UNIT –IV

Lesson VIII

MACRO ECONOMICS

Reading objective:

After reading this lesson the candidate may be able to understand that the word macro

indicates the study about the whole and the word micro indicates the study at the micro level i.e.

about the individuals. So here macro economics indicates the study about the whole economic

conditions prevalent in the country, like National Income, Employment, Unemployment, Exports

and Imports of the country, GDP of the country, etc. Apart from this it also includes aggregate

demand and aggregate supply of goods, and the objectives of economic policies. In short, the

study about the whole economy comes under the category of macro economics and the study

about the demand for and supply of the individual goods and its price level comes under the

category of micro economics.

Lesson Outline:

 Objectives of Economic policies

 National income concepts
 Approaches to calculate national income
 Factors determining national income
 Difficulties in measuring national income
 Economic indicators
 Key economic indicators of India
 Review questions
Introduction:

Macro economics is the study of aggregate economic behaviour of the economy as a

whole. Macro economics deals with the output, (total volume of goods and services produced)

levels of employment and unemployment, average prices of goods and services. It also deals

with the economic growth of the country, trade relationship with other countries and the

exchange values of the currency in the international market.

The major factors influencing these outcomes are international market forces like

population growth, consumption behaviour of the country, external forces like, natural

calamities, political instability and policy related changes such as tax policy, government

expenditure (budget) money supply and various other economic policies of the country.

Therefore it is essential to know the aggregate demand and aggregate supply of the country.

Aggregate demand: the total quantity of output demanded at prevailing price levels in a given
time period, ceteris paribus.

Aggregate supply: the total quantity of the output the producers are willing and able to supply at
prevailing price levels in a given time period.

These two summarizes the market activity of the economy. But the economy is disturbed

by unemployment, inflation and business cycles. Various economic policies like Fiscal policy

and monetary policy are followed by the government to achieve the equilibrium between

aggregate demand and aggregate supply.

 The following chapters will help us to understand the Macro Economic concepts, their

behaviour and its impact on the economy. Thus, an understanding of macro economics and

policies is of utmost importance to managers. Managers have to cope with the economic

environment at two levels - firm level and macro level.

Objectives of economic policies:

The major macro level economic policies framed by the government of India to achieve the
objectives are:
1. To achieve national level full employment
2. To stabilize the price fluctuations in the market
3. To achieve overall economic growth
4. To develop regions economically
5. To improve the standard of living of the people
6. To reduce income inequalities
7. To control monopoly market structure
8. To avoid cyclical fluctuations in various economic activities of the country
9. To improve the Balance of Payment of the country and
10. To bring social justice in various aspects.
Now let us understand the various macroeconomic concepts.

NATIONAL INCOME

The purpose of national income accounting is to obtain some measure of the performance

of the aggregate economy. The major concepts used in the national income calculation are Gross

Domestic Product (GDP), Gross National Product (GNP), Net National Product (NNP), personal

income and Disposable income.

Gross Domestic Product is the total market value of all final goods and services currently

produced within the domestic territory of a country in a year. It measures the market value of

annual output of goods and services currently produced and counted only once to avoid double

counting. It includes only final goods and services. It includes the value of goods and services

produced within the domestic territory of a country by nationals and non nationals.

Gross National Product is the market value of all final goods and services produced in a year.

GNP includes net factor income from abroad. GNP = GDP + Net factor income from abroad

(income received by Indian’s abroad – income paid to foreign nationals working in India)

Net National Product at market price is the market value of all final goods and services after

providing for depreciation.

NNP = GNP – Depreciation

Depreciation means fall in the value of fixed capital due to wear and tear.
NNP at factor cost is called as National Income:

National income is the sum of the wages, rent, interest and profits paid to factors for their
contribution to the production of goods and services in a year.

NNP = NNP (market price) – indirect tax + subsidies

Personal income (PI) is the sum of all incomes earned by all individuals / households during a
given year. Certain incomes are received but not earned such as old age pension etc.,
PI = NI – social security contribution – corporate income tax – undistributed corporate
profits + transfer payments.
Disposable income is calculated by deducting the personal taxes like income tax, personal

property tax from the personal income (PI).

Disposable Income = personal income – personal taxes = consumption + saving

Supernumerary income: the expenditure to meet necessary living costs deducted from

disposable consumer income is called as supernumerary income.

The economy is divided into different sectors such as agriculture, fisheries, mining,

construction, manufacturing, trade, transport, communication and other services. The gross

production is found out by adding up the net values of all the production that has taken place in

these sectors during a given year. This method helps to understand the importance of various

sectors of the economy.

Approaches to calculate National Income:

The income approach: The income of individuals from employment and business, the profits of

the firms and public sector earnings are taken into consideration.

National Income is the income of individuals + self employment + profits of firms and

public corporate bodies + rent + interest (transfer payments, scholarships, pensions are not

included) this includes the sum of the income earned by individuals from various input factors

such as rent of land, wages and salaries of employees, interest on capital, profits of entrepreneurs

and income of self employed people. This method indicates the income distribution among

various income groups of people.

The expenditure approach: In this approach national income is calculated by using the

expenditure of individuals, private, government and foreign sectors. i.e. the sum of all the

expenditure made on goods and services during a year. i.e.

National Income = expenditure of individuals + government + private firms + foreigners

GDP = C + I + G + (X-M)
Where,
C= expenditure on consumer goods and services by individuals and households
I = expenditure by private business enterprises on capital goods
G = government expenditure on goods and services (government purchase)
X-M = exports - imports

The output approach: in this approach we measure the value of output produced by firms and

other organization in a particular time period. i.e. the National Income = income from agriculture

+ fishery + forestry + construction + transportation + manufacturing + tourism + water + energy

GDP at market price + subsidies –taxes

GNP at factor cost + net income from abroad

Factors determining National Income:

1. Quantity of goods and services produced by the country. Higher the quantity of
production, higher shall be the national income.
2. Quality of products and services produced in the country will also determine the national
income of a country.
3. Innovation of more technical skills will improve the productivity which will reflect on
national income of the country.
4. Political stability strengthens the national income of an economy.
Difficulties in the calculation of National Income:

1. Any income earned abroad have to be included

2. To avoid double counting, value added method should be considered
3. Services rendered free of charges are not to be included
4. Capital gains, transfer payments are not to be included
5. Changes in price level will also affect the calculation
6. Value of military services will not be taken into consideration.

Problems in measuring National Income in India:

1. Non monetized sector: there are number of sectors in which the wages and
salaries are provided in kind, not in monetary measures.
2. Illiteracy: due to higher illiteracy rate the results may be biased.
3. Lack of occupational specification: we have difficulty in classifying the nature
of the job existing in India.
4. Unorganized productive activities: people involved in unorganized productive
activities are not fully covered in the calculation of national income.
5. Lack of adequate statistical data: Inadequate data leads to approximation of the
calculation.
6. Self consumption: Farm products kept for self consumption are not considered
for the national income calculation.
7. Unpaid Services: services of house wives are not reckoned as national income.

Uses of National Income estimates:

1. National income is a measure of economic growth

2. National income is an indicator of success or failure of planning
3. Useful in estimating per capita income
4. Useful in assessing the performance of different production sectors
5. Useful in measuring inequalities in the distribution of income
 6. Useful in measuring standard of living
7. Useful in revealing the consumption behaviour of the society
8. Useful in measuring the level and pattern of investment
9. Makes international comparisons possible

Difficulties of comparing national income:

It is difficult to compare the national income of a country with others due to the

difference in population size, working hours of labour force, currency values in the market,

consumption pattern of general public, cultural difference and inflationary pressure of the

country. Even with all the above mentioned difficulties the GDP is the major economic indicator

of an economy.

National income and managers:

The managers of various organizations in different sectors follow the national income

statistics to take managerial decisions at the firm level. Particularly national income data is

useful for the marketing managers, financial managers, production managers, and advertising

agents of any firm. The macro level policy makers will also use the data for their decision

making. The following chapter provides the details regarding the major economic indicators of

India.
ECONOMIC INDICATORS

The Indian economy is estimated to grow at 6.9 per cent in 2011-12, after having grown

at the rate of 8.4 per cent in each of the two preceding years. This indicates a slowdown when

compared to the previous two years but even during the period 2003 to 2011. Inflation as

measured by the wholesale price index (WPI) was higher during most of the current fiscal year,

though by the year end there was a clear slowdown. Food inflation, in particular, has come down

to around zero, with most of the remaining WPI inflation being driven by non-food

manufacturing products. Monetary policy was tightened by the Reserve Bank of India (RBI)

during the year to control inflation and curb inflationary pressures. The slowing inflation reflects

the lagged impact of actions taken by the RBI and the government. Reflecting the weak

manufacturing activity and rising costs, revenues of the centre have remained less than

anticipated; and, with higher than- budgeted expenditure, a slippage is expected on the fiscal

side.

The global economic environment, which has been tenuous at best throughout the year,

turned adversely in September 2011 owing to the turmoil in the Euro zone, and questions about

the outlook on the US economy provoked by rating agencies. However, for the Indian economy,

the outlook for growth and price stability at this juncture looks more promising. There are signs

from some high frequency indicators that the weakness in economic activity has slowed down

and a gradual upswing is imminent. The key economic indicators of India for the year 2011-12

are given in the table below.

Table – Key Economic Indicators of India 2011-2012

 Table – Ratio’s of Savings and Investment to GDP (at current market price %)

The major national savings and investments are shown in the above table. In the past five years
public sector savings reduced and on other hand its investment has grown. Household’s saving
and investment has come down.

Trend in Sectoral Composition of GDP

 The sectoral contribution of GDP shows that in the 1950s agricultural sector’s

contribution was around 53% but now it has come down to 14% . After opening up our economy

the service sectors contribution has grown tremendously and it has reached 60%. Industrial

growth of our country is very slow with an increase from 16% in 1950 to 27% in 2012.

Graph - GDP Growth estimates and projection

The GDP growth estimates of various countries are given in the above graph. It is found

that China’s growth rate is nearly 10% followed by India with 7%. Italy and Euro areas have

negative growth. It indicates that Asian countries are growing at a faster rate than the Western

countries.
 Share of World GDP

From the above table we can understand that the share of advanced economies in the

world GDP is declining. It has reduced from 76% to 66%. whereas in the case of India, it has

increased from 1.7% to 2.6%. From this we can conclude that Indian economy is growing and it

is expressed in the various economic activities of our country. The major economic indicators are

growing at a faster rate. The service sector’s contribution towards the economic development of

our country is very high, due to this change the employment opportunities created by this sector

has also grown at a faster rate. This is discussed in the following chapters.

Review Questions:

1. Define macro economics.

2. What do you mean by aggregate demand and aggregate supply?
3. What are the major objectives of macroeconomic policies of our country?
4. Discuss the major National Income concepts.
5. Explain the three national income calculation methods.
 6. List out the major difficulties and problems in the national income calculation of our
country.
7. Mention the uses of national income calculation in the manager’s point of view.
8. Give an account of major economic indicators of India.
9. Is there any relationship between GDP and saving and investment of a country?
10. Explain briefly the trend in GDP of India.
11. Explain the managerial uses of knowing macroeconomic indicators of a country.

BUSINESS CYCLE

Reading objective:

After reading this chapter the candidate may be able to understand that the economic
conditions are changing cyclically. That is because of the changes in the total demand for
certain goods and supply of the same may be due to the change in the technology or taste etc.
this may be normally analysed in the form of Depression, Recovery, Boom and Recession. The
depression is an economic condition where there is no demand for certain goods and services
may be due to the lack of buying power in the hands of the public. The Recovery is a stage where
the Governments try to halt the depressionery conditions by injecting buying power in the hands
of the public. So that the increased demand will lead to production, employment, income and
thus growth in the economy. The Boom period is said to be a prosperous period where economy
is at equilibrium at higher level. Recession is the again the sliding stage. The recessionary
conditions in America in the recent past and the president Barack Obama’s fight with it is a
classic example of recession.

Lesson Outline:

 Business cycle
 Characteristic features of business cycle
  Various phases of a business cycle
 Theories on business cycle
 Review questions

Introduction

A study of fluctuations in business activity is called business cycle. Business cycle can be

defined as a periodically recurring wave like movements in aggregate economic activity (like

national income, employment, investment, profits, prices) reflected in simultaneous, fluctuations

in major macro economic variables.

R A Gordon defined business cycle as consisting of “recurring alteration of expansion

and contraction in aggregate economic activity, the alternating movements in each direction

being self-reinforcing and prevailing virtually all parts of the economy”.

Characteristic features of Business Cycle:

1. It occurs periodically: the fluctuations in economic activities occur periodically

but not at a fixed period of interval.
2. It is international in character: the changes in any economic activity of a
country have impact on economies of the world (for example financial crisis in
US had impact on various other countries economic activities).
 3. It is wave like: the fluctuations indicate ups and downs in various economic
indicators of a country.
4. The process is cumulative: the process is cumulative in nature, that means
change in income level, savings or any other activity will be in aggregates.
5. The cycles will be similar but not identical: the cycle has ups and downs but not
identical spacing that means the time period of occurrence will differ.

Phases of a Business Cycle:

The business cycle has four phases, Boom, Recession, Slump and Recovery. In

economics it has been observed that income and employment tend to fluctuate regularly

overtime. These fluctuations are known as business cycle or trade cycle.

Peak / Boom: when the economy is booming national income of the country is high and there is

full employment, the consumption and investment is high. Tax revenue is high. Wages and

profits will also increase. There will be inflationary pressure in the economy.

Recession: when the economy moves into recession, output and income fall leading to a

reduction in consumption and investment. Tax revenue begins to fall and government

expenditure begins to benefit the society. Wage demands moderate as unemployment rises,

import and inflationary pressure declines.

Trough: economic activities of the country are low, mass unemployment exists, so consumption

investment and imports will be low. Pricing may be falling (there will be deflation)
Recovery: as the economy moves into recovery, national income and output begin to increase.

Unemployment falls, consumption, investment and import begins to rise. Workers demand more

wages and inflationary pressure begins to mount.

peak

Recession
Boom /
Prosperity Revival

Depression

Crisis

The fluctuation in the activities is measured with respect to a horizontal line indicating a

given steady level of economic activity. However, if the time series reveals a significant long

term trend, the vertical deviations of the reported or actual points from the estimated trend line

are measured and plotted separately to obtain a clear picture of the underlying business cycle.

Most economic variables go through ups and downs over time and the economy as a whole

experience periods of prosperity and periods of recession. The measure of prosperity is the

amount of goods/services produced (GDP) during a year. Actual business cycle are measured by

changes in real GDP, that is the market value of all the goods and services produced within a

nation’s borders, with market values measured in constant prices (prices of a specific base year).

Expansion or boom: is the period in the business cycle from a trough up to a peak,

during which output and employment rise.

 Contractions, recession, or slump: is the period in the business cycle from a peak down

to a trough, during which output and employment fall.

Recession: a decline in total output (real GDP) for 2 or more consecutive quarters.

Reduction in investment, employment and production, reduction in income, expenditure, prices

and profits reduction in bank loans. The business expansion stops that leads to depression.

Depression: the level of economic activity is extremely low. The income, production,

employment, prices, profits of the country is very low. Organizations fix low price which leads

to low profit, low wages, people suffer, closing down of business.

Recovery: slow increase in output, employment, income and price. Increase in demand,

investment, bank loan, advances. This leads to recovery, revival of prosperity.

Theories on Business Cycle:

1. Sunspot theory / climate theory: depending on climatic changes agricultural

products are produced. Based on the production other ancillary units will function

therefore the base for any change in economic activity of the country is climate.

2. Psychological theory: during depression or crisis of any business organization it

is completely based on the psychology of the entrepreneur as to whether the

organization can be revived or shut down.

3. Monetary theory: means the demand and supply of money is the primary reason

for economic fluctuations of a country.

4. Over investment theory: if the organizations and individuals save more and

invest a huge amount then their expectations on increase in their returns.

 5. Over savings/ under consumption theory: As per this theory the increase in

savings and investment will bring down the consumption which will reduce the

demand for goods in the market.

6. Innovation theory: According to this theory more innovations lead to new

technology and new business that leads to prosperity in the economy.

There are two types of business cycle models, they are (i) Exogenous model; due to

economic shocks like war. (ii) Endogenous model; trade cycle because of factors which lie

within the economic system.

A monetarist explanation: business cycles are essentially monetary phenomena caused

by changes in the money supply. Change in money supply leads to change in employment and

national income which increases the price. The path to an increased price level is cyclical. The

link between changes in money supply and changes in income is known as the transmission

mechanism.

Review Questions:

1. Define Business cycle, list out its characteristic features.

2. Explain various phases of a business cycle.
3. Discuss the theories on business cycle.
4. Explain the managerial uses of business cycle.
5. Are cyclical fluctuations necessary for economic growth?
 INFLATION

Reading objective:

The purpose of studying this chapter is to acquaint with economic phenomenon of rising
prices of goods and services. The law of demand states the supply remaining constant whenever
the demand increases the prices will grow up. If this happens for a substantially continuous
period it is called as inflation. Depending upon the nature of the rise in prices the inflation will
be called as a creping inflation, walking inflation, running inflation, galloping inflation and
hyper inflation. The tendency of the rise in prices is not always unwanted. In fact the moderate
rise in prices may lead to additional investment, production, employment and income. But
however the alarming rate of rise in prices may lead to distortions in the economy. It may Rob
Paul and Pay Peter. ie It will affect the fixed income group of people and benefit the business
community .This rise in the prices will decrease the demand for goods and services and this in
turn will lead to fall in demand for production, investments, output, employment, income and the
GDP .Therefore there is a need for regulating it.

Lesson Outline:

 Inflation
 Types of inflation
 Effects of inflation
 Methods of controlling inflation
 Review questions

Introduction
 Inflation is an economic condition in which the aggregate prices are always increasing in

a country. The value of money is falling. Inflation is nothing but too much of money chasing too

few goods. For example in Zimbabwe the inflationary rate is too high as more than 1000 % and

in turn they require bag full of money for a meal. And the value of their currency is very low in

the market. Inflation means not only sustainable rise in the price of the goods and services, but

the value of the currency falls in the market and the supply of money in circulation is more.

Deflation is the opposite of inflation. It is a state of disequilibrium in which a contraction

of purchasing power tends to cause or is the effect of a decline of the price level.

Types of inflation on the basis of speed:

1. Creeping inflation: the inflationary rate is less than 2% that means prices are increasing
gradually.
2. Walking inflation: the inflationary rate of a country is around 5% little more than
creeping.
3. Running inflation: the rate of growth in prices are more i.e. the inflation is growing at
the rate of 10%.
4. Galloping inflation: higher growth rate compared to the earlier stages i.e. the change is
around 25%.

The major four types of inflation is depicted graphically in the following graph. ‘X’ axis denotes

the year and ‘Y’ axis for rise in price level. Based on the elasticity and slope we can understand

over a period of time sustainable inflationary situation leads to higher level of inflation in the

economy.

Graph – Types of Inflation

 Y

Rise in price level (in %)

0 X
Year

On the basis of inducement:

1. Deficit induced: the deficit in the balance of payments of the country or fiscal deficit is

the reasons for inflation. The value of the currency is falling due to the above mentioned

reasons.

2. Wage induced: due to higher wages and salaries the money supply in the country

increases leading to inflation.

3. Profit induced: higher the profit the organizations earn, they tend to share with their

stakeholders which induces the money supply and reduces the value of money.

4. Scarcity induced: the raw material and other input factor scarcity (for example petrol)

may induce the price hike in the market.

5. Currency induced: the value of currency fluctuates due to various internal and external

forces.
6. Sectoral inflation: a particular sector of a country may be the reason for economic

growth or money supply. (for example in India the growth in service sector particularly

IT)

7. Foreign trade induced: if the country has unfavorable balance of payments, that means

the country’s exports are less than the imports, then we need more of foreign currency to

make payments to the exporters ultimately this increases the demand for other currencies

in the market.

8. War time, Post war, Peace time: During war period the government expenditure on

various amenities will induce the inflation and the production, availability of the

commodities will be low which leads to price hike. To settle down the economy after

war or natural calamities the government spending will be more.

On the basis of extent of coverage:

Based on the coverage, economists classify the inflation as open and repressed;

Comprehensive and sporadic.

Effects of inflation on various economic activities of the country:

On Producers: producers will earn more profit due to higher prices.

On debtors and creditors: creditors will be happy to receive more returns on their lending.
On wage and salary earners: wage holders will struggle to purchase the goods and services.
On fixed income group: income is fixed but the value of the currency is falling and prices are
increasing therefore it is difficult to manage the normal life. i.e. they are affected.
On investors: investors will receive more returns on their investments.
On farmers: farmers will suffer.
On social, moral and political effects: due to money supply and higher the cash in hand the
social, moral values are declining in the society with political disturbances.
 Demand pull inflation: inflation will result if there is too much spending when

compared to output. Aggregate demand is greater than aggregate supply which leads to price

hike and inflation. An increase in aggregate demand when the economy is at less than full

employment level will result in an increase in both price and output. If the economy is at full

employment then the demand will increase which leads to inflation.

Cost push inflation: inflation is caused by change in the supply side of the economy, it

increases cost of production, prices and inflation. Initially increase in costs leads to a chain of

wage increases which leads to increase in demand and cost.

Methods of controlling Inflation

Control of inflation:

It is clear that the inflationary situation in the long run is not going to help the economy to

grow. Therefore the Government has to take many steps to overcome this problem. The given list

of measures was taken through monetary and fiscal policy of our country and is explained in

detail in the following chapters.

1. Monetary measures : to control inflation are:

Bank rate
Open market operations
Higher reserve ratio
Consumer credit control
Higher margin requirements

2. Fiscal measures:
Regulating to Government expenditure
 Taxation
Public borrowing
Debt management
Over valuation of home currency
3. Others:
Wage policy
Price control measures and rationing the essential supplies
Moral suasion

Anti inflationary measures:

The two important tools of macro level economic policy are monetary policy and fiscal policy.

The monetary policy regulates the supply of money and availability of credit in the economy. It

deals with both the lending and borrowing rates of interest for commercial banks. These two

tools are used to control inflation and mitigate its severity.

Monetary measures: since too much money is the fundamental problem in the economy, the

central banking authorities use various instruments to reduce the money supply and credit.

Fiscal measures: by adopting suitable measures in taxation, public expenditure and borrowing,

the government can curb inflation. The following chapter discusses these two measures in detail.

Review Questions
1. What is inflation? What are the types of inflation?
2. Write short note on demand pull inflation and cost push inflation.
3. List out the major factors influencing inflation in India.
4. Explain the effects of inflation on various groups of people in the society.
5. Discuss the causes and control measures of the inflation.
 MONETARY POLICY

Reading objective:

After reading this chapter the reader may be able to understand that the monetary policy

is the policy of the monetary authority namely central bank of the country to achieve certain

goals like controlling the inflation, deflation, obtaining full employment and economic

development of the country. The objectives of the monetary policy may change from time to time.

In recent past, the people of India were appreciating the Honorable finance minister

Mr.P.Chidambaram, Dr.Y.V.Reddy the former Governor, Reserve Bank of India and the

Dr.D.Subba Rao the present Governor, Reserve Bank of India for their deft handling of the

economic condition of India from without being affected by the global financial meltdown. The

Monetary authority of the country has certain tools in its hands and uses it depending upon its

understanding of the economic conditions of the country.

Lesson Outline:

 Monetary policy
 Objectives of monetary policy of India
 Instruments of monetary policy
 Limitations of monetary policy
 Review questions

Introduction

Monetary policy is an important economic tool which is used to attain many

macroeconomic goals. Monetary policy regulates the supply of money and availability of credit
in the economy. It deals with both the lending and borrowing rates of interest of commercial

banks. It aims to maintain price stability, full employment and economic growth. Reserve Bank

of India (RBI) is responsible for formulating and implementing monetary policy of India. It was

announced twice a year (slack season and busy season) but now once in a year. It refers to the

credit control measures adopted by the central bank of a country.

The efforts of monetary authorities to increase the benefits of existing monetary system

and to reduce the disabilities in the process of economic development and growth can be called

the monetary policy of the country.

Objectives of Monetary Policy of India:

1. To achieve Price stability

2. To attain Exchange rate stability
3. To avoid the negative impacts of business cycle
4. To experience full employment position

Instruments: the major instruments used to achieve the above said objectives are

Bank rate: the rate of interest charged by the RBI against the commercial bank borrowings. If

RBI increases the bank rate from 2% to 3% then the commercial banks rate of interests will go

up from for example 7% to 10% which in turn reduce the public borrowings due to higher

interests and minimize the money circulation in the country.

Reserve ratio: CRR (Cash Reserve Ratio), SLR (statutory Liquidity Ratio) the RBI insist on

commercial banks to keep a certain percentage as reserve in their hands for ensuring liquidity

and regulating credit. The RBI can increase the CRR from 3% to 15%. In case when the RBI
increases CRR from 10% to 12% then the availability of money in the hands of banks will come

down. Thus the credit creating capacity of the commercial banks will be reduced and money

supply in the market also will be regulated.

Open market operation: RBI selling the government securities to the public. In that case

instead of having money in the hands the public will receive certificates for a fixed time period

and they will receive interest against the same. But the money circulation among the public will

be reduced.

Margin requirements: margin requirement for mortgaging against the loans will be increased to

reduce to credit and it will be reduced to increase the credit flow.

Credit rationing: the loans and advances are provided only for production purpose and for

essential activities to cut down the money in circulation.

Moral suasion: RBI controls the commercial banks for creating loans and advances by

persuasion through issue of circular.

Direct actions: sometimes RBI takes direct action against the credit created by the banks in

contravention of the RBI guide line to overcome the inflationary situation.

Limitations of monetary policy:

1. Monetary policy operates in a broad front
2. Success and failure depends on the banking system of the country
 3. It has Institutional restrictions
4. Unorganized money market does not support the monetary policy
5. Existence of non monetized sector also defies RBI’s regulation
6. It is not very effective in overcoming depression.

Monetary policy and economic development:

1. Economic development needs the support of credit planning
2. Improving the efficiency of banking system
3. Decide interest rates
4. Public debt management

Monetary policy refers to various decisions and measures of the monetary authorities, state and

central bank, influencing money supply and credit situation in the monetary system as a whole

with a view to full fill certain macro economic goals. It deals with the cost of credit and the

availability of credit. Monetary policy is the attempt by the government or its agent, the central

bank, to manipulate monetary variables such as the rate of interest or the money supply to

achieve policy goals.

Review Questions:

1. What do you understand by monetary policy?

2. What are the objectives of monetary policy of India?
3. Explain the major instruments of monetary policy of our country.
4. List out the limitations of monetary policy of India.
5. Highlight the current monetary policy of India.
 FISCAL POLICY

Reading Objectives:

The purpose of introducing this part in the managerial economics is to familiarize the

candidate about the role played by the Government of the country in fulfilling certain objectives

like, economic stability, price stability, achieving full employment, promoting exports and

achieving balanced regional growth through the tools like taxation, public barrowing and deficit

financing. These tools are mostly used only in its budget proposals it may make clear the minds

of the reader that the objectives of the monetary policy and the fiscal policy are more or less the

same. Therefore to achieve the goals most often these two are used in combination. The

managerial economist while taking their managerial decisions will have to keep in their mind

these policies to take wise decisions.

Lesson Outline:

 Fiscal policy
 Objectives of fiscal policy of India
 Key features of Budget 2012-13
 Tax proposals
 Receipts and expenditure of the government of India
 Review questions

Introduction:
 Fiscal policy is defined as the conscious attempt of the government to achieve certain

macro economic goals of policy by altering the volume and pattern of its revenue and

expenditures and the balance between them. The major economic goals of fiscal policy are to

maintain a high average level of employment and business activity, to minimize fluctuations in

employment activity, prevent inflation and to produce and promote economic growth.

The fiscal policy is used to control inflation through making deliberate changes in

government revenue and expenditure to influence the level of output and prices. It is a budgetary

policy. Fiscal policy is the use of government taxes and spending to alter macroeconomic

outcomes of the country. During the great depression of the 1930s people were out of work, they

were unable to buy goods and services therefore government had to increase, to regulate

macroeconomic values and money supply.

The use of government spending and taxes to adjust aggregate demand is the essence of

fiscal policy. The simplest solution to the demand shortfall would be to increase government

spending. The government increases it’s spending through construction of tanks, schools,

highways. This increased spending is a fiscal stimulus. Economic stability is a macro goal of the

fiscal policy of a country whether developed or developing. By economic stabilization it means;

controlling recession or depression and price stability.

Objectives of Fiscal policy:

1. To maintain economic stability in the country
2. To bring Price stability
3. To achieve full employment
4. To provide social justice
5. To promote export and introduce import substitution
 6. To mobilize more public revenue
7. To reallocate available resources
8. To achieve balanced regional growth.

Instruments:

The major instruments to be used to control inflation and to achieve the above said

objectives are (i) Taxation (ii) Public borrowings (iii) Deficit financing.

Fiscal policy deals with the government expenditure and its composition. Government

expenditures are classified into two categories as capital expenditure and consumption

expenditure. The spending on construction of road, dams and others are called as capital

expenditure. Government expenditure on consumption of goods and services are called as

consumption expenditure. The interest paid by the government against the borrowings or

national debt is called as interest payment. Governments’ transfer of money from one sector to

other is called Transfer of payments.

KEY FEATURES OF BUDGET 2012-2013

For Indian economy, recovery was interrupted this year due to intensification of debt

crises in Euro zone, political turmoil in Middle East, rise in crude oil price and earthquake in

Japan. GDP is estimated to grow by 6.9 per cent in 2011-12, after having grown at 8.4 per cent in

preceding two years. Growth moderated and fiscal balance deteriorated due to tight monetary
policy and expanded outlays. Manufacturing sectors are under recovery period. The 12th five

year plan is to be launched with the aim of “faster, sustainable and more inclusive growth”.

BUDGET ESTIMATES 2012-13

The major estimates are:

1. Gross Tax Receipts estimated at `10,77,612 crore.
2. Net Tax to Centre estimated at `7,71,071 crore.
3. Non-tax Revenue Receipts estimated at `1,64,614 crore.
4. Non-debt Capital Receipts estimated at `41,650 crore.

Temporary arrangement to use disinvestment proceeds for capital expenditure in social

sector schemes extended for one more year. Total expenditure for 2012-13 budgeted at 14,90,925

crores. Plan expenditure for 2012-13 at 5,21,025 crore is 18 per cent higher than Budget

Expenditure of 2011-12. This is higher than 15 per cent projected in Approach to the Twelfth

Plan. Non-plan expenditure estimated at 9,69,900 crore. 3,65,216 crore estimated to be

transferred to States including direct transfers to States and district level implementing agencies.

Entire amount of subsidy is given in cash and not as bonds in lieu of subsidies. Fiscal deficit has

reduced from 5.9 to 5.1 per cent of GDP in 2012-13. Net market borrowing required to finance

the deficit to be 4.79 lakh crore in 2012-13. Central Government debt is 45.5 per cent of GDP in

2012-13 as compared to Thirteenth Finance Commission target of 50.5 per cent. Effective

Revenue Deficit to be 1.8 per cent of GDP in 2012-13.

TAX PROPOSALS ON DIRECT TAXES:

1. Exemption limit for the general category of individual taxpayers proposed to be

enhanced from 1,80,000 to 2,00,000 giving tax relief of 2,000.
2. The upper limit of 20 per cent tax slab proposed to be raised from `8 lakh to `10 lakh.
3. Proposal to allow individual tax payers, a deduction of upto `10,000 for interest from
Savings bank accounts and upto 5,000 for preventive health check up.
4. Senior citizens not having income from business, proposed to be exempted from
payment of advance tax.
5. Restriction on Venture Capital Funds to invest only in 9 specified sectors proposed to
be removed.
6. Proposal to continue to allow repatriation of dividends from foreign subsidiaries of
Indian companies at a lower tax rate of 15 per cent upto 31.3.2013.
7. Investment link deduction of capital expenditure for certain businesses proposed to be
provided at the enhanced rate of 150 per cent.
8. New sectors to be added for the purposes of investment linked deduction.
9. Proposal to extend weighted deduction of 200 per cent for R&D expenditure in an in
house facility for a further period of 5 years beyond March 31, 2012.
10. Proposal to provide weighted deduction of 150 per cent on expenditure incurred for
Agri-extension services.
11. Proposal to extend the sunset date for setting up power sector undertakings by one
year for claiming 100 per cent deduction of profits for 10 years.
12. Turnover limit for compulsory tax audit of account and presumptive taxation of
SMEs to be raised from `60 lakhs to `1 crore.
13. Exemption from Capital Gains tax on sale of residential property, if sale
consideration is used for subscription in equity of a manufacturing SME for purchase
of new plant and machinery.
14. Proposal to provide weighted deduction at 150 per cent of expenditure incurred on
skill development in manufacturing sector.
15. Reduction in securities transaction tax by 20 per cent on cash delivery transactions.
16. Proposal to extend the levy of Alternate Minimum Tax to all persons, other than
 Companies, claiming profit linked deductions.
17. Proposal to introduce General Anti Avoidance Rule to counter aggressive tax
avoidance scheme.
18. Measures proposed to deter the generation and use of unaccounted money.
19. A net revenue loss of `4,500 crore estimated as a result of Direct Tax proposals.

INDIRECT TAXES

Service Tax
Service tax confronts challenges of its share being below its potential, complexity in tax law,

and need to bring it closer to Central Excise Law for eventual transition to GST. Overwhelming

response to the new concept of taxing services based on negative list.

1. Proposal to tax all services except those in the negative list comprising of 17 heads.
2. Exemption from service tax is proposed for some sectors.
3. Service tax law to be shorter by nearly 40 per cent.
4. Number of alignment made to harmonize Central Excise and Service Tax. A common
simplified registration form and a common return comprising of one page are steps in
this direction.
5. Revision Application Authority and Settlement Commission being introduced in
Service Tax for dispute resolution.
6. Utilization of input tax credit permitted in number of services to reduce cascading of
taxes.
7. Place of Supply Rules for determining the location of service to be put in public
domain for stakeholders’ comments.
8. Study team to examine the possibility of common tax code for Central Excise and
Service Tax.
9. New scheme announced for simplification of refunds.
10. Rules pertaining to point of taxation are being rationalized.
 11. To maintain a healthy fiscal situation proposal to raise service tax rate from 10 per
cent to 12 per cent, with corresponding changes in rates for individual services.
12. Proposals from service tax expected to yield additional revenue of `18,660 crore.

Other proposals for Indirect Taxes

13. Excise duty on large cars also proposed to be enhanced. No change proposed in the
peak rate of customs duty of 10 per cent on nonagricultural goods.
14. To stimulate investment relief proposals for specific sectors - especially those under
stress.

Agriculture and Related Sectors: Basic customs duty reduced for certain agricultural

equipment and their parts; Full exemption from basic customs duty for import of equipment for

expansion or setting up of fertilizer projects up to March 31, 2015.

Infrastructure: Proposal for full exemption from basic customs duty and a concessional

CVD of 1 per cent to steam coal till 31st March, 2014. Full exemption from basic duty provided

to certain fuels for power generation.

Mining: Full exemption from basic customs duty to coal mining project imports. Basic

custom duty proposed to be reduced for machinery and instruments needed for surveying and

prospecting for minerals.

Railways: Basic custom duty proposed to be reduced for equipments required for

installation of train protection and warning system and upgradation of track structure for high

speed trains.
 Roads: Full exemption from import duty on certain categories of specified equipment

needed for road construction, tunnel boring machines and parts of their assembly.

Civil Aviation: Tax concessions proposed for parts of aircraft and testing equipment for

third party maintenance, repair and overhaul of civilian aircraft.

Manufacturing: Relief proposed to be extended to sectors such as steel, textiles, branded

readymade garments, low-cost medical devices, labour-intensive sectors producing items of mass

consumption and matches produced by semi-mechanized units.

Health and Nutrition: Proposal to extend concessional basic customs duty of 5 per cent

with full exemption from excise duty/CVD to 6 specified life saving drugs/vaccines. Basic

customs duty and excise duty reduced on Soya products to address protein deficiency among

women and children. Basic customs duty and excise duty reduced on Iodine. Basic customs duty

reduced on Probiotics.

Environment: Concessions and exemptions proposed for encouraging the consumption

of energy-saving devices, plant and equipment needed for solar thermal projects. Concession

from basic customs duty and special CVD being extended to certain items imported for

manufacture for hybrid or electric vehicle and battery packs for such vehicles. There is a

proposal to increase basic customs duty on imports of gold and other precious metals.
Additional resource mobilization

Proposals to increase excise duty on ‘demerit’ goods such as certain cigarettes, hand-

rolled bidis, Pan Masala, Gutkha, chewing tobacco, unmanufactured tobacco and zarda scented

tobacco. Cess on crude petroleum oil produced in India revised to `4,500 per metric tonne. Basic

customs duty proposed to be enhanced for certain categories of completely built units of large

cars/MUVs/SUVs.

Central outlay by sectors (in crores)

Sectors Budget outlay

Agriculture 14855
Rural development 48128
Irrigation 489
Energy 155495
Industry and minerals 40581
Transport 109205
Communication 11994
Science & technology and environment 12713
General economic services 1942
Social services 148060
General services 5536
Total 558172

The above table indicates that the central outlay for year 2012-13. It is clear that the

highest amount spent on energy which is the need of the hour followed by social services and

transportation. But in other hand the amount spent on irrigation is very low.
Receipts and Expenditure of the Government of India
The Receipts and Expenditure of the Central Government

The table shows the various receipts and expenditure of the government which implies

that the revenue earned through tax or non tax sources are growing year after year. It is estimated

to have more revenue deficit. The revenue deficits are lesser than the fiscal deficit of the country.

The detailed schedule with the percentage change is discussed in the table.

It is concluded that both monetary and fiscal policies are complementary. The monetary

policy influences the money supply, currency and deposits in banks and the cost of borrowing it.

Fiscal policy is concerned with money which flows in and out of the treasury by means of

taxation, public borrowings, government expenditures and management of public debt. There

fore without coordination of both the policies, in developing economy the desired objectives

cannot be realized.

Review Questions

1. What do you mean by fiscal policy?

2. Briefly explain the instruments of fiscal policy.
3. Give the highlights of the current budget 2012-13.
4. Discuss the central outlay by major sectors.
5. Describe the current receipts and expenditure of central government of India.

Exercises:

(a) Suppose that you are a member of the Board of Governors of the RBI. The economy
is experiencing a sharp and prolonged inflationary trend. What changes in

(i) Reserve Ratio

(ii) The discount rate and
(iii) Open market operations
Would you recommend? Explain in each case as to how the changes you advocate would affect
commercial bank reserves, the money supply, interest rates and aggregate demand.
 (b) Suppose that you are a member of the Board of Governors of the RBI. The economy
is experiencing a sharp and prolonged inflationary trend. What changes in a) reserve ratio b) the
discount rate and c) open market operation would you recommend? Explain in each case how the
change you advocate would affect commercial bank reserves, the money supply, interest rates
and aggregate demand.

(c)Given the following data about the economy:

Consumption 7000
Investment 5000
Proprietor’s income 2500
Corporate income taxes 2150
Government expenses 3000
Profits 2500
Wages 7000
Net exports 2750
Rents 250
Depreciation 250
Indirect business taxes 1000
Undistributed corporate profits 600
Net foreign factor income 30
Interest 1500
Social security contribution 0
Transfer payments 0
Personal taxes 1650

i. Calculate GDP and GNP with both the expenditure and income approach
ii. Calculate NDP, NNP,NI and Domestic income
iii. Calculate Personal income.
iv. Calculate Disposable Personal income.