the dollar.

1967- IMF- gold was displaced by creating the Special Drawing Rights (SDRs), also known as ‘paper gold’

International Monetary Fund (IMF)

It was established at the conference of 44 nations held at Bretton Woods, New Hampshire, USA, in July 1944.
IMF was officially created in 1945 with 29 member countries.
It was established to prevent unstable exchange rates and competitive devaluation among economies.
Headquarters of IMF - Washington DC

AIMS OF IMF:

IMF promotes international monetary cooperation
It helps in expansion and balanced growth of international trade
It promotes exchange stability
It helps to remove deficiency in Balance of Payments

FUNCTIONS OF IMF

IMF set standards for global economy and monitors financial communications between countries.
It helps its member countries by lending money to make their economies and financial structure stable.
It assists the member countries to develop sustainable financial policies.
It provides economic advice to countries to maximise their financial effectiveness.
It helps developing countries to stabilise and sustain themselves in global economy

World Bank

World Bank was formed on July 1944 at the Bretton Woods Conference.
Headquarter of World Bank is located at Washington D.C. (U.S.A.)
The main purpose of the World Bank is ''Reduction of Poverty''.
World Bank is comprises of two institutions - International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA).
World Bank is member of the United Nations Development Group as well as World Bank Group.
World Bank Group includes - International Bank for Reconstruction and Development (IBRD), International Development Association, International Finance Corporation, Multilateral Investment Guarantee Agency, International Center for Settlement of Investment Disputes.
The president of the World Bank comes from the largest shareholder. Members are represented by a Board of Governors.

Breakdown of the Bretton Woods system

The breakdown of the Bretton Woods system was preceded by many events, such as the
Devaluation of the pound in 1967,
flight from dollars to gold in 1968 leading to the creation of a two-tiered gold market (with the official rate at $35 per ounce and the private rate market determined), and
Finally in August 1971, the British demand that US guarantee the gold value of its dollar holdings.