The Coordination Committee formed by GR No. Abhyas - 2116/(Pra.Kra.

43/16) SD - 4
Dated 25.04.2016 has given approval to prescribe this textbook in its meeting held on
30.01.2020 and it has been decided to implement it from academic year 2020-21.

ECONOMICS
STANDARD TWELVE

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2020
Maharashtra State Bureau of Textbook Production and
Curriculum Research, Pune.
First Edition : 2020 © Maharashtra State Bureau of Textbook Production and
Curriculum Research, Pune - 411 004.
The Maharashtra State Bureau of Textbook Production
and Curriculum Research reserves all rights relating to
the book. No part of this book should be reproduced
without the written permission of the Director, Maharashtra
State Bureau of Textbook Production and Curriculum
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Economics Subject Committee: Illustrations and Cover :

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Dr. Manjusha Musmade (Chairperson), Pune
Translation Coordination :
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Shri Ravikiran Jadhav
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Printer :
Economics Study Group:
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 Preface
Dear Students,
We welcome you to Std. XII. You have already been acquainted with the subject of
Economics as a separate discipline in Std. XI.
The textbook of Std. XI includes various important changes that have taken place in Indian
economy in the recent times. This textbook has also introduced many terms and concepts in
Economics. The revised syllabus of Std. XII is also based on the maxims of teaching such as simple
to complex, concrete to abstract etc. with ‘constructivism’ as the most important goal of education.
This book prepared by the Maharashtra State Bureau of Textbook Production and Curriculum
Research, incorporates both Micro and Macro approach to the study of Economics. It covers a
detailed explanation of micro-economic concepts such as utility, laws of demand and supply,
different market structures etc. For the first time, macro-economic concepts such as public finance,
money market and capital market in India, foreign trade etc. have been introduced to the students.
Index Numbers from Statistics have been included as a remarkable change in the revised syllabus.
This will significantly benefit the students to pursue their advanced studies. Statistics has been
introduced intentionally, to prepare the students to face new challenges in this competitive age
based on Information and Technology.
The study of Economics is of utmost importance to understand the process of development
of a country. Units in this book are logically arranged with the purposeful intention of providing
comprehensive introduction as well as developing interest for the subject among the students of Std.
XI and XII. Following the practice similar to Std. XI, no compromise has been made whatsoever
with respect to the use of economic language. A list of abbreviations and glossary of economic
terms is provided towards the end of the textbook. Use QR code given in the text book for extra
information and reference.
The units in the syllabus are innovative and have practical application. They are selected
without hindering the basic principles and goals of education. This will enable the students to be
alert and capable to face the challenges of 21st century. Innovative exercises at the end of each unit
will motivate the students to prepare for the competitive examinations in future.
We look forward to a positive response from the teachers and students.
Our best wishes to all!

Vivek Gosavi
Director
Pune
Maharashtra State Bureau of
Date : 21 February 2020 Textbook Production and
Bharatiya Saur : 2 Phalguna 1941 Curriculum Research, Pune
 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.
 - For Teachers -

Dear Teachers, students the importance of data collection

  We are happy to introduce the revised and data analysis.
textbook of Economics for Std. XII. This P Major concepts of economics have a
book is a sincere attempt to follow the scientific base and they deal with abstractions.
maxims of teaching as well as develop a Encourage group work, learning through
‘constructivist’ approach to enhance the each other’s help etc. Facilitate peer learning
quality of learning. Demand for more as much as possible by reorganizing the
activity based, experiential and innovative class structure frequently.
learning opportunities is the need of the hour. P Teaching-learning interactions, processes
The present curriculum has been restructured and participation of all students are very
so as to bridge the credibility gap that exists necessary and so is your active guidance.
between what is taught and what students P Do not use the boxes titled ‘Do you know?’
learn from direct experience in the outside for evaluation. However, teachers must
world. Guidelines provided below will help ensure that students read this extra
to enrich the teaching-learning process and information.
achieve the desired learning outcomes. P Information provided in boxes with the title
P To begin with, get familiar with the textbook ‘You Should Know’ should be considered
yourself. for evaluation.
P The present book has been prepared for P Exercises provided after each unit are
constructivist and activity-based teaching. prepared using different parameters such as
P Teachers must skillfully plan and organize observation, co-relation, critical thinking,
the activities provided in each chapter to analytical reasoning etc. Evaluation pattern
develop interest as well as to stimulate the should be based on the given parameters.
thought process among the students. Equal weightage should be assigned to all
P Always teach with proper planning. the topics. Use different combinations of
P Use teaching aids as required for the proper questions. Stereotype questions should be
understanding of the subject. avoided.
P Follow the tentative number of periods P Use QR Code given in the textbook. Keep
mentioned in the page of 'Contents' to give checking the QR Code for updated
due justice to the topic. information.
P Follow the order of the chapters strictly as P Certain important links, websites have been
listed in the contents because the units are given for references. Teachers as well as the
introduced in a graded manner to facilitate students can use these references for extra
knowledge building. reading and in-depth understanding of the
P Statistics is placed as the sixth unit to subject.
facilitate integrative learning through P Economic terms included in the Glossary are
interdisciplinary approach. highlighted in blue colour in each chapter.
P Ask questions on statistical information P List of abbreviations is provided towards the
related to trends and patterns. Efforts have end of the textbook for further clarification.
been made to provide the latest data Best wishes for a wonderful teaching
available. Teachers must explain to the experience!
 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 the

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

1
 (a) Theory of Product Pricing : The price of
Maynard Keynes published his famous
an individual commodity is determined by
book the "General Theory of Employment,
the market forces of demand and supply.
Interest and Money" in 1936. Keynes
Micro economics is concerned with demand
used macro economic approch to analyse
analysis i.e. individual consumer behaviour,
economic problems. The credit for the
development of macro economic approach and supply analysis i.e. individual producer
goes to Lord Keynes. Besides Keynes, behaviour.
Malthus, Wicksell, Walras, Irving Fisher (b) Theory of Factor Pricing : In Micro
are other economists who have contributed economics, land, labour, capital and
to the development of macro economics. entrepreneur are the factors that contribute
to the production process. Micro economics
Meaning of Micro Economics : helps in determining the factor rewards for
Micro means a small part of a thing. Micro land, labour, capital, and entrepreneur in
economics thus deals with a small part of the the form of rent, wages, interest, and profit
national economy. It studies the economic
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 the
allocation of resources is attained when it
Definitions of Micro Economics :
results in maximization of satisfaction of
You have already studied some important
the people. Economic efficiency involves
definitions of micro economics, let us review
three efficiencies :
some more definitions :
1) Maurice Dobb - “Micro economics is in • Efficiency in production : Efficiency in
fact a microscopic study of the economy.” production means producing maximum
possible amount of goods and services from
2) Prof A. P. Lerner - “Micro economics
consists of looking at the economy through 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 – the in consumption means distribution of
individuals or households as consumers and produced goods and services among the
individuals or firms as producers play their people for consumption in such a way as to
part in the working of the whole economic maximize total satisfaction of the society.
organism.” The following chart gives an • Overall economic efficiency : It means the
idea of the scope of micro economics. production of those goods which are most
Scope of Micro Economics desired by the people.
  Micro economic theory shows under what
Theory of Theory of Theory of conditions these efficiencies are achieved.
Product Pricing Factor Pricing Economic
Welfare
 Thus, the focus of micro economics
Rent
Wages is mainly confined to price theory and
Demand Supply
Analysis Analysis Interest resource allocation. It does not study the
Profit aggregates relating to the whole economy.
Efficiency in Efficiency in Overall Economic This approach does not study national
Production Consumption Efficiency economic problems such as unemployment,
2
 poverty, inequality of income etc. Theory of an additional unit. Marginal analysis helps
growth, theory of business cycles, monetary to study a variable through the changes.
and fiscal policies etc. are beyond the limits Producers and consumers take economic
of micro economics. decisions using this principle.
Features of Micro Economics : 7) Analysis of Market Structure : Micro
1) Study of Individual Units : Micro economics analyses different market
economics is the study of the behaviour structures such as Perfect Competition,
of small individual economic units, like Monopoly, Monopolistic Competition,
individual firm, individual price, individual Oligopoly etc.
household etc. 8) Limited Scope : The scope of micro
2) Price Theory : Micro economics deals with economics is limited to only individual
determination of the prices of goods and units. It doesn’t deal with the nationwide
services as well as factors of production. economic problems such as inflation,
Hence, it is known as price theory. deflation, balance of payments, poverty,
3) Partial Equilibrium : Equilibrium is unemployment, population, economic
the balance between two factors. Micro growth etc.
economic analysis deals with partial Importance of Micro Economics :
equilibrium which analyses equilibrium 1) Price Determination : Micro economics
position of an individual economic unit explains how the prices of different
i.e. individual consumer, individual firm, products and various factors of production
individual industry etc. It isolates an are determined.
individual unit from other forces and studies
2) Free Market Economy : Micro economics
its equilibrium independently.
helps in understanding the working of a free
4) Based on Certain Assumptions : Micro
market economy. A free market economy
economics begins with the fundamental
is that economy where the economic
assumption, “Other things remaining
decisions regarding production of goods,
constant” (Ceteris Paribus) such as perfect
such as ‘What to produce?, How much to
competition, laissez-faire policy, pure
produce?, How to produce? etc.’ are taken
capitalism, full employment etc. These
at individual levels. There is no intervention
assumptions make the analysis simple.
by the Government or any other agency.
5) Slicing Method : Micro economics uses
slicing method. It splits or divides the whole 3) Foreign Trade : Micro economics helps
economy into small individual units and in explaining various aspects of foreign
then studies each unit separately in detail. trade like effects of tariff on a particular
For example, study of individual income commodity, determination of currency
out of national income, study of individual exchange rates of any two countries, gains
demand out of aggregate demand etc. from international trade to a particular
country etc.
6) Use of Marginalism Principle : The
concept of Marginalism is the key tool 4) Economic Model Building : Micro
of micro economic analysis. The term economics helps in understanding various
'marginal' means change brought in total by complex economic situations with the help

3
 of economic models. It has made a valuable 2) Prof Carl Shapiro - “Macro economics
contribution to economics by developing deals with the functioning of the economy
various terms, concepts, terminologies, tools as a whole.”
of economic analysis etc. Economic models The following chart gives an idea about
are built using various economic variables. the scope of macro economics.
Scope of Macro Economics
5) Business Decisions : Micro economic
theories are helpful to businessmen for
Theory of Theory of Theory of Macro
taking crucial business decisions. These Income and General Economic Theory of
decisions are related to the determination Employment Price Growth and Distribution
of cost of production, determination of Level and Development
Inflation
prices of goods, maximization of output
Theory of Theory of
and profit, etc.
Consumption Investment
6) Useful to Government : It is useful to Function Function
government in framing economic policies Theory of
such as taxation policy, public expenditure Business Cycles
policy, price policy etc. These policies i) Theory of Income and Employment :
help the government to attain its goals Macro economic analysis explains which
of efficient allocation of resources and factors determine the level of national
promoting economic welfare of the society. income and employment and what causes
7) Basis of Welfare Economics : Micro fluctuations in the level of income, output and
economics explains how best results can employment. To understand, how the level of
be obtained through optimum utilization employment is determined, we have to study
of resources and its best allocation. It also the consumption function and investment
studies how taxes affect social welfare. function. Theory of Business Cycles is also a
part and parcel of the Theory of Income and
Meaning of Macro Economics :
Employment.
Macro economics is the branch of
economics which analyses the entire economy. ii)
Theory of General Price Level and
It deals with the total employment, national Inflation : Macro economic analysis shows
income, national output, total investment, total how the general price level is determined and
consumption, total savings, general price level further explains what causes fluctuations
interest rates, inflation, trade cycles, business in it. The study of general price level is
fluctuations etc. Thus, macro economics is the significant on account of the problems
study of aggregates. created by inflation and deflation.
iii) Theory of Growth and Development :
Definitions of Macro Economics :
Macro economics consists of the theory
1) J. L. Hansen - “Macro economics is that of economic growth and development. It
branch of economics which considers the explains the causes of underdevelopment
relationship between large aggregates such and poverty. It also suggests strategies for
as the volume of employment, total amount accelerating growth and development.
of savings, investment, national income
iv) Macro Theory of Distribution : Macro
etc.”
theory of distribution deals with the relative
4
 shares of rent, wages, interest and profit in various factors that contribute to economic
the total national income. growth and development. It is useful in
Features of Macro Economics : developing growth models. These growth
models are used for studying economic
1) Study of Aggregates : Macro economics
development. For example, Mahalanobis
deals with the study of economy as a whole.
growth model emphasized on basic heavy
It is concerned with the aggregate concepts
industries.
such as national income, national output,
national employment, general price level, 7) General Price Level : Determination and
business cycles etc. changes in general price level are studied in
macroeconomics. General price level is the
2) Income Theory : Macro economics studies
average of all prices of goods and services
the concept of national income, its different
currently being produced in the economy.
elements, methods of measurement and
8) Policy-oriented : According to Keynes,
social accounting. Macro economics deals
macro economics is a policy oriented
with aggregate demand and aggregate
science. It suggests suitable economic
supply. It explains the causes of fluctuations
policies to promote economic growth,
in the national income that lead to business
generate employment, control of inflation,
cycles i.e. inflation and deflation.
and depression etc.
3) General Equilibrium Analysis : Macro
Importance of Macroeconomics :
economics deals with the behaviour of
1) Functioning of an Economy : Macro
large aggregates and their functional
economic analysis gives us an idea of the
relationship. General Equilibrium deals
functioning of an economic system. It helps
with the behaviour of demand, supply and
us to understand the behaviour pattern
prices in the whole economy.
of aggregative variables in a large and
4) Interdependence : Macro analysis takes complex economic system.
into account interdependence between
2) Economic Fluctuations : Macro economics
aggregate economic variables, such as
helps to analyse the causes of fluctuations
income, output, employment, investments,
in income, output and employment and
price level etc. For example, changes in
makes an attempt to control them or reduce
the level of investment will finally result
their severity.
into changes in the levels of income, levels
of output, employment and eventually the 3) National Income : Study of macro
level of economic growth. economics has brought forward the immense
importance of the study of national income
5) Lumping Method : Lumping method is the
and social accounts. Without a study
study of the whole economy rather than its
of national income, it is not possible to
part. According to Prof. Boulding, “Forest
formulate correct economic policies.
is an aggregation of trees but it does not
4) Economic Development : Advanced studies
reveal the properties of an individual tree.”
in macro economics help to understand the
This reveals the difference between micro
problems of developing countries such as
economics and macro economics.
poverty, inequalities of income and wealth,
6) Growth Models : Macro economics studies differences in the standards of living of the

5
 people etc. It suggests important steps to
achieve economic development. Tools Individual Aggregate
Demand and Demand and
5) Performance of an Economy : Macro
Individual Aggregate
economics helps us to analyse the
Supply Supply
performance of an economy. National
Income (NI) estimates are used to measure Scope Demand, National
the performance of an economy over time supply, prod- income,
by comparing the production of goods and uct pricing, general
services in one period with that of the other factor pricing, price level,
period. production, employment,
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
important. Main economic problems are Importance Price Economic
related to the economic variables such determination, fluctuations,
as behaviour of total income, output, Model Study of
employment and general price level in the building, national
economy. Business income,
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
You should know : Employment
Theory
Micro Economics and Macro Economics
Examples Individual National
at a glance
income, income,
Basis for Micro Macro Individual National
comparison economics economics
output etc. output etc.
Meaning Micro Macro
economics economics
studies the studies the Try this :
behaviour of behaviour of 1) Visit the vegetable market in the nearest
individual aggregates of area and try to get information about
unit of an the economy income and expenditure items of a
economy as a whole particular seller

6
 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
Q. 3. Identify and explain the concepts from the
c) Econometrics d) None of these
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
Q. 5. State with reasons whether you agree or
  3) only c 4) only a
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.



7
 2 Utility Analysis

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

concept. Utility differs from person to
1) Want denotes a feeling of lack of
person. This is due to differences in taste,
satisfaction.
preferences, likes, dislikes, nature, habits,
2) Wants are unlimited.
profession etc. For example, stethoscope
3) They are recurring in nature.
has utility to a doctor but not to a layman.
4) They differ with age, gender, seasons,
habits and culture. 3) Ethically neutral concept : The concept of
5) Utility is the capacity of a commodity utility has no ethical consideration. It is a
morally colourless concept. The commodity
to satisfy human wants. In other words,
should satisfy any want of a person without
utility is the want satisfying power of a
consideration of what is good or bad,
good.
desirable or undesirable. For example, a
Introduction : knife has utility to cut fruits and vegetables
You have been already introduced to the as well as it can be used to harm someone.
concept of utility in class XI. This unit gives a Both wants are of different nature but are
detailed explanation of consumer’s behaviour. satisfied by the same commodity. Thus,
In practice, every individual tries to utility is ethically neutral.
satisfy his wants with available resources. 4) Utility differs from usefulness : Utility
It is true that all human wants cannot be is the capacity of a commodity to satisfy
satisfied fully at a specific time. Utility analysis human wants, whereas usefulness indicates
explains a consumer’s behaviour in relation to value in use of the commodity. For example,
maximization of satisfaction. milk has both utility as well as usefulness to
a consumer, while liquor has utility only to
Try this : an addict, but has no usefulness.
1) Make a list of 10 commodities which
5) Utility differs from pleasure : A
  satisfy your wants. commodity may possess utility but it may
2) Make a list of 10 commodities which not give any pleasure to the consumer. For
satisfy the wants of particular individuals example, injection for a patient has utility
performing specific activities. For because it cures the ailment but it hardly
example, A chalk has utility for a teacher. gives any enjoyment or pleasure to him.
6) Utility differs from satisfaction : Utility
Features of Utility : is a cause of consumption, satisfaction is
Following are the features of utility : the end result of consumption. They are
1) Relative concept : Utility is related to interrelated but still different concepts. For
time and place. It varies from time to example, a thirsty person drinks a glass
time and place to place. For example, (i) of water since water has the capacity to
woollen clothes have a greater utility in the satisfy thirst. Utility of water is the cause of
winter. (ii) sand has greater utility at the consumption and the satisfaction derived is
construction site than at the sea shore. the end result of consumption.

8
 7) Measurement of utility is hypothetical : 2) Place utility : When utility of a commodity
Utility is an abstract concept. Cardinal or increases due to a change in its place, it is
numerical measurement of utility is not called place utilities. For example, woollen
possible. For example, a thirsty person clothes have more utility at cold places than
after drinking water, may derive higher or at warm places. Transport creates place
lower level of utility. Thus, utility can only utility.
be experienced and found either positive,
zero or negative. Negative utility is called
disutility.
8) Utility is multi-purpose : A commodity
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   Fig. 2.2
at some point of time. 3) Service utility : Service utility arises when
9) Utility depends on the intensity of want : personal services are rendered by various
Utility depends on the intensity of a want. professionals. For example, services of
More intense the want, greater will be the doctors, teachers, lawyers etc.
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. Fig. 2.3

Types of Utility : 4) Knowledge utility : When a consumer

Following are some of the different types of utility acquires knowledge about a particular
1) Form utility : When utility is created due product, it is called knowled uitility. For
to a change in the shape or structure of an example, utility of a mobile phone or a
existing material, it is called form utility. computer increases when a person knows
For example, toys made of clay, furniture about its various functions.
from wood etc.

Fig. 2.1 Fig. 2.4

9
 5) Possession utility : Possession utility arises
Try this :
when the ownership of goods is transferred
Following are the various types of utility
from one person to another. For example,
and their respective examples. Arrange the
transfer of goods from the sellers to the
information in the form of pairs:
buyers.
Types of utility : Time utility, possession
utility, service utility and place utility.
Examples : 1) A dentist giving dental
treatment to a patient.
2) A mountaineer using oxygen cylinder at
a high altitude.
  3) A farmer selling rice stored in the
    Fig. 2.5 warehouse at the end of the season.
4) A retail trader purchasing 100 chairs
6) Time utility : When the utility of a
from the wholesale trader.
commodity increases with a change in its
time of utilization, it is called time utility. Concepts of Utility :
For example, a student has more utility for Following are the two main concepts of
text books during examinations than in the utility :
vacations. Time utility is also observed 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

10
 TU Curve = Total Utility Curve
You should know :
Formulae explaining the relationship MU Curve = Marginal Utility Curve
between total utility and marginal utility : X axis measures the units of the commodity
TU = Σ MU or consumed while Y axis indicates the figures of
TU = MU1 + MU2 + MU3 ……….. + MUn
total and marginal utility.
MUn = TUn – TU(n–1)
Where TU = Total Utility Fig. 2.7 shows that total utility curve slopes
MU = Marginal Utility upwards whereas marginal utility curve slopes
MU1, MU2, MU3 = Marginal Utility of each unit. downwards. Marginal utility curve shows zero
MUn = Marginal Utility of nth unit. and negative levels of marginal utility whereas
TUn = 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 called
3 24 6 the point of satiety. (TU highest, MU = 0)
4 28 4
4) After this point, any additional unit
5 30 2
6 30 0 consumed further results in a decline in the
7 28 –2 total utility, while marginal utility becomes
Table 2.1 explains the relationship between negative. (TU MU negative)
total utility and marginal utility. 5) After reaching the point of satiety, a rational
On the basis of Table 2.1 Total utility and consumer should stop his consumption
Marginal Utility curves (TU and MU) can be since the maximum limit of satisfaction is
derived with the following diagram. reached and there is no addition to total
Y Point of satiety
32 utility by any further increase in the stock
S
28
of a commodity.
TU
Curve 6) Consumption beyond the point of satiety
Total and Marginal utility

24
transforms satisfaction into dissatisfaction.
20
In other words, a consumer starts
16
experiencing ill effects of consumption.
12

8 Try this :
Complete the following chart with proper
4
statement and bring about the difference
0 1 2 3 4 5 6 7 X
MU
between the two concepts i.e total utility
-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 increase in the stock that he already has.”
sum total of the is the addition In other words, marginal utility that any
individual utilities made to the total
consumer derives from successive units of a
derived from the utility from every
consumption of a additional unit particular commodity goes on diminishing as
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 have,
increases at a 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 of
satiety MU = O
diminishing marginal utility :
4) Total utility 4) 1) Rationality : Consumer is assumed to
declines if be rational. It means that his behaviour
consumption is normal and he tries to maximize his
continues.
satisfaction.
5) Total utility deter- 5)
mines value in use 2) Cardinal measurement : The law assumes
of a commodity. that utility can be cardinally or numerically
6) 6) Marginal utility measured. Hence, mathematical operations
can be positive, are easily possible to know and compare
negative, zero. the utility derived from each unit of a
7) Diagram : 7) Diagram : commodity.
y
3) Homogeneity : All units of a commodity
4 consumed are exactly homogeneous or
TU

TU curve identical in size, shape, colour, taste etc.

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

3) Addictions : It is observed in case of a

6
drunkard that the level of intoxication
4 increases with every additional unit of
2 liquor consumed. So MU received by
drunkard may increase. Actually it is
0 1 2 3 4 5 6 7 X only an illusion. This condition is similar
MU
-2 Disutility to almost all addictions. However, this
Units of Commodity x violates the assumption of rationality.
Fig. 2.8 4) Power : This is an exception to the law
Explanation of the Diagram : because when a person acquires power, his
In the above diagram, units of commodity x lust for power increases. He desires to have
are measured on X axis and marginal utility is more and more of it. However, this again
measured on Y axis. Various points of MU are violates the rationality assumption.
plotted on the graph as per the given schedule. 5) Money : It is said that the MU of money
When the locus of all the points is joined, MU never becomes zero. It increases when the
curve is derived. stock of money increases. This is because
MU curve slopes downwards from left to money is a medium of exchange which is
right which shows that MU goes on diminishing used to satisfy various wants. However,
with every successive increase in the consumption according to some economists, this law
of a commodity. is applicable to money too. For example,
When MU becomes zero, MU curve intercepts marginal utility of money is more to a poor
the X axis. Further consumption of a commodity person than to a rich person.

13
 However, these, exceptions are only resources, it is necessary to ‘diversify’ the
apparent. Since they violate some or the consumption.
other assumptions of the law and hence, 2) Useful to the government : The law is
they are not real exceptions. useful to the government in framing various
Criticisms of the Law : policies such as progressive tax policy,
The law of diminishing marginal utility is trade policy, pricing policy etc.
criticised on the following grounds. 3) Basis of paradox of values : The law
1) Unrealistic assumptions : The law of of diminishing marginal utility helps us
diminishing marginal utility is based upon to understand the paradox of values. It
various assumptions like homogeneity, includes goods that have more value-in-use
continuity, constancy, rationality etc. but and zero or less value-in-exchange such as
in reality it is difficult to fulfil all these air, water, sunshine etc. as well as goods
conditions at a point of time. that have more value-in-exchange and less
value-in-use such as gold, diamonds etc.
2) Cardinal measurement : The law assumes
4) Basis of law of demand : The law of demand
that utility can be expressed cardinally so
is based on the law of diminishing marginal
it can be added, compared and presented
utility. According to the law of demand, the
through a schedule. In reality cardinal
quantity demanded of a good rises with a
measurement of utility is not possible
fall in price and falls with an increase in
because utility is a psychological concept.
price. When a consumer purchases more
3) Indivisible goods : The law is not and more units of a good, its marginal
applicable to indivisible and bulky goods utility steadily declines. Hence, he would
like refrigerator, car, TV sets etc. which are buy additional units of a commodity only
normally purchased in single unit at a time. at a lower price.
4) Constant marginal utility of money : The
law assumes that MU of each unit of money Try this :
remains constant. However, critics argue Write an informative note on paradox of
that MU of money differs from person to values along with examples.
person. It is influenced by changes in prices, Relationship between Marginal Utility and
stock of money etc. Price :
5) A single want : The law is restricted to Let us discuss the relationship between
the satisfaction of a single want at a point marginal utility and price in order to understand
of time. However, in reality, a man has to how the law of diminishing marginal utility
satisfy many wants at a point of time. forms the basis of law of demand. It is a perfect
Significance of the Law : example of practical application of the law of
In spite of the criticisms, the law of Diminishing Marginal Utility (DMU).
diminishing marginal utility is a very popular To understand the relation, it is essential
and an important law in Economics because of to convert marginal utility in terms of money so
its universal application. that it can be compared with market price.
1) Usefulness to the consumers : This law Let us assume : One unit of marginal utility =
creates awareness among the consumers. ` 10.
To obtain maximum utility from the limited Market price per unit of x = ` 50.
14
 Table 2.3 marginal utility and price :
No MU/ MU in terms Market Comparison 1) Units which a consumer willingly buys
of units of money price/unit between MU because MU is greater than price are called
units of x 1unit = ` 10 of x = ` 50 and price
“Intra-marginal units” (MUx>Px)
1 10 100 (10 × `10 ) ` 50 100 MU> `50

2) Unit at which MU becomes equal
2 8 80 (8 × ` 10 ) ` 50 80 MU> `50
with market price is “marginal unit”.
3 7 70 (7 × ` 10 ) ` 50 70 MU> `50 (MUx=Px) = Consumer’s equilibrium
4 5 50 (5 × ` 10 ) ` 50 50 MU = `50 3) Units which a rational consumer is not
5 3 30 (3 × ` 10 ) ` 50 30 MU< `50 willing to buy and consume where he has
6 1 10 (1 × ` 10 ) ` 50 10 MU< `50 to pay more than the MU are called “Extra-
marginal units.” (MUx<Px)
Table 2.3 explains the relationship between Thus, a rational consumer attains
marginal utility (MU) and price. equilibrium where MUx=Px. This relationship
The table shows that a consumer between marginal utility and price paved way
starts buying units of commodity x for his for law of demand.
consumption, one after the other. Marginal
utility which is added to his stock goes on Do you know?
diminishing with every further unit consumed. Two English Economists, J. R. Hicks
When MU is converted in terms of money, one and R. G. D. Allen were
can easily compare it with market price which is the main exponents of
shown in the column 5 of the table 2.3 ‘Indifference Method’. It
For the first three units consumed, it is was evolved to supersede
found that marginal utility in terms of money is cardinal utility analysis
greater than the price paid. A rational consumer given by Prof. Alfred
will willingly buy these units since the benefit J R Hicks Marshall. Indifference curve
derived is more than the price paid. At the 4th analysis adopts the concept
unit marginal utility and price become equal. of ordinal utility.
So the consumer can also think of buying the   An indifference curve is
4th unit. In the case of 5th and 6th units, marginal the locus of points indicating
utility derived is less than the market price paid. particular combinations of
A rational consumer will not buy further once two goods from which the
the equality between marginal utility and price consumer derives the same
R.G.D Allen
is established. level of satisfaction. As
From the given table 2.3, following a result, he is indifferent to the particular
inferences can be made with reference to combination that he consumes.

15
 EXERCISE

Q. 1. A) Complete the following statements by 2) Statments indicating consumer equilibrium :

choosing the correct alternatives. a) MU is greater than price
1) In the law of diminishing marginal utility, b) MU is equal to price
Alfred Marshall assumes that marginal utility c) MU is less than price
of money………. d) Price is less than one
a) increases b) remains constant Options :
c) decreases d) rises and then falls   i) a and b   ii) a, b, c and d
iii) a, b and c iv) only b
2) As per the law of diminishing marginal utility,
measurement of utility is assumed to be ………. Q. 3. Identify and explain the concepts from 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
3) MU of the commodity becomes negative when the other.
TU of a commodity is ……… 4) Bhushan refused to eat fifth chapati after eating
a) rising   b) constant   c) falling   d) zero four chapatis.
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:
c) TU is maximum and MU is zero Unit of a commodity TU units MU units
d) MU is falling and TU is rising. 1 6 6
2 11 5
5) When MU is falling, TU is……….
3 15 4
a) rising b) falling 4 15 0
c) not changing d) maximum 5 14 –1
1) Draw total utility curve and marginal utility
Q. 2. Choose the correct option :
curve.
1) A    B
1) Time utility a) Transport 2) a) When total utility is maximum marginal
utility is
2) Place utility b) Blood Bank
3) Service utility c) Mobile phone b) When total utility falls, marginal utility
becomes
4) Knowledge utility d) Doctor
Options : Q. 5. Answer in detail :
 i) 1-d, 2-b, 3-a, 4-c   ii) 1-b, 2-a, 3-d, 4-c 1) State and explain the law of diminishing
iii) 1-a, 2-b, 3-c, 4-d   iv) 1-b, 2-c, 3-d, 4-a marginal utility with exceptions.



16
 3A Demand Analysis

Introduction : Demand Schedule :

You have already studied the concept of Demand schedule is a tabular representation
utility in the previous chapter. Utility is the basis of the functional relationship between price and
of demand. Utility may generate a desire or a quantity demanded for a particular commodity.
need to have a particular commodity, but utility A demand schedule may be either individual
on its own cannot generate demand for the demand schedule or market demand schedule.
commodity. This chapter is an effort to analyse Individual Demand Schedule :
the concept of demand. Demand analysis is Individual demand is the quantity of a
concerned with consumer behaviour. commodity demanded by a consumer at a given
Meaning of Demand : price during a given period of time.
In ordinary language, demand means a Individual demand schedule is a tabular
desire. Desire means an urge to have something. representation showing different quantities of
In Economics, demand means a desire which is commodities that an individual consumer is
backed by willingness and ability to pay. prepared to buy at various prices over a given
For example, if a person has the desire to period of time.
purchase a television set but does not have This can be explained with the help of the
the adequate purchasing power then it will be following individual demand schedule.
simply a desire and not a demand. Individual demand schedule :
Thus, demand is an effective desire. All Table 3.1
desires are not demand. Price of commodity Quantity demanded of
In short, ‘x’ ( ` ) commodity ‘x’ (in kgs)
Demand = Desire + willingness to 10 1
purchase + Ability to pay. 8 2
6 3
Try this : 4 4
2 5
Identify the concepts :
Table 3.1 shows different quantities of
1) A poor person wants to have a car ……
commodity ‘x’ purchased by an individual
2) A rich person bought a car ……
consumer at various prices. It can be observed
that less quantity of commodity is demanded at
Definition of Demand :
rising prices and more quantity of commodity
According to Benham, “the demand for
is demanded at falling prices. It indicates an
anything at a given price is the amount of it, inverse relationship between price and quantity
which will be bought per unit of time at that demanded.
price.”
Individual Demand Curve :
  Thus, following are the features of demand :
Individual demand curve is a graphical
1) Demand is a relative concept. representation of the individual demand
2) Demand is essentially expressed with schedule.
reference to time and price. Fig. 3.1 represents an individual demand curve
17
 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
This can be explained with the help of
D DD = Demand Curve
10 following market demand schedule.
8 Market demand schedule :
Price in `

Table. 3.2
6
Price of Quantity of ‘x’ Market
4 commodity demanded Kgs. demand
Con- Con- Con-
2 D ‘x’( ` ) A+B+C
sumer sumer sumer
A B C
0 1 2 3 4 5 6 7 X
10 5 10 15 30
Quantity Demanded in (Kgs) 8 10 15 20 45
Fig. 3.1 6 15 20 25 60
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
the commodity. The demand curve DD slopes Table 3.2 shows different quantities of
downward from left to right, indicating an commodity x purchased by different consumers
inverse relationship between price and quantity (A, B, C) at various prices. It can be observed
demanded. that less quantity of commodity is demanded at
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
Market Demand Curve
Y DD = Market Demand Curve
D
Fig. 3.2 Individual Demand 10
Market Demand Schedule : 8
Price in `

Market demand is total demand for a

6
commodity from all the consumers at a given
price during a given period of time. 4
Market demand schedule is a tabular 2 D
representation showing different quantities of
commodity which all consumers are prepared to 0 20 40 60 80 100 X
buy at various prices over a given period of time. Quantity Demanded in (Kgs)
It is obtained by a horizontal summation of Fig. 3.3
18
 In figure 3.3, X axis represents market 4) Multi-purpose uses : When a commodity
demand and Y axis represents the price of the can be used for satisfying several needs, its
commodity. The market demand curve ‘DD’ demand will rise with a fall in its price and
slopes downward from left to right, indicating an fall with a rise in its price.
inverse relationship between price and market 5) New Consumers : When the price of a
demand. commodity falls, a new consumer class
appears who can now afford the commodity.
Thus, total demand for commodity increases
with fall in price.

Try this :
Complete the following hypothetical
demand schedule.
Price of commodity ‘x’(`) Qty. Demanded kgs
350 3
300
250 10
Fig. 3.4 Market Demand 200
Try this : 150
Prepare a monthly demand schedule of
100 30
your family for various commodities. For
example, vegetables, fruits, medicines etc. Types of Demand :
Reasons justifying downward sloping demand 1) Direct demand
curve are as follows : 2) Indirect demand
Types of
1) Law of Diminishing Marginal Utility : 3) Complementary/ Joint demand
Demand
We have seen that marginal utility goes on 4) Composite demand
diminishing with an increase in the stock 5) Competitive demand
of a commodity and vice-versa. Therefore,
a consumer tends to buy more when price 1) Direct demand : It is the demand by
falls and vice-versa. This implies that the consumer for goods which satisfy
demand curve is downward sloping. their wants directly. They serve direct
consumption needs of the consumers. Thus,
2) Income effect : In the case of normal goods,
it is the demand for consumer goods. For
when price falls, purchasing power (real
example, demand for cloth, sugar, etc.
income) of a consumer increases which
enables him to buy more of that commodity. 2) Indirect demand : Indirect demand is
This is known as income effect. also known as derived demand. It refers
to demand for goods which are needed
3) Substitution effect : In case of substitute
for further production. It is the demand
goods, when the price of a commodity
rises, the consumer tends to buy more of for producer's goods. Hence, all factors of
its substitute and less of that commodity production have indirect or derived demand.
whose price has increased. This is known For example, demand for workers in a sugar
as substitution effect. factory is derived or indirect demand.

19
 3) Complementary/Joint demand : When 2) Income : Income of a consumer decides
two or more goods are demanded jointly to purchasing power which in turn influences
satisfy a single want, it is known as joint or the demand for the product. Rise in income
complementary demand. For example, car will lead to a rise in demand for the
and fuel etc. commodity and a fall in income will lead to
a fall in demand for the commodity.
4) Composite demand : The demand for a
commodity which can be put to several 3) Prices of Substitute Goods : If a substitute
uses is known as composite demand. For good is available at a lower price then
example, electricity is demanded for several people will demand cheaper substitute good
than costly good. For example, if the price
uses such as light, fan, washing machine etc.
of sugar rises then demand for jaggery will
5) Competitive demand : It is demand for rise.
those goods which are substitute for each
4) Price of Complementary Goods : Change
other. For example, tea or coffee, sugar or
in the price of one commodity would also
jaggery etc.
affect the demand for other commodity. For
Try this : example, car and fuel. If the price of fuel
rises, then demand for cars will fall.
Complete the table
5) Nature of product : If a commodity is a
Type of demand Example
necessity and its use is unavoidable, then
Direct demand
its demand will continue to be the same
Workers in cotton textile irrespective of the corresponding price.
industry
For example, medicine to control blood
Joint demand Coffee
Powder pressure.
For 6) Size of population : Larger the size of
preparing population, greater will be the demand
Coffee
for a commodity and smaller the size of
population smaller will be the demand for
CNG and petrol, pen and
a commodity.
pencil
Tea 7) Expectations about future prices : If
Curd the consumer expects the price to fall in
Milk Direct future, he will buy less in the present at the
consumption
Sweets
prevailing price. Similarly, if he expects the
price to rise in future, he will buy more in
the present at the prevailing price.
Determinants of Demand :
The demand for goods is determined by the 8) Advertisement : Advertisement, sales
promotion scheme and effective sales-
following factors :
manship tend to change the preferences
1) Price : Price determines the demand for a of the consumers and lead to demand for
commodity to a large extent. Consumers many products. For example, cosmetics,
prefer to purchase a product in large tooth brush etc.
quantities when price of a product is less and 9) Tastes, Habits and Fashions : Taste and
they purchase a product in small quantities habits of a consumer influence the demand
when price of a product is high. for a commodity. If a consumer likes to
20
 eat chocolates or consume tea, he will x = Commodity
demand more of them. Similarly, when a f = Function
new fashion hits the market, the consumer Px = Price of a commodity
demands that particular type of commodity.
If a commodity goes out of fashion then Assumptions :
suddenly the demand for that product tends Law of demand is based on the following
to fall. assumptions :
10) Level of Taxation : High rates of taxes on 1) Constant level of income : If the law
goods or services would increase the price of demand is to find true operate then,
of the goods or services. This, in turn would consumers' income should remain constant.
result in a decrease in demand for goods or If there is a rise in income, people may
services and vice-versa. demand more at a given price.
11) Other factors : 2) No change in size of population : It is
1) Climatic conditions assumed that the size of population remains
unchanged. Any change in the size and
2) Changes in technology
composition of population of a country
3) Government policy
affects the total demand for the product.
4) Customs and traditions etc.
3) Prices of substitute goods remain constant
Law of Demand : : It is assumed that the prices of substitutes
Introduction : remain unchanged. Any change in the price
The law of demand was introduced by of the substitute will affect the demand for
Prof. Alfred Marshall in his book, ‘Principles of the commodity.
Economics’, which was published in 1890. The 4) Prices of complementary goods remain
law explains the functional relationship between constant : It is assumed that the prices
price and quantity demanded. of complementary goods remain unchanged
because a change in the price of one good
Statement of the Law :
will affect the demand for the other.
According to Prof. Alfred Marshall,
5) No expectations about future changes in
“Other things being equal, higher the price of a
prices : It is assumed that consumers do not
commodity, smaller is the quantity demanded
expect any further change in price in the
and lower the price of a commodity, larger is the
near future. If consumers expect a rise in
quantity demanded.”
prices in future, they may demand more in
In other words, other factors remaining the present even at existing high price.
constant, if the price of a commodity rises,
6) No change in tastes, habits, preferences,
demand for it falls and when price of a
fashions etc. : It is assumed that consumers'
commodity falls demand for the commodity
tastes, habits, preferences, fashions etc.
rises. Thus, there is an inverse relationship
should remain unchanged. Any change
between price and quantity demanded.
in these factors will lead to a change in
Symbolically, the functional relationship demand.
between demand and price is expressed as :
7) No change in taxation policy : Taxation
 Dx = f (Px) policy of the government has a great impact
Where D = Demand for a commodity on demand for various goods and services.

21
 Therefore, it is assumed that there is no In fig. 3.5, X axis represents the demand for
change in the policy of taxation declared the commodity and Y axis represents the price
by Government. of commodity x. DD is the demand curve which
The law of demand is explained with the slopes downward from left to right due to an
help of the following demand schedule and inverse relationship between price and quantity
diagram. demanded.
Demand schedule :
Try this :
Table. 3.3
Draw a demand curve from the following
Price of Quantity demanded of
demand schedule :
commodity ‘x’ (`) commodity ‘x’ (in kgs.)
50 1 Price of Apple (`) Quantity demanded
per kg (in kgs.)
40 2
40 5
30 3
50 4
20 4
60 3
10 5
70 2
As shown in Table 3.3 when price of 80 1
commodity ‘x’ is ` 50, quantity demanded is 1
kg. When price falls from ` 50 to ` 40, quantity Exceptions to the Law of Demand :
demanded rises from 1 kg to 2 kgs. Similarly, at
There are certain exceptions to the law
price ` 30, quantity demanded is 3 kgs and when
of demand. It means that under exceptional
price falls from ` 20 to ` 10, quantity demanded
circumstances, consumer buys more when the
rises from 4 kg sto 5 kgs
price of commodity rises and buys less when
Thus, as the price of a commodity falls,
price of commodity falls. In such cases, demand
quantity demanded rises and when price of
curve slopes upwards from left to right. i.e. the
commodity rises, quantity demanded falls. This
demand curve has a positive slope as shown in
shows an inverse relationship between price and
fig. 3.6.
quantity demanded.
Exceptional Demand Curve
Demand Curve
Y DD = Exceptional Demand curve
Y
D
D
50
40
Price in `
Price in `

30

20

10 D D
0 X
0 1 2 3 4 5 X
Quantity Demanded in kgs Quantity Demanded in kgs
Fig. 3.5 Fig. 3.6

22
Following are the exceptions to the law of consumption, certain goods like tea is
demand: purchased in required quantities even at a
1) Giffen's paradox : Inferior goods or low higher price.
quality goods are those goods whose
Find out :
demand does not rise even if their price
falls. At times, demand decreases when the Examples of the given exceptions to the
price of such commodities fall. law of demand.
  Sir Robert Giffen observed this behaviour 1) Prestigious goods –
in England in relation to bread. He noted 2) Habitual goods –
that, when the price of bread declined, 3) Branded goods –
people did not buy more because of an
increase in their real income or purchasing Variations in Demand :
power. They preferred to buy superior When the demand for a commodity falls or
good like meat. This is known as Giffen's rises due to a change in price alone and other
paradox. factors remain constant, it is called variations in
2) Prestige goods : Expensive goods like demand. It is of two types :
diamond, gold etc. are status symbol. So 1) Expansion of demand : Expansion of
rich people buy more of it, even when their demand refers to rise in quantity demanded
prices are high. due to fall in price alone while other factors
3) Speculation : The law of demand does like tastes, income of the consumer, size of
not hold true when people expect prices to population etc. remain unchanged.
rise still further. In this case, although the  Demand moves in downward direction
prices have risen today, consumers will on the same demand curve.
demand more in anticipation of further rise  This is explained with the help of
in price. For example, prices of oil, sugar following fig. 3.7
etc. tend to rise before Diwali. So people go Expansion of Demand
on purchasing more at a high price as they
anticipate that prices may rise during Diwali. Y
4) Price illusion : Consumers have an illusion
that high priced goods are of a better
D
Price in `

P a
quality. Therefore, the demand for such
goods tend to increase with a rise in their b
P1
prices. For example, branded products
D
which are expensive are demanded even at
a high price. 0 Q Q1 X
5) Ignorance : Sometimes, due to ignorance Quantity Demanded in kgs
people buy more of a commodity at high Fig. 3.7
price. This may happen when consumer is  As shown in fig. 3.7, DD is demand
ignorant about the price of that commodity curve. A downward movement on the
at other places. same demand curve from point a to point b
6) Habitual goods : Due to habit of indicates an expansion of demand.

23
 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,
Y
income of the consumer, size of population
etc. remain unchanged.

Price in `
 Demand curve moves in the upward
D D1
direction on the same demand curve.
a increase b
 This can be explained with the help of P
following fig. 3.8 D D1
Contraction of Demand 0 Q Q1 X
Quantity Demanded in kgs
Y Fig. 3.9
As shown in fig. 3.9, DD is the original
Price in `

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 Q2 Q 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 shows Decrease in Demand
contraction of demand.
Changes in Demand : Y
When demand for a commodity increases
or decreases due to changes in other factors and
Price

price remains constant, it is known as changes in D2 D

demand. It is of two types :
P bdecrease a
1) Increase in demand : It refers to increase
D2 D
in quantity demanded due to favourable
changes in other factors like tastes, income 0 Q2 Q X
of the consumer, climatic conditions etc. Quantity Demanded
and price remains constant. 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.

24
 You should know : 2) Aggregate demand is a macro economic
1) Demand is a micro economic concept. concept. It refers to the total amount of
Demand is that quantity of a commodity sales proceeds which an entrepreneur
which a person is ready to buy at a actually expects from the sale of output
particular price and during a specific produced at a given level of employment
period of time. 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 at
and price of its substitute is…….. 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 the
for inferior goods is……. factors determining demand other than price
a) direct ………
b) inverse 5) A desire which is backed by willingness to
c) no effect purchase and ability to pay ………
d) can be direct and inverse
Q. 3. Distinguish between :
3) Symbolically, the functional relationship

1) Desire and Demand
between Demand and Price can be expressed as
2) Expansion of demand and Contraction of demand
................
3) Increase in demand and Decrease in demand
a) Dx = f(Px)
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 for
b) expansion of demand it increases.
c) decrease in demand 
d) contraction in demand

25
Q. 5. Observe the following table and answer the 3) Explain the diagrams :
following questions : A) B)
Quantity demanded Y Y

Market D D
Price Con- Con- Con-

Price in `

Price in `
demand
per kg. sumer sumer sumer P a P2 a
(in kgs)
in ` A B C b b
(A+B+C) P1 D P D
25 16 15 12
0 Q Q1 X 0 Q2 Q X
30 12 11 10
Quantity Demanded in kgs Quantity Demanded in kgs
35 10 09 08 A) B)
40 08 06 04 1) Diagram A    1) Diagram B
represents ...... in represents ....... in
a) Complete the market demand schedule. 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 Q. 6. Answer in detail :
D2 D D1
1) State and explain the law of demand with
exceptions.
Price in `

D1 2) Explain in detail the determinants of demand.

D
D2 
0 Q2 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..........

26
 3B Elasticity of Demand

Introduction : unchanged. It is expressed as :

In the previous chapter you have already Percentage change in Qty. Demanded
Ey =
studied the law of demand which shows the 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 Q Y
= ×
demanded. Therefore, Prof. Alfred Marshall Q Y
explained the concept of elasticity of demand. Where,

Concept of Elasticity of Demand :  = Represents change

The term elasticity indicates responsiveness Q = Orignal demand
of one variable to a change in the other variable. Y = Orignal income
Elasticity of demand refers to the degree of Q = Change in quantity demanded
responsiveness of quanitity demanded to a Y = Change in income of a consumer
change in its price or any other factor.
According to Prof. Marshall, “Elasticity You should know :
of demand is great or small according to the • Positive income elasticity
amount demanded which rises much or little for Normal goods for which demand
a given fall in price and quantity demanded falls increases with increase in income.
much or little for a given rise in price.” • Negative income elasticity
It is clear from the above definition that Inferior or goods for which demand
elasticity of demand is a technical term which decreases with increase in income of
describes the responsiveness of change in consumer.
quantity demanded to fall or rise in its price. In
• Zero income elasticity
other words, it is the ratio of percentage change
Necessary goods for which demand
in quantity demanded of a commodity to a
remains constant with increase in income
percentage change in price.
of the consumer.
Types of Elasticity of Demand :
1) Income elasticity 2) Cross elasticity : It refers to a change in
2) Cross elasticity quantity demanded of one commodity due
to a change in the price of other commodity.
3) Price elasticity
(Complementary goods or substitutes)
1) Income elasticity : It refers to the degree
of responsiveness of a change in quantity Percentage change in Qty. demanded of A
Ec =
demanded to a change in the income Percentage change in Price of B
only, other factors including price remain (A = Original commodity, B = Other commodity)
27
 % QA price
Symbolically, Ec =
% PB Types of Price Elasticity of Demand :
QA PB
  = ÷ 1) Perfectly Elastic Demand (Ed = ∞) :
QA PB
QA PB When a slight or zero change in the price
  = × P brings about an infinite change in the
QA B
quantity demanded of that commodity, it is
Where, called perfectly elastic demand. It is only
QA = Original quantity demanded of commodity A a theoretical concept. For example, 10%
QA = Change in quantity demanded of fall in price may lead to an infinite rise in
commodity A demand.
PB = Original price of commodity B Percentage change in Quantity Demanded
Ed = =∞
PB = Change in price of commodity B Percentage change in Price
Ed = ∞
You should know : Perfectly elastic demand
• Positive cross elasticity : Substitute goods. Y
  Example, tea and coffee.
• Negative cross elasticity : Complementary
  goods. Example, tea and sugar.
Price D D
P
• Zero cross elasticity : Non-related goods. Ed = ∞
  Example, tea and books.

3) Price elasticity : According to Prof. Alfred 0 X

Marshall, price elasticity of demand is Quantity Demanded
a ratio of proportionate change in the
Fig. 3.11
quantity demanded of a commodity to a
In figure 3.11, the demand curve is a
given proportionate change in its price.
horizontal line parallel to the X axis indicating
Percentage change in Quantity Demanded
Ed = perfectly elastic demand.
Percentage change in Price
%Q 2) Perfectly inelastic demand (Ed = 0) :
Symbolically, Ed = , When a percentage change in price has
%P
no effect on the quantity demanded of a
Q P
Ed = ÷ commodity it is called perfectly inelastic
Q P
demand. For example, 20% fall in price
Q P
Ed = × will have no effect on quantity demanded.
Q P
%Q
Where, Ed =
%P
Q = Original quantity demanded 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.
28
 Perfectly inelastic demand Ed = 0 more than proportionate change in quantity
Y demanded, the demand is said to be relatively
elastic. For example, 50% fall in price leads
D to 100% rise in quantity demanded.
P1
%Q
Price

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

Price
P Ed > 1
OP1 or when price falls from OP to OP2, demand
P1 D
remains unchanged at OQ. Therefore, the demand
curve is a vertical straight line parallel to the Y
0 Q Q1 X
axis, indicating perfectly inelastic demand.
Quantity Demanded
3) Unitary elastic demand (Ed = 1) :
Fig. 3.14
When a percentage change in price leads to a
  In figure 3.14, when price falls from OP to OP1
proportionate change in quantity demanded
(50%), demand rises from OQ to OQ1 (100%).
then demand is said to be unitary elastic. For
Therefore, the demand curve has a flatter slope.
example, 50% fall in price of a commodity
leads to 50% rise in quantity demanded. 5) Relatively inelastic demand (Ed < 1) :
%Q 50 When a percentage change in price leads
Ed = = =1 ∴ Ed = 1 to less than proportionate change in the
%P 50
Unitary elastic demand quantity demanded, demand is said to be
Y relatively inelastic. For example, 50%
fall in price leads to 25% rise in quantity
demanded.
D
%Q 25
Price

P Ed = 1 Ed = = = 0.5
%P 50
P1 D Ed = 0.5 ∴Ed < 1
Relatively inelastic demand. Ed < 1
0 Q Q1 X Y
Quantity Demanded
Fig. 3.13 D
Price

In figure 3.13, when price falls from OP P

Ed < 1
to OP1 (50%), demand rises from OQ to OQ1
P1
(50%). Therefore, the slope of the demand curve D
is a 'rectangular hyperbola'.
0 Q Q1 X
4) Relatively elastic demand (Ed >1) :
Quantity Demanded
When a percentage change in price leads to Fig. 3.15
29
 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
Ed =
Percentage change in Price
Find out :
%Q
Identify the type of price elasticity of Ed =
%P
demand for the following goods.
Mathematically, the above formula can be
1) Cosmetics   2) Medicine
presented as under.
3) School uniform   4) Air conditioners
Q P Q P
Ed = ÷ ∴ Ed = ×
Q P Q P
Try this :
Complete the table Numerical example :
Sr. Degree of Types of Description Price Qty. Demanded Formula
No. elasticity elasticity Percentage (`) (in Kg)
of of 20 10 Q P
demand demand Ed = ×
25 09 Q P
1 Perfectly Change in
inelastic price does not Original Price, P = 20, New price P = 25
affect demand P = 5 (Difference between new and original
at all.
price)
2 Ed = 1 Change in
demand is Original Quantity Demanded, Q = 10, New
equal to demand = 9
change in
Q = 1 (Difference between new and original
price
quantity demanded)
3 Ed > 1 Relatively
elastic Q P
Ed = ×
4 Relatively Change in Q P
inelastic demand is 1 20
less than Ed = ×
10 5
change in
Ed = 0.4
price
5 Ed = ∞ Slight change Ed < 1
in price It means elasticity of demand is relatively
brings infinite inelastic.
change in
demand. Do you know?
While using percentage method of
Methods of Measuring Price Elasticity of measuring price elasticity of demand we
Demand : must keep following points in our mind :
1) Ratio or Percentage method : Ratio method
1) Value of elasticity of demand is negative
is developed by Prof. Marshall. According
because of the negative slope of demand
to this method, elasticity of demand is
curve but for the sake of simplicity we
measured by dividing the percentage
ignore negative sign.
change in demand by the percentage change
30
 ` 10 per unit and quantity demanded is 6 units.
2) Price elasticity of demand is a pure
Therefore, total expenditure incurred is ` 60.
number. It does not depend upon units
When price rises to ` 20 quantity demanded falls
in which price of the commodity and its
to 5 units, the total expenditure incurred is ` 100.
quantity are measured.
In this case, total outlay is greater than original
2) Total Expenditure Method : This method expenditure. Hence, in this example elasticity
was developed by Prof. Marshall. In this of demand is greater than one. (Ed >1) that is
method, total amount of expenditure before relatively elastic demand.
and after the price change is compared. In example ‘B’, original price is ` 30 per
Here the total expenditure refers to the unit and quantity demanded is 4 units. Therefore
product of price and quantity demanded. total expenditure is ` 120. When price rises to
` 40 quantity demanded falls to ‘3’ units. Total
Total expenditure = Price × Quantity demanded
expenditure incurred is ` 120. In this case total
In this connection, Marshall has given the
outlay is same (equal) to original expenditure.
following propositions :
Hence, in this example, elasticity of demand
A) Relatively elastic demand (Ed >1) : is equal to one (Ed = 1) that is unitary elastic
When with a given change in the price of a demand.
commodity total outlay increases, elasticity In example ‘C’, original price is ` 50 per
of demand is greater than one. unit and quantity demanded is 2 units. Therefore
B) Unitary elastic demand (Ed = 1) : total expenditure is ` 100. When price rises
When price falls or rises, total outlay does to ` 60, quantity demand falls to 1 unit and
not change or remains constant, elasticity total expenditure incurred is ` 60. In this case
of demand is equal to one. total outlay is less than original expenditure.
C) Relatively inelastic demand (Ed <1) : Hence, elasticity of demand is less than one
When with a given change in price of a (Ed <1) that is relatively inelastic demand.
commodity total outlay decreases, elasticity
of demand is less than one. Find out :
  This can be explained with the help of the As the price of peanut packets increases
following example. by 5% the demand for number of peanut
packets falls by 8%. What is the elasticity
Table 3.4 : Total outlay method
of demand for peanut packets?
Price in Quantity Total Elasticity %Q
` (P) demanded outlay of Apply the formula, Ed =
%P
in units (Q) (P×Q) ` demand
10 6 60 3) Point method or Geometric Method :
A 20 Ed >1
5 100 Prof. Marshall has developed another
30 4 120 method to measure elasticity of demand,
B 40 Ed = 1 which is known as point method or
3 120
geometric method. The ratio method and
50 2 100
C 60 Ed <1 total outlay methods are unable to measure
1 60
elasticity of demand at a given point on the
In table 3.4 in example ‘A’ original price is demand curve.
31
 At any point on the demand curve, Thus, at point P1, demand is relatively
elasticity of demand is measured with the inelastic (ed < 1)
help of the following formula : 3) At point P2, the point elasticity is measured
Lower segment of demand as :
curve below a given point (L) PB 6
Point elasticity P2 = 2 = =3
= P2A 2
of demand (Ed) Upper segment of demand
curve above a given point (U) Thus, at point P2, demand is relatively
elastic (ed > 1)
Demand curve may be either linear or
4) At point A, the point elasticity is ∞ because
non-linear as shown below :
upper segment is zero. (perfectly elastic
A) Linear Demand Curve : When the demand demand)
curve is linear i.e. a straight line, we extend
5) At point B, the point elasticity is zero
the demand curve to meet the Y axis at ‘A’
because lower segment is zero (perfectly
and X axis at ‘B’. Price elasticity of demand
inelastic demand.)
at ‘X’ axis is zero and ‘Y’ axis is infinite.
Elasticity of demand will be different at B) Non-linear demand curve : When the
each point. demand curve is non-linear i.e. convex
Point method (Linear demand curve)
to origin, to measure price elasticity of
demand we have to draw a tangent ‘AB’
Y
touching the given point on the demand
A Ed = ∞ curve and extending it to meet ‘Y’ axis at
point ‘A’ and ‘X’ axis at point ‘B’.
Price in `

P2 Ed > 1
Lower segment of the tangent
P Ed = 1
below a given point L
Ed = =
P1 Ed < 1 Upper segment of the tangent U
above a given point
Ed = 0
0 B X Point method - Non-linear demand curve
Quantity Demanded
Y
Fig. 3.16
A
Let us assume that AB is a demand curve d
and its length is 8 cm. Point elasticity at various
Price

points on a linear demand curve can be measured P E

as follows : d
1) At point P, the point elasticity is measured
as :
PB 4 0 Q B X
P = = =1
PA 4
Thus, at point P, demand is unitary elastic Quantity Demanded
(ed = 1) Fig. 3.17

2) At point P1, the point elasticity is measured If EB = EA (Ed = 1) - Unitary elastic demand
as : EB > EA (Ed >1) - Relatively elastic demand
PB 2
P1 = 1 = = 0.33 EB < EA (Ed <1) - Relatively inelastic demand
P1A 6

32
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 relatively greater will be the elasticity of demand and
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 substitutes
Price
like salt the demand will be inelastic.
Determinants Nature elasticity of
3) Number of uses : Single use goods have a demand
less elastic demand. Multi-use goods have 1) Availability a) Abundant a) Relatively
more elastic demand, For example, coal, of factors elastic
electricity etc. b) Few b) Relatively
inelastic
4) Habits : Habits make demand for certain
2) Nature of a) Necessary a) Relatively
goods relatively inelastic. For example,
commodity goods inelastic
addicted goods, drugs etc.
b) Luxury b) Relatively
5) Durability : The demand for durable goods elastic
goods is relatively elastic. For example, 3) Habits a) Habituated a) Relatively
furniture, washing machine etc. Demand for inelastic
perishable goods is inelastic. For example, b) Not b) Relatively
milk, vegetables etc. Habituated elastic
4) Time period a) Short-run a) Relatively
6) Complementary goods : The demand for
inelastic
a commodity which is used in conjunction
b) Long-run b) Relatively
with other commodities to satisfy a single elastic
want is relatively inelastic. For example, 5) Postpone- a) Possibility a) Relatively
a fall in the price of mobile handsets may ment of of Postpone- elastic
lead to rise in the demand for sim cards. consumption ment
7) Income of the consumer : Demand for b) Impossible b) Relatively
to Postpone inelastic
goods is usually inelastic, if the consumer
6) Number a) Several a) Relatively
has high income. The demand pattern of a
of uses of a elastic
very rich and an extremely poor person is commodity b) Specific b) Relatively
rarely affected by significant changes in the inelastic
price.

33
Importance of Elasticity of Demand : price as compared to those having elastic
The concept of elasticity of demand is of demand. For example, workers can ask for
great importance to producers, farmers, workers higher wages, if the demand for the product
and the Government. Lord Keynes considered produced by them is relatively inelastic.
this concept to be the most important contribution 4) Importance in Foreign Trade : The
of Alfred Marshall. Significance of the concept concept of elasticity of demand is useful to
becomes clear from the following applications : determine terms and conditions in foreign
1) Importance to a Producer : Every producer trade. The countries exporting commodities
has to decide the price of his product at which for which demand is relatively inelastic can
he has to sell it. For this purpose, elasticity of raise their prices. For example, Organization
demand becomes important. If the demand of Petroleum Exporting Countries (OPEC)
for a product is relatively inelastic, he will fix have increased the price of oil several times.
up a higher price and vice-versa. The concept The concept is also useful in formulating
of elasticity of demand is also useful to a export and import policy of a country.
monopolist to practice price discrimination. 5) Public Utilities : In case of public utilities
2) Importance to Government : Taxation like railways which have an inelastic
policy of the Government is based on the demand, Government can either subsidise
concept of elasticity of demand. Those or nationalise them to avoid consumers
commodities whose demand is relatively exploitation.
inelastic will be taxed more because it will 6) Proportion of expenditure : If the
not affect their demand much and vice-versa. proportion of expenditure in a person's
3) Important in Factor Pricing : The income is small, then demand for the product
concept of elasticity of demand is useful is relatively inelastic. For example, news
in determination of factor prices. The papers. If the proportion of expenditure
factor of production for which demand is is large, then demand for the product is
relatively inelastic can command a higher relatively elastic.

EXERCISE

Q. 1. Complete the following statements : a) perfectly elastic demand   

1) Price elasticity of demand on a linear demand b) perfectly inelastic demand
curve at the X axis is ............... c) relatively elastic demand   
a) zero  b) one  d) relatively inelastic demand
c) infinity  d) less than one 4) When percentage change in quantity demanded
2) Price elasticity of demand on a linear demand is more than the percentage change in price, the
curve at the Y-axis is equal to ................. demand curve is ................
a) zero  b) one  a) flatter
c) infinity  d) greater than one b) steeper
c) rectangular
3) Demand curve is parallel to X axis, in case of
d) horizontal
................
34
 5) Ed = 0 in case of ................ 2) (A) is False, but (R) is True
a) luxuries 3) Both (A) and (R) are True and (R) is the
b) normal goods correct explanation of (A)
c) necessities 4) Both (A) and (R) are True and (R) is not the
d) comforts correct explanation of (A)

Q. 2. Give economic terms : 2) Assertion (A) : A change in quantity demanded

1) Degree of responsiveness of quantity demanded of one commodity due to a change in the price
to change in income only. of other commodity is cross elasticity.

2) Degree of responsiveness of a change in quantity Reasoning (R) : Changes in consumers income

demanded of one commodity due to change in leads to a change in the quantity demanded.
the price of another commodity. Options : 1) (A) is True, but (R) is False
3) Degree of responsiveness of a change of quantity 2) (A) is False, but (R) is True
demanded of a good to a change in its price. 3) Both (A) and (R) are True and (R) is the
4) Elasticity resulting from infinite change in correct explanation of (A)
quantity demanded. 4) Both (A) and (R) are True and (R) is not the
5) Elasticity resulting from a proportionate change correct explanation of (A)
in quantity demanded due to a proportionate
3) Assertion (A) : Degree of price elasticity is less
change in price.
than one in case of relatively inelastic demand.
Q. 3. Complete the correlation : Reasoning (R) : Change in demand is less then
1) Perfectly elastic demand : Ed = ∞ :: : Ed the change in price.
=0 Options : 1) (A) is True, but (R) is False
2) Rectangular hyperbola : : Steeper 2) (A) is False, but (R) is True
demand curve : Relatively inelastic demand. 3) Both (A) and (R) are True and (R) is the
3) Straight line demand curve : Linear demand correct explanation of (A)
curve :: : non linear demand curve. 4) Both (A) and (R) are True and (R) is not the
4) Pen and ink : :: Tea and Coffee: correct explanation of (A)
Substitutes. Q. 5. Distinguish between :
%Q
5) Ratio method : Ed = %P :: : Ed = 1) Relatively elastic and Relatively inelastic
Lower segment demand.
Upper segment
2) Perfectly elastic demand and Perfectly inelastic
Q. 4. Assertion and Reasoning type questions : demand.
1) Assertion (A) : Elasticity of demand explains
Q. 6. Answer the following questions :
that one variable is influenced by another
variable. 1) Explain the factors influencing elasticity of
demand.
Reasoning (R) : The concept of elasticity
of demand indicates the effect of price and 2) Explain the total outlay method of measuring
changes in other factors on demand. elasticity of demand?

Options : 1) (A) is True, but (R) is False 3) Explain importance of elasticity of demand.

35
Q. 7. Observe the following figure and answer the 2) In the following diagram AE is the linear
questions : demand curve of a commodity. On the basis of
1) Identify and define the degrees of elasticity of the given diagram state whether the following
demand from the following demand curves. statements are True or False. Give reasons to
a) b) your answer.
Y D Y
Y
A
Price

Price
B

Price
D D
D
D
0 X 0 X C
Quantity Demanded Quantity Demanded E
0 X
c) d)
Y Y Quantity Demanded
1) Demand at point ‘C’ is relatively elastic
Price

Price

D D
P P demand.
P1 D P1 D 2) Demand at point ‘B’ is unitary elastic demand.
3) Demand at point ‘D’ is perfectly inelastic
0 Q Q1 X 0 Q Q1 X demand.
Quantity Demanded Quantity Demanded 4) Demand at point ‘A’ is perfectly elastic demand.



36
 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 amount a day, a week, a month or a year.
of a specific good or service that is available to Stock Supply
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 commodity
is not possible. Normally, stock exceeds supply that a seller is willing and able to offer for sale
and it is fixed and inelastic. In case of perishable at a given price, during a certain period of time.
goods such as milk, fish etc. stock may be equal For example, a farmer's total output of rice is
to supply. On the other hand, for durable goods 4000 kgs. This is the total stock. If the price is `
such as furniture, garments etc. stock can exceed 40 per kg, he offers 1000 kgs for sale. This is the
the supply. actual supply.
Supply : Supply schedule :
Supply is a relative term. It is always A supply schedule is a tabular representation
expressed in relation to price, time and quantity. of the functional relationship between price and
quantity supplied of a particular commodity.
Meaning of Supply :
The word ‘supply’ implies the various 1) Individual Supply Schedule : Individual
quantities of a commodity offered for sale supply schedule refers to a tabular
by producers during a given period of time at representation showing various quantities
a given price. It is related to time and price. of a commodity that a producer is willing to

37
 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
(in `) (in kgs.)
30 300 Seller Seller Seller (A+B+C)
A B C
40 400
10 100 200 300 600
50 500
20 200 300 400 900
Table 4.1 explains the functional 30 300 400 500 1200
relationship between price and quantity supplied
40 400 500 600 1500
of a commodity. Lower the price, lower the
50 500 600 700 1800
quantity of a commodity supplied and vice
versa. At the lowest price of ` 10, supply is also In Table 4.2, market supply is obtained by
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
S SS = Market Supply Curve
50 Y
S
40 50
Price in `

30 40
Price in `

20 30
10 20
S
0 100 200 300 400 500 X 10 S

Quantity Supplied in kgs 0 300 600 900 1200 1500 1800 X

Fig. 4.2
Quantity Supplied in kgs
In figure 4.2, quantity supplied is shown on
Fig. 4.3
the X axis and price on the Y axis. Supply curve
In figure 4.3, quantity supplied is shown on
SS slopes upwards from left to right, indicating
the X axis and price on the Y axis. Supply curve
a direct relationship between price and quantity
SS slopes upwards from left to right, indicating
supplied.
a direct relationship between price and market
2) Market Supply Schedule : Market supply supply.
38
 Try this : will reduce the supply and vice versa
Draw a supply curve with the help of a 8) Other factors : It includes,
hypothetical supply schedule. • nature of the market,
• relative prices of other goods,
Determinants of Supply : • export and imports,
1) Price of commodity : Price is an important • industrial relations,
factor influencing the supply of a • availability of factors of production etc.
commodity. More quantities are supplied If all factors are favourable, supply of a
at a higher price and less quantities are commodity will be more and vice versa.
supplied at a lower price. Thus, there is
Law of Supply
a direct relationship between price and
Introduction :
quantity supplied.
The law of supply is also a fundamental

2) State of technology : Technological principle of economic theory like law of
improvements reduce the cost of production demand. It was introduced by Prof. Alfred
which lead to an increase in production and Marshall in his book, ‘Principles of Economics’
supply. which was published in 1890. The law explains
3) Cost of Production : If the factor price the functional relationship between price and
increases, the cost of production also quantity supplied.
increases, as a result, supply decreases.
Statement of the Law :
4) Infrastructural facility : Infrastructure “Other things being constant, higher the
in the form of transport, communication, price of a commodity, more is the quantity
power, etc. influences the production process supplied and lower the price of a commodity less
as well as supply. Shortage of these facilities is the quantity supplied”
decreases the supply and vice versa. In simple words, “other factors remaining

5)
Government policy : Favourable constant, a rise in price results in a rise in the
Government policies may encourage supply quantity supplied and vice-versa. Thus, there is
and unfavourable government policies a direct relationship between price and quantity
may discourage the supply. Government supplied.
policies like taxation, subsidies, industrial Symbolically,
policies, etc. may encourage or discourage Sx = f (Px)
production and supply, depending upon S = Supply
government policy measures. x = Commodity
6) Natural conditions : The supply of f = Function
agricultural products depends on the natural P = Price of commodity
conditions. For example, a good monsoon Assumptions of the law :
and favourable climatic condition will The law of supply is based on the following
produce a good harvest, so the supply of assumptions :
agricultural products will increase and 1) Constant cost of production : It is assumed
unfavourable climatic conditions will lead that there is no change in the cost of
to a decrease in supply. production .A change in cost of production
7) Future expectations about price : If the will affect the profits of the seller. Therefore
prices are expected to rise in the near future, less quantity will be supplied at the same
the producer may withhold the stock. This price.
39
2) Constant technique of production : It is when price rises supply also rises and when
also assumed that technique of production price falls supply also falls. Thus, there is direct
does not change. Improved technique of relationship between price and quantity supplied
production may lead to an increase in which is shown in following figure 4.4 :
production. This in turn may lead to an Supply Curve
increase in the supply at the same price. Y
3) No change in weather conditions : It is
50 S
assumed that there is no change in the
weather conditions. Natural calamities 40

Price in `
like floods, earthquakes etc. may decrease 30
supply.
20
4) No change in Government policy : It is
also assumed that government policies like 10
S
taxation policy, trade policy etc. remain
unchanged. 0 100 200 300 400 500 X
5) No change in transport cost : It is assumed Quantity Supplied in kgs
that there is no change in the condition of Fig. 4.4
transport facilities and transport cost. For In the figure 4.4, X axis represents quantity
example, better transport facility increases supplied and Y axis represents the price of the
supply at the same price. commodity. Supply curve 'SS' slopes upwards
6) Prices of other goods remain constant : from left to right which has a positive slope. It
Prices of other goods are assumed to remain indicates a direct relationship between price and
constant. If they change, the law of supply quantity supplied.
may not hold true because producer may
Exceptions to the Law of Supply :
transfer resources to other products.
Following are the exceptions to the law of supply:
7) No future expectations : The law also
1) Supply of labour : Labour supply is the
assumes that the sellers do not expect future
changes in the price of the product. total number of hours that workers to work
Law of supply is explained with the help of at a given wage rate. It is represented
the following schedule and diagram : graphically by a supply curve. In case of
Table 4.3 labour, as the wage rate rises the supply
Supply Schedule of labour (hours of work) would increase.
So supply curve slopes upward. Supply of
Price of commodity x Supply of commodity x
(in `) (in kgs.) labour (hours of work) falls with a further
10 100 rise in wage rate and supply curve of
20 200 labour bends backward. This is because the
30 300 worker would prefer leisure to work after
40 400 receiving higher amount of wages. Thus,
50 500 after a certain point when wage rate rises
Table 4.3 explains the direct relationship the supply of labour tends to fall.
between price and quantity of commodity  It can be explained with the help of a
supplied. When price rises from ` 10 to 20, 30, backward bending supply curve. Table no.
40 and 50, the supply also rises from 100 to 200, 4.4 and fig. no 4.5 explains the backward
300, 400 and 500 units respectively. It means, bending supply curve of labour.
40
 Table. 4.4 Due to unfavourable changes in weather,
Labour Supply Schedule if the agricultural production is low, their
Wage rate (`) Hours of work Total amount supply cannot be increased even at a higher
per hour per day of wages (`) price.
100 5 500
3) Urgent need for cash : If the seller is in
200 7 1400
urgent need for hard cash, he may sell his
300 6 1800
product at which may even be below the
SAS1 = Backward bending market price.
labour supply curve
Y SA = Increasing supply curve 4) Perishable goods : In case of perishable
AS = Leisure time goods, the supplier would offer to sell more
Wage rate (`) per hour

quantities at lower prices to avoid losses.

S1
300 For example, vegetables, eggs etc.
5) Rare goods : The supply of rare goods
200 A
cannot be increased or decreased according
100 to its demand. Even if the price rises, supply
S remains unchanged. For example, rare
0 5 6 7 X paintings, old coins, antique goods etc.
Variations in Supply :
Supply of Labour (hours of work)
When quantity supplied of a commodity
Fig. 4.5
varies due to change in its price, other factors
In fig. 4.5, supply of labour (hours of
remaining constant, it is known as variations
work) is shown on X axis and wage rate
in supply. There are two types of variations in
per hour is shown on the Y axis. The curve
supply :
SAS represents backward bending supply
1) Expansion of supply : Expansion of supply
curve of labour. Initially, when the wage
refers to a rise in the quantity supplied due
rate is ` 100 per hour, the hours of work is
to a rise in the price of a commodity, other
5. The total amount of wages received is `
factors remaining constant. Expansion in
500. When wage rate rises from ` 100 to
supply leads to an upward movement on the
` 200, hours of work will also rise from 5
same supply curve due to a rise in price. It is
hours to 7 hours and total amount of wages
shown in figure 4.6
would also rise from ` 500 to ` 1400. At this
point, labourer enjoys the highest amount Expansion of supply
i.e. ` 1400, and works for 7 hours. If wage Y SS = Supply Curve
rate rises further from ` 200 to ` 300, total MN = Extension of supply
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 S
Price

only for 6 hours. At the point A, the supply P1 N

curve bends backward, which becomes an M
exception to the law of supply. P
S
2) Agricultural goods : The law of supply
does not apply to agricultural goods as they 0 Q Q1 X
are produced in a specific season and their Quantity Supplied
production depends on weather conditions. Fig. 4.6
41
 In figure 4.6, quantity supplied is shown shifts to the right of the original supply
on the X axis and price on the Y axis. Quantity curve. It is shown in figure 4.8
supplied rises from OQ to OQ1, with a rise in Increase in supply
price from OP to OP1, resulting in an upward SS = Original supply curve
Y
movement from M to N along the same supply S1S1 = Shift in supply curve
curve SS. It is known as Expansion of supply.
2) Contraction of supply : Contraction of S
supply refers to a fall in the quantity supplied,

Price
S1
M N
due to fall in the price of a commodity, P
other factors remaining constant. In case of S
contraction of supply, there is a downward S1
movement on the same supply curve. It is
shown in figure 4.7 0 Q Q1 X
Contraction of supply Quantity Supplied
SS = Supply Curve
Fig. 4.8
Y
In figure 4.8, quantity supplied is shown on
NM = Contraction of Supply
the X axis and price on the Y axis. Supply rises
from OQ to OQ1 at the same price OP, resulting
S in an outward shift of the original supply curve to
Price

P N the right from SS to S1S1. It is known as Increase

in supply.
P2 M
2) Decrease in supply : Decrease in supply
S
refers to a fall in the supply of a given
0 Q2 Q X commodity due to unfavourable changes in
Quantity Supplied other factors such as increase in the prices
Fig. 4.7 of inputs, increase in tax rate, outdated
In figure 4.7, quantity supplied is shown technology, strikes by worker, while price
on the X axis and price on the Y axis. Quantity remains constant. The supply curve shifts
supplied falls from OQ to OQ2 with a fall in to the left of the original supply curve. It is
price from OP to OP2, resulting in a downward shown in figure 4.9
movement from N to M on the same supply curve Decrease in supply
SS = Original supply curve
SS. It is known as Contraction of supply. Y S2S2 = Shift in supply curve
Changes in Supply : S2
When other factors change and price remains
N M S
constant, it is known as changes in supply. There P
Price

are two types of changes in supply :

S2
1) Increase in supply : Increase in supply refers
to rise in the supply of a given commodity
S
due to favourable changes in other factors
such as fall in the price of inputs, fall in tax 0 Q2 Q X
rates, technological upgradation etc., while Quantity Supplied
price remains constant. The supply curve Fig. 4.9
42
 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 variable
from OQ to OQ2 at the same price OP, resulting costs are those expenses of production
in an inward shift of the original supply curve to which are incurred on variable factors such
the left from SS to S2S2. It is known as Decrease as labour, raw material, power, fuel etc.
in supply. 2) Average Cost (AC) : Average cost refers to
cost of production per unit. It is calculated
You should know :
by dividing total cost by total quantity of
1) Supply : Supply is a micro-economic production.
concept. Supply refers to quantity of a TC
AC =
commodity that a seller is willing and able TQ
to offer for sale at a particular price, during AC = Average cost
a certain period of time. TC = Total cost
2) Aggregate supply : It is a macro-economic TQ = Total quantity
concept. It refers to the minimum amount of For example, If the total cost of production
sales proceeds which entrepreneurs expect of 40 units of commodity is ` 800 then the
to receive from the sale of output at a given average cost is :
level of 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 producing
make payments for such inputs. The expenditure one more unit of output.
incurred on these inputs is known as the cost of MCn = TCn – TCn-1
production. Cost of production increases with an
  n = Number of units produced
increase in need of output. There are three types
MCn = Marginal cost of the nth unit
of costs which are as follows :
TCn = Total cost of nth unit
1) Total Cost (TC) : Total cost is the total
expenditure incurred by a firm on the factors TCn-1 = Total cost of previous units
of production required for the production of If previous total cost of producing 4 units
goods and services. Total cost is the sum is ` 200 and total cost of producing 5 units
of total fixed cost and total variable cost at is ` 250, then :
various levels of output. MCn = TCn – TCn-1
TC = TFC + TVC   = ` 250 – ` 200
TC = Total cost   = ` 50
TFC = Total Fixed Cost
TVC = Total Variable Cost Find out :

Total Fixed Cost (TFC) : Total fixed costs If a firm produces 600 units of a
are those expenses of production which commodity in a day and incurs a total cost
are incurred on fixed factors such as land, of ` 30,000. Calculate the Average Cost.

43
B) Revenue Concepts : For example, if the total revenue of 15 units,
The term ‘revenue’ refers to the receipts is ` 3000, then average revenue is calculated as :
obtained by a firm from the sale of certain TR
AR =
quantities of a commodity at given price in the TQ
market. The concept of revenue relates to total 3000
  =
revenue, average revenue and marginal revenue. 15
1) Total Revenue (TR) : Total revenue is the   = ` 200
total sales proceeds of a firm by selling a 3) Marginal Revenue : Marginal revenue is
commodity at a given price. It is the total the net addition made to total revenue by
income of a firm. Total revenue is calculated selling an extra unit of the commodity.
as follows :
MRn = TRn – TRn-1
Total revenue = Price × Quantity
MRn = Marginal revenue of nth unit
For example, if a firm sells 15 units of a
commodity at ` 200 per unit TR is calculated TRn = Total revenue of nth unit
as : TRn-1 = Total Revenue of previous units
TR = P × Q n = Number of units sold
= ` 200 × 15 For example, if the previous total revenue
= ` 3000 from the sale of 20 tables is ` 4000 and
2) Average Revenue (AR) : Average revenue that from the sale of 21 tables is ` 4200,
is the revenue per unit of output sold. It is marginal revenue is calculated as :
obtained by dividing the total revenue by MRn = TRn – TRn-1
the number of units sold.   = 4200 – 4000
TR   = ` 200 per table
AR =
TQ
Find out :
AR = Average Revenue
TR= Total Revenue If a firm sells 400 units of a commodity
TQ =Total Quantity at ` 10 unit. Calculate the TR and AR.

EXERCISE

Q. 1. Complete the following statements : b) decrease in supply

1) When supply curve is upward sloping, it’s slope c) expansion of supply
is .............. d) increase in supply
a) positive   3) A rightward shift in supply curve shows
b) negative ................
c) first positive then negative  a) contraction of supply
d) zero b) decrease in supply
2) An upward movement along the same supply c) expansion of supply
curve shows ................ d) increase in supply
a) contraction of supply 4) Other factors remaining constant, when less

44
 quantity is supplied only due to a fall in price, it Q. 5. Observe the following table and answer the
shows ................ questions :
a) contraction of supply A) Supply schedule of chocolates
b) decrease in supply Price in ` Quantity supplied in units
c) expansion of supply 10 200
d) increase in supply 15
20 300
5) Net addition made to the total revenue by selling
25 350
an extra unit of a commodity is ..................
30
a) total Revenue 35
b) marginal Revenue 40
c) average Revenue 1) Complete the above supply schedule.
d) marginal Cost
2) Draw a diagram for the above supply schedule.
Q. 2. Complete the Correlation : 3) State the relationship between price and
1) Expansion of supply : Price rises :: Contraction quantity supplied.
of supply :
B) Observe the market supply schedule of potatoes
2) Total revenue : :: Average revenue : and answer the following questions.
TR/TQ
Price Firms Market
3) Total cost : TFC + TVC :: Average cost : in ` “A” “B” “C” supply
(kg)
4) Demand curve : :: Supply curve : 1 20 45 100
2 37 30 45
Upward
3 40 55 155
5) : Change in supply :: Other factors
4 44 50 154
constant : Variation of supply
1) Complete the quantity of potato supplied by the
Q. 3. Give economic terms : firms to the market in the above table.
1) Cost incurred on fixed factor. 2) Draw the market supply curve from the schedule
2) Cost incurred per unit of output. and explain it.
3) Net addition made to total cost of production.
Q. 6. Answer the following questions :
4) Revenue per unit of output sold.
1) Explain the concept of total cost and total
Q. 4. Distinguish between : revenue.
1) Stock and Supply.
2) Explain determinants of supply.
2) Expansion of Supply and Increase in Supply.
Q. 7. Answer in detail :
3) Contraction of Supply and Decrease in Supply.
4) Average Revenue and Average Cost. 1) State and explain law of supply with exceptions.



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 services produced.
takes place among them. 2) National market : National market is
Definition of Market : a domestic market in a given country.
Each national market is governed by the
According to Augustin Cournot,
regulation of its own country.
“Economists understand the term market, not
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
buyers and sellers trade in goods and
in which buyers and sellers are in such a close
services across the national borders.
contact with one another that the prices of the
same goods tend to equality easily and quickly.” II) On the basis of time :
Thus, market is a network of dealings 1) Very short period : Very short period is a
between potential buyers and potential sellers. At period in which supply is fixed and price is
any point of time, a market will exist if there are : determined by the demand. The time period
is for a few days or weeks in which the
1) Buyers and sellers
supply of commodity cannot be 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 services.
Classification of Market : 3) Long period : Long run is a period of time
Market can be classified on the basis of in which all factors of production and costs
Classification of Market on the basis of
I) Place II) Time III) Competition
A) Local A) Very short period A) Perfect
competition
B) National B) Short period
B) Imperfect
C) International C) Long period competition
D) Very long period

i) Monopoly ii) Oligopoly iii) Monopolistic competition

Fig. 5.1
46
 are variable. In the long run, firms are able none of them is in a position to influence
to adjust all costs. It is for a few years, the price in the market.
generally up to five years.
2) Homogeneous product : An important
4) Very long period : Very long period is feature of a perfectly competitive market
a production time that is so long that all is that the product sold is homogeneous or
inputs are variable. It is of more than five identical in respect of size, design, colour,
years. taste etc. All the products are perfect
III) On the basis of Competition : substitutes to each other.
Competition among the sellers and buyers is 3) Free entry and exit : There are no barriers
the most important criteria for classification of to the entry and exit of firms. Any firm can
markets in economics. Let us study the various enter or quit the industry at its own will. If
types of markets on the basis of competition there is hope of profit, the firm will enter the
among the sellers : market and if there is possibility of loss the
A) Perfect Competition : firm will leave the market.
Meaning and Definition : Perfect 4) Single price : A single uniform price
competition is an ideal and imaginary prevails under perfect competition which
concept of market rather than an actual is determined by the interaction of demand
market. According to Mrs. Joan Robinson, and supply.
“Perfect competition prevails when the 5) Perfect knowledge of market : The buyers
demand for the output of each producer is and sellers possess a perfect knowledge
perfectly elastic.” about the market conditions. Every seller
  A perfectly competitive market is and buyer has the knowledge about price,
one in which the number of buyers and quality, source of supply of products etc.
sellers is very large. All the buyers and 6) Perfect mobility of factors of production :
sellers are engaged in buying and selling There is perfect mobility of factors of
a homogeneous product without any production under perfect competition.
restrictions. Moreover both buyers and Labour and capital are mobile not only
sellers possess perfect knowledge of market geographically but also occupationally.
conditions.
7) Absence of transport cost : In perfect
 Following are the features of Perfect
competition, price is uniform because we
Competition :
assume that transport cost does not exist.
1) Large number of sellers and buyers : This assumption will lead to uniformity in
Under perfect competitions, there are large price.
number of sellers and buyers. As mentioned
8) No government intervention : Laissez-
earlier, each seller forms a negligible part
faire policy is an important feature of
in the total market. Hence, none of them
perfect competition. It means there is
is in a position to influence the price and
absence of Government intervention in
supply in the market. Thus, sellers are price
economic activities.
takers under perfect competition.
  The number of buyers is also large. The Price determination under Perfect Competition:
share of each buyer is so negligible that The interaction of demand and supply

47
determine price of the commodity in perfect diagram, X axis represents quantity demanded and
competition. This is known as ‘equilibrium quantity supplied, whereas Y axis represents the
price.’ Marshall has compared the process of price. DD is the downward sloping demand curve
price determination to the cutting of cloth with which shows inverse relationship between price
a pair of scissors. Just as both the blades of and quantity demanded. SS is the upward sloping
scissors are required to cut the cloth, both the supply curve which shows direct relationship
forces of demand and supply are essential to between price and quantity supplied. E is the
determine the equilibrium price in the market. equilibrium point where DD and SS curve intersect
This is explained with the help of the following each other. Accordingly ` 300 is the equilibrium
schedule and diagram. price and 3000 kgs. is the equilibrium quantity
Table no 5.1 Demand and Supply Schedule demanded and supplied. This equilibrium price is
Price per Quantity Quantity Relationship determined by market demand and market supply.
Kg. of demanded supplied between DD
Apples (in `) (in Kg.) (in Kg.) and SS
Y Excess Supply
100 5000 1000 DD > SS
200 4000 2000 DD > SS 500 D SS > DD S

Price (in `) per kg

300 3000 3000 DD = SS 400
400 2000 4000 DD < SS E
500 1000 5000 DD < SS 300 DD = SS

From the table no 5.1, following conclusions 200

can be drawn : 100 S
DD > SS
D
1) When price rises from ` 100 to ` 200 Excess Demand
quantity demanded falls from 5000 kgs. to 0 1000 2000 3000 4000 5000 X
4000 kgs. whereas supply increases from
Quantity Demanded and Quantity Supplied (in kgs.)
1000 kgs. to 2000 kgs. This is because
demand falls with rise in price and supply Fig. 5.2
rises with a rise in price. This is the stage B) Imperfect Competition :
where demand is greater than supply (DD > 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 one
500, demand falls from 2000 kgs. to 1000 seller who controls the entire market supply for
kgs. and supply rises from 4000 kgs. to 5000 a product which has no close substitute.
kgs. Thus, supply is greater than demand. According to E. H. Chamberlin, “Monopoly
(SS > DD). refers to a single firm which has control over
The process of price determination is the supply of a product which has no close
explained in the following figure 5.2. In this substitute.”

48
 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 monopolist. trade mark, copyrights etc. The law forbids
Therefore, the buyers have no choice. the potential competitors to imitate the
They have to either buy the product from design or form of the product registered
the monopolist or go without it. The cross under given branded names. For example,
elasticity of demand for his product is either Amul products.
zero or negative. 4) Natural monopoly : The monopoly created
3) Barriers to entry : Entry of the rivals is on the basis of natural conditions like
restricted due to legal, natural, technological climate, rainfall, specific location etc. is
barriers which do not allow the competitors known as natural monopoly. For example,
to enter the market. 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 price discriminating monopoly, firm charges
of his own product as he controls the whole different prices to different buyers for the
market supply. Monopolist is a price maker. same product. For example, doctor charges
6) Price discrimination : Monopolist being a different fees to different patients.
price maker, he can charge different prices
7) Voluntary monopoly : To avoid cut
to different consumers for the same product,
throat competition, some monopolists
on the basis of time, place etc. Thus, price
voluntarily come together and form a
discrimination is an important feature of
group of monopolists. This facilitates
monopoly market. For example, students
them to maximise the profit. For example,
and senior citizens are provided railway
Organisation of Petroleum Exporting
tickets at concessional rates.
Countries (OPEC).
7) No distinction between firm and industry:
A monopolist is the sole seller and producer You should know :
of the product. A monopoly firm itself is an Price descrimination under monopoly
industry.
Types of monopoly : Personal Place wise Time wise Use
Following are some of the types of
Doctors Differences ST bus fare Electricity
monopoly : charge in house differs for charges are
1) Private monopoly : When an individual or different rent in rural over night different for
private body controls a monopoly firm it is fees to and urban and day domestic and

different areas time travels commercial
known as private monopoly. For example,
patients uses
Tata Group.
49
 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.
1) Tea in Assam
2) Atomic energy 5) Lack of uniformity : There is a lack of
3) Logo of a commercial bank uniformity among the firms in terms of 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 monopoly.
element of uncertainty in this type of market
It exists when there are many sellers but
due to different behaviour patterns. Rivals
only one buyer. Buyer’s monopoly is rarely
may join hands and co-operate or may try
found. A monopsonist can exploit the sellers
to fight each other.
just as a monopolist may exploit the buyers.
In the labour market, a particular kind of III) Monopolistic competition :
labour is used by one employer only. Different brands of liquid cleaners :

II) Oligopoly :
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. Fig. 5.3
Features of oligopoly :
Meaning and Definition : Monopolistic
1) Few firms or sellers : Under oligopoly competition is very realistic in nature. In this
market, there are few firms or sellers. These market there are some features of perfect
few firms dominate the market and enjoy competition and some features of monopoly
a considerable control over the price of a acting together. Prof. E. H. Chamberlin coined
product.
this concept in his book “Theory of Monopolistic
2) Interdependence : The seller has to be Competition” which was published in 1933.
cautious with respect to any action taken According to Chamberlin, “Monopolistic
by the competing firms. Since there are competition refers to competition among a large
few sellers in the market, if any firm makes number of sellers producing close but not perfect
the change in the price, all other firms in substitutes.”
the industry also try to follow the same to Following are the main features of
remain in the competition. monopolistic competition :
3) Advertising : Advertising is a powerful 1) Fairly large number of sellers : In
instrument in the hands of oligopolist. A monopolistic competition, the number of
firm under oligopoly can start an aggressive sellers is large but comparatively it is less
and attractive advertising campaign with than that of perfect competition. Due to this
the intention of capturing a large part of reason sellers’ behaviour is like monopoly.
market.
50
 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 to
monopolistic competition. In this market, each other. For example, different brands of
there are many firms producing a particular soaps, toothpastes etc.
product, but the product of each firm is in
7) Concept of group : Under monopolistic
some way differentiated from the product
competition, Chamberlin introduced the
of every other firm in the market. This is
concept of ‘Group’ in place of industry.
known as product differentiation. Product
Industry means the number of firms
differentiation may take the form of brand
producing identical products. A ‘Group’
names, trade marks, peculiarity of package
means a number of firms producing
or container, shape, quality, cover, design,
differentiated products which are closely
colour etc. This means that the product of
related. For example, group of firms
a firm may find close substitutes and its
producing medicines, automobiles etc.
cross elasticity of demand is very high. For
example, mobile handsets, cold drinks etc. Find out :
4) Free entry and exit : Under monopolistic Close substitutes for the following
competition there is freedom of entry and products.
exit, that is new firms are free to enter the Products Substitutes
market if there is profit. Similarly, they can 1) Gemini Oil
leave the market, if they find it difficult to 2) Colgate Toothpaste
survive. 3) Red Label Tea
5) Selling Cost : Selling cost are peculiar to 4) Bru Caffee
monopolistic competition only. It refers to 5) Activa Two-wheeler
the cost incurred by the firm to create more

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, International
purchased. market
b) An arrangement through which buyers and b) Very short period market, Local market,
sellers come in close contact with each other National market.
directly or indirectly. c) Short period market, National market,
c) A shop where goods are sold. International market.
d) Local market, National market, Short period
d) All of the above.
market.
51
Options :1) a, b and c 2) b, c and d Q. 4. Find the odd word out :
3) only a 4) a and d 1) Selling cost : Free gifts, Advertisement
hoardings, Window displas, Patents.
3) Homogeneous product is a feature of this
market. 2) Market sructure on the basis of competition
a) Monopoly     : Monopoly, Oligopoly, Very Short Period
b) Monopolistic competition market, Perfect competition.
c) Perfect competition 3) Features of monopoly : Price maker, Entry
d) Oligopoly barriers, Many sellers, Lack of substitutes.
Options :1) c and d 2) a, b and c 4) Legal monopoly : Patent, OPEC, Copyright,
3) a, c and d 4) only c Trade mark.

4) Under Perfect competition, sellers are Q. 5. Answer the following :

a) Price makers b) Price takers 1) Explain the features of Oligopoly.
c) Price discriminators d) None of these 2) Explain the types of Monopoly.
Options :1) a, b and c 2) only b Q. 6. Observe the table and answer the questions :
3) only c 4) a and c
Price of Demand (in Supply Relation
Q. 2. Give economic terms : banana dozen) (in between DD
(per dozen) and SS
1) The market where there are few sellers. dozon) in `
2) The point where demand and supply curve 10 500 100 DD > SS
intersect. 20 400 DD > SS
30 300 DD = SS
3) The cost incurred by the firm to promote sales.
40 200 DD < SS
4) Number of firms producing identical product.
50 500 DD < SS
5) Charging different prices to different consumers
for the same product or services. 1) Fill in the blanks in the above schedule.
2) Derive the equilibrium price from the above
Q. 3. Complete the Correlation :
schedule with the help of a sutiable diagram.
1) Perfect competition : Free entry and exit ::
: Barriers to entry. Q. 7. Answer in detail :
1) Explain the meaning of Monopolistic
2) Price taker : :: Price maker :: Monopoly. competition with its features.

3) Single price : Perfect competition :: 2) Explain the meaning of Perfect competition
Discriminated prices : with its features.



52
 6 Index Numbers

Introduction : reference to time, geographical location

Index numbers are one of the most used and other characteristics such as income,
statistical tools in economics. An index number profession etc.”
is a device to measure changes in an economic 2) Croxton and Cowden : “Index Numbers
variable (or group of variables) over a period of are devices for measuring differences in the
time. Index numbers were originally developed to magnitude of a group of related variables.”
measure changes in the price level. In the present
Features of Index Numbers :
context, it is also used to measure trends in a
1) Index numbers are statistical devices.
wide variety of areas that includes stock market
2) Index numbers are specialized averages
prices, cost of living, industrial and agricultural
which are capable of being expressed in
production, changes in exports and imports etc.
percentages.
Index numbers are not directly measurable, but
3) Index numbers measure the net change in
represent relative changes.
one or more related variables over a period
Do you know? of time or between two different time
Origin of Index Numbers : During the 17th periods or two different localities.
century, Rice Vaughan, an Englishman and 4) Index number which is computed from a
eminent writer was concerned with the rise in single variable is called a ‘univariate index’,
prices which had occurred in his native land whereas an index which is constructed from
over the preceding century. The first study a group of variables is called a ‘composite
using Index Numbers was done in the early index’.
18th century. In 1707, William Fleetwood 5) The year for which the index number is
made a comparison of the prices of certain prepared is the current year.
commodities such as wheat, oats, beans, 6) The year with which the changes are
cloth, meat etc. for the periods 1440-1460 measured is called the base year.
and 1686-1706. The results of this study are 7) The base year’s index is assumed as 100
presented in his work, ‘Chronicon Preciosum’ and accordingly the value of the current
(1707). In 1738, Charles de Ferrare Dutot year is calculated.
of France constructed a simple aggregative 8) Index numbers are also referred to as
index for two periods 1508 and 1735 and ‘barometers of economic activity’, since it
compared the costs for an identical list of is used to measure the trends and changes
commodities. However, the first recorded in the economy.
index number appeared in the work of G.R.
Carli, an Italian who used a modified form of You should know :
the simple average of price relatives in 1764. Terminologies used in index numbers -
Base Year : The year with respect to which
Definitions of Index Numbers : comparisons are made is the base year. It is
1) Spiegel : “An index number is a statistical denoted by the suffix ‘o’.
measure designed to show changes in a Current Year : The year for which
variable or a group of related variables with comparisons are required to be made is the

53
 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
p1 = Price of the commodity in the current • Index of Industrial Production
year • Index of Service Production
q0 = Quantity of the commodity consumed • Index of Export/Import
or purchased in the base year • Human Development Index
q1 = Quantity of the commodity consumed Significance of Index Numbers in Economics :
or purchased in the current year 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 numbers
INDEX QUANTITY INDEX NUMBER provide guidelines to policy makers in
NUMBERS VALUE INDEX NUMBER framing suitable economic policies such
SPECIAL PURPOSE INDEX NUMBER as agricultural policy, industrial policy,
fixation of wages and dearness allowances
1) Price Index Number : It measures the
in accordance with the cost of living etc.
general changes in the prices of goods. It
compares the level of prices between two 2) Studies trends and tendencies : Index
different time periods. numbers are widely used to measure changes
in economic variables such as production,
2) Quantity Index Number : It is also called
prices, exports, imports etc. over a period of
volume index number. It measures changes
time. For example, by examining the index
in the level of output or physical volume of
of industrial production for the last five
production in the economy. For example,
years, we can draw important conclusions
changes in agricultural production, industrial
about the trend of industrial production
production etc. over a period of time.
whether it shows an upward tendency or a
3) Value Index Number : The value of a downward tendency.
commodity is the product of its price and
3) Forecasting about future economic
quantity (p × q). Value index number
activity : Index numbers are useful for
measures the changes in the value of a
making predictions for the future based on
variable in terms of rupee. It is a more
the analysis of the past and present trends
informative index as it combines both,
in the economic activities. For example,
changes in the price as well as quantity.
based on the available data pertaining to
4) Special Purpose Index Number : They imports and exports, future predictions can
are constructed with some specific purpose. be made. Thus, forecasting guides in proper
For example, import-export index numbers, decision making.
labour productivity index numbers, share
4) Measurement of inflation : Index numbers
price index numbers etc.
are also used to measure changes in the
Do you know? price level from time to time. It enables
Some of the widely used index numbers the government to undertake appropriate
by the Government of India : anti-inflationary measures. There is a
legal provision to pay the D.A. (dearness
54
 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 represent
real terms : Deflating means to make the tastes, habits and customs of the people.
adjustments in the original data. Index Besides this, only standardized or graded
numbers are used to adjust price changes, items should be included to give better
wage changes etc. Thus, deflating helps 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 achieve
for constructing the index number, its scope accuracy, proper selection of representative
as well as which variable is intended to places and persons is required.
be measured should be clearly decided to 5) Choice of a suitable average : Construction
achieve fruitful results. of index numbers requires choice of a
2) Selection of the base year : Base year is suitable average. Generally, Arithmetic
also called the reference year. It is the year mean is used in the construction of index
against which comparisons are made. The numbers because it is simple to compute
base year should be normal i.e. it should be compared to other averages.
free from natural calamities. It should not 6) Assigning proper weights : Weight
be too distant in the past. refers to the relative importance of the
different items in the construction of an
Do you know? index number. Weights are of two types
In 2015, the Central Statistical i.e. quantity weights (q) and value weights
Organisation (CSO) under the Ministry of (p x q). Since all items are not of equal
Statistics changed the base year for tabulating importance, by assigning specific weights,
Gross Domestic Product from 2004-05 to better results can be achieved.
2011-12. Periodic rebasing of GDP series 7) Selection of an appropriate formula :
every seven to ten years is carried out to Various formulae are devised for the
account for the changing economic structure construction of index numbers. Choice of a
and relative prices. Besides this, the base suitable formula depends upon the purpose
year of Index of Industrial Production (IIP) of index number and availability of data.
and the base year of Wholesale Price Index
Methods of Constructing Index Numbers :
(WPI) has also been changed from 2004-05
There are two methods of constructing
to 2011-12. At present, the process of further
index numbers:
rebasing the base year is underway.
a) Simple Index Number 
3) Selection of items : It is necessary to select a b) Weighted Index Number
sample of the number of items to be included The following chart explains the methods
in the construction of a particular index of constructing index numbers :
55
 SIMPLE INDEX where, Σq1 = sum total of the quantities of the
CONSTRUCTION OF
NUMBER current year
INDEX NUMBERS WEIGHTED Σq0 = sum total of the quantities of the base year
INDEX NUMBER
Ex 2 : Construct a Quantity index number using
A) Simple Index Number : In this method, the simple method from the given data :
every commodity is given equal importance. Steps : 1) Add the quantities of the different
It is the easiest method of constructing index
commodities of the base year to derive Σq0
numbers. This method can be applied to
determine 2) Add the quantities of the different commodities
1) Price Index Number of the current year to derive Σq1
2) Quantity Index Number 3) Apply the formula :
Σq
3) Value Index Number Quantity Index Number Q01 = Σq1 × 100
0
Some Solved Examples :
Commodities Qty. in 2000 Qty. in 2001
1) Price index number : It is measured as: (Base year) q0 (Current year) q1
Σp
Price Index Number P01 = Σp1 × 100 A 30 45
0

where, Σp1 = sum total of the prices of the current year B 55 70

Σp0 = sum total of the prices of the base year C 90 105

Ex 1 : Construct a Price index number using the D 35 60

simple method from the given data : Total Σq0 = 210 Σq1 = 280
Steps : 1) Add the prices of the different Σq
Quantity Index Number Q01 = Σq1 × 100
commodities of the base year to derive Σp0 0
280
2) Add the prices of the different commodities of Q01 = × 100 = 133.33
210
the current year to derive Σp1
Q01 =133.33
3) Apply the formula :
Σp 3) Value Index Number : It is measured as :
Price Index Number P01 = Σp1 × 100
0 Σp1q1
Commodities Prices in 2010 Prices in 2015 Value Index Number V01 = Σp q × 100
0 0
(in `) Base (in `) (Current
where, Σp1q1 = sum total of the product of the
year) p0 year) p1
prices and quantities of the current year.
A 20 30
B 60 80 Σp0q0 = sum total of the product of the prices and
C 100 130 quantities of the base year.
D 40 60 Ex 3 : Construct a Value index number using the
Total Σp0 = 220 Σp1 = 300 simple method from the given data :
Σp
Price Index Number P01 = Σp1 × 100 Steps : 1) Find the product of prices and their
0
300 respective quantities of the different commodities
P01 = 220 × 100 = 136.36 for the base year to derive p0q0. Take the sum
P01 =136.36 total of the products to derive Σp0q0.
2) Quantity index number : It is measured as : 2) Find the product of prices and their respective
Σq quantities of the different commodities for the
Quantity Index Number Q01 = Σq1 × 100
0

56
current year to derive p1q1. Take sum total of the Ex. 1 : Construct Laaspeyre’s Index for the given
products to derive Σp1q1. data :
3) Apply the formula : Commodities Base year Current year
Σp q p0 q0 p1 q1
Value Index Number V01 = Σp1q1 × 100 A 20 4 30 6
0 0
B 10 5 20 8
Commodities Base year Current year C 40 8 60 5
p0 q0 p0q0 p1 q1 p1q1
D 30 4 40 4
P 5 4 20 20 10 200
Solution :
Q 10 3 30 30 8 240
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
A 20 4 30 6 120 80
Total Σp0q0 = 100 Σp1q1 = 880
B 10 5 20 8 100 50
Σp q C 40 8 60 5 480 320
Value Index Number V01 = Σp1q1 × 100
0 0 D 30 4 40 4 160 120
880 Total 860 570
V01 = × 100 = 880
100
Steps : 1) Find out the product p1q0 of the
V01 = 880
different commodities.
B) Weighted Index Number : In this method, 2) Find out the product p0q0 of the different
suitable weights are assigned to various commodities.
commodities. It gives relative importance 3) Add all the products p1q0 obtained to derive
to the commodity in the group. In most of Σp1q0.
the cases ‘quantities’ are used as weights. 4) Add all the products p0q0 obtained to derive
There are various methods of constructing Σp0q0.
weighted index number such as Laaspeyre’s 5) Apply the given formula :
Price Index, Paasche’s Price Index etc. Σp1q0
P01 = Σp q × 100
Some Solved Examples : 0 0

Étienne Laspeyres : German 860

P01 = × 100 = 150.87
economist Étienne Laspeyres 570
(1834–1913) formulated an Thus, Laaspeyre’s index P01 = 150.87
index for measuring current
Do you know?
prices or quantities in relation to
Sensex and Nifty are stock market indices
those of a selected base period.
The distinctive feature of the Laspeyres index which represent Bombay Stock Exchange
is that it uses a group of commodities purchased (BSE) and National Stock Exchange (NSE)
in the base period as the basis for comparison. respectively.
Sensex, also called BSE 30, is the market
1) Laaspeyre’s Price Index Number : In
index consisting of 30 well-established
this technique, ‘base year’ quantities are
and financially sound companies listed on
considered as weights. Laaspeyre’s price
index is calculated as : Bombay Stock Exchange (BSE). The base
Σp1q0 year of Sensex is 1978-79.
P01 = Σp q × 100 Nifty, also called NIFTY 50, is the market
0 0

57
 5) Apply the given formula :
index consisting of 50 well-established
Σp q
and financially sound companies listed on P01 = Σp1q1 × 100
0 1
National Stock Exchange of India (NSE).
The base year of Nifty is taken as 1995. 134
P01 = × 100 = 212.69
63
Hermann Paasche : German economist Hermann Thus, Paasche’s index P01 = 212.69
Paasche (1851-1925) developed
Find out :
an index for measuring current
price or quantity levels relative   • List of crops included in the Index of
to those of a selected base period. Agricultural Production in India.
Paasche’s index uses current-   • List of products included in the Index of
period weighting. Industrial Production in India.
2) Paasche’s Price Index Number : In this
Limitations of index numbers :
technique, quantities of the ‘current year’
Index numbers are useful in practice.
are considered as weights. Paasche’s Price
However they suffer from certain limitations.
Index is calculated as :
Therefore, they are not completely reliable.
Σp q
P01 = Σp1q1 × 100 1) Based on samples : Index numbers are
0 1
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 constructed on the basis of various types of
O 1 7 2 10
data which may be incomplete. There may
P 5 8 10 5
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 numbers
p0 q0 p1 q1 p1 q1 p0 q1 can be misused. They compare a situation in
M 2 10 5 8 40 16 the current year with a situation in the base
N 4 5 8 3 24 12 year. Hence a person may choose a base
O 1 7 2 10 20 10 year which will be suitable for his purpose.
P 5 8 10 5 50 25 For example, a businessman may choose a
Total 134 63
year in which his profit is high as the base
Steps : 1) Find out the product p1q1 of the year and show that his profit is falling in the
different commodities. current years.
2) Find out the product p0q1 of the different 4) Defects in formulae : There is no perfect
commodities. formula for the construction of an index
3) Add all the products p1q1 obtained to derive number. It is only an average and so it has
Σp1q1. all the limitations of an average.
4) Add all the products p0q1 obtained to derive 5) Changes in the economy : The habits,
Σp0q1. tastes and expectations of the people in
58
 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 for
estimation of index numbers. one purpose then it cannot be used for any
6) Qualitative changes : The price or quantity other purpose.
index numbers may ignore the changes
Find out :
in qualities of the products. At any given
Newspaper headlines related to the
time, a better quality commodity will have
following types of index numbers :
a higher production cost and a higher price
than an ordinary commodity which is a • Price Index
substitute for the better product. • Agricultural Productivity Index
7) Arbitrary weights : The weights assigned • Index of Industrial Production
to different commodities may be arbitrary. • 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 index weights.
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 Σp q
1) Price Index   a)  1 1 × 100
policies. Σp0q0
d) Index numbers can be misused. Σq1
2) Value Index   b)  × 100
Options :1) b, c and d 2) a, c and d Σq0
3) a, b and d 4) a, b and c Σp1q1
3) Quantity Index   c)  × 100
Σp0q1
3) Statements that apply to weighted index
numbers. Σp1
4) Paasche's Index   d)  × 100
Σp0
a) Every commodity is given equal importance.
b) It assigns suitable 'weights' to various Options :1) 1-d, 2-c, 3-a, 4-b 2) 1-d, 2-a, 3-b, 4-c
commodities. 3) 1-b, 2-c, 3-d, 4-a 4) 1-c, 2-d, 3-a, 4-b

59
Q. 2. Complete the Correlation : 4) Calculate Laaspeyre's and Paasche's index from
1) Price Index : Inflation :: : Agricultural the 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 given level only.
data : 2) Index numbers are free from limitations.
Commodity P Q R S T
Base year quantities
3) Index numbers can be constructed without the
170 150 100 195 205
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 2) Explain the significance of index numbers in
Commodity
Price Quantity Price Quantity economics
A 40 15 70 20
B 10 12 60 22 Q. 7. Answer in detail :
C 50 10 90 18 1) Explain the steps involved in the construction of
D 20 14 100 16 index numbers.
E 30 13 40 15


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 factories, According to NIC “A national estimate
shops and markets, banks and financial measures the volume of commodities and
institutions, various departments and their offices services turned out during a given period
etc. National income is a composite measure counted without duplication.”
of all economic activities such as production,
2) Prof. A.C. Pigou : “National dividend is
distribution, exchange and consumption, but is
that part of objective income
also an objective indicator of economic welfare
of the community including of
of the people in a country.
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
5) Prof. Irving Fisher : “National dividend
compilation of National Income estimates. At
or income consists solely of
present, Central Statistical Organisation (CSO)
services as received by ultimate
compiles and publishes data on national income consumers, whether from their
and allied aggregates every year. material or from their human
Meaning : environments.”
Modern economy is a money economy. Features of National Income :
Hence, national income of a country is expressed 1) Macro Economic concept : National
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 : In
of goods and services produced in an economy order to avoid double counting in national
during a year. income, the value of only final goods and
61
 services produced in the economy are Firms, Government and Foreign sector)
considered. The value of intermediate goods Y = C + I + G + (X-M)
or raw materials is not considered. For The circular flow of goods and money in a
example, while estimating the production two sector model is explained below :
of shirts, there is no need to take the value Two sector model of Circular flow of National
of cotton, as it is already included in the Income :
price of the shirts. There are two sectors, households and
3) Net aggregate value : National income firms. It divides the diagram into two parts. The
includes net value of goods and services upper half represents the factor market and the
produced and does not include depreciation lower half represents the commodity market.
cost. (i.e. wear and tear of capital assets) Fig. no. 7.2 explaines circular flow of
4) Net income from abroad : National income and expenditure in a two sector model.
income includes net income from abroad i.e. Land, Labour, Capital and Enterprise
difference between export value and import
value (X-M) and net difference between Consumption Expenditure on
receipts from abroad and payments made Goods and Services
abroad (R-P).
Households Firms
5) Financial year : National income is always
expressed with reference to a time period.
Factor Income, Rent,
In India, it is from 1st April to 31st March. Wages, Interest, Profit
6) Flow concept : National income is a flow
concept as it shows flow of goods and Flow of Goods and Services
services produced in the economy during a Fig. 7.2
year. In the above figure 7.2, the factors of
7) Money value : National income is always production flow from the households to the
expressed in monetary terms. It represents firms. The firms use these factors to produce
only those goods and services which are goods and services required by the households.
exchanged for money. Thus, goods flow from the households to the
firms and from the firms back to the households.
Circular Flow of National Income :
It is called product flows.
Circular flow of income is the basic concept
In the same way, money flows from the
in macro economics. The circular flow of income
firms to the households in the form of factor
refers to the process whereby an economy's
payments such as rent, wages, interest and
money receipts and payments flow in a circular
profit. Households use this income to purchase
manner continuously through time.
goods and services. Thus, money flows from the
Circular flow of income can be determined firms to the households and from the households
for the following : back to the firms. It is called money flows.
1) Two sector Economy (Households and In the circular flow of income, production
Business Firms.)  Y = C + I generates factor income, which is converted
2) Three sector Economy (Households, into expenditure. This flow of income continues
Business Firms and Government sector) as production is a continuous activity due to
Y=C+I+G never ending human wants. It makes the flow of
3) Four Sector Economy (Households, Business income circular
62
 4) Net National Product (NNP) : Net National
Do you know?
Product is the net market value of all final
I) Three Sector Model of Circular Flow goods and services produced by the residents
of National Income : Under a three sector of a country, during a period of one year.
model, the government sector is added to ∴ NNP = GNP – Depreciation.
the existing two sectors i.e. households and
business firms. Find out :
II) Four Sector Model of Circular Income : India’s GDP data.
In an four sector model, foreign sector
is added to the existing three sectors You should know :
i.e. households, business firms and Concept of Green GNP :
government sector. It is defined as, “Green GNP is an
indicator of sustainable use of natural
Different Concepts of National Income : environment and equitable distribution of
Following are some of the important benefits of development.”
concepts related to national income. Gross National product does not take
1) Gross Domestic Product (GDP) : Gross into consideration the cost in terms of (i)
Domestic Product is the gross market value Environmental pollution, (ii) Depletion of
of all final goods and services produced natural resources caused by production of
within the domestic territory of a country, output. Mere increase in GNP will not reflect
during a period of one year. improvement in quality of life, when it
∴ GDP = C + I + G + (X-M) , increases environmental pollution or reduce
available resources for future generations.
Where C = Private consumption expenditure
So Green GNP has been introduced while
I = Domestic Private Investment measuring economic welfare.
G = Government's consumption and Investment Following are the characteristics of Green
Expenditures GNP :
X - M = Net export value (Value of Exports - 1) Sustainable economic development, i.e.
Value of imports development which should not cause
2) Net Domestic Product (NDP) : Net environmental degradation (pollution)
Domestic Product is the net market value and depletion of natural resources.
of all final goods and services produced, 2) Equitable distribution of benefits of its
within the territorial boundaries of a development.
country, during a period of one year. 3) Promotes economic welfare for a long
period of time.
∴ NDP = GDP – Depreciation.
Measurement :
3) Gross National Product (GNP) : Gross Green GNP = GNP - (Net fall in stock of
National Product means the gross value of natural capital + pollution load.)
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)
63
 consumers. Hence, the value of final output
Find out :
includes the value of intermediate products.
Names of five countries making use of
  For example, the price of bread includes,
the concept of Green GNP. the cost of wheat, making of flour, etc.,
Methods of Measurment of National Income : wheat and flour are both intermediate goods.
Their values are paid up during the process
There are three methods of measuring
of production. In the final product i.e. bread,
national income.
the values of intermediate goods are already
1) Output Method/Product Method
included.
2) Income Method
 Thus, a separate accounting of the
3) Expenditure Method
values of intermediate goods, along with
Output Method
the accounting of the value of final product,
Methods of Measurement
Income Method would mean double counting. To avoid this,
of National Income
Expenditure Method
the value of only the final product or goods
must be computed.
1) Output Method :
ii) Value Added Approach / The Value
This method of measuring national income
Added Method : In order to avoid double
is also known as product method or inventory
counting value added approach is used.
method.
According to this approach, the value added
This method approaches national income
at each stage of the production process is
from the output side. According to this method,
included. The difference between the value
the economy is divided into different sectors,
of final outputs and inputs, at each stage of
such as agriculture, mining, manufacturing,
production is called the value added. Thus,
small enterprises, commerce, transport,
GNP is obtained as the sum total of the
communication and other services. The output or
values added by all the different, stages of
product method is followed either by valuing all
the production process, till the final output is
the final goods and services, produced during a
reached in the hands of consumers, to meet
year, at their market price or by adding up all the
the final demand. This can be illustrated
values at each higher stage of production, until
with the help of the following table.
these products are turned into final products.
Table No. 7.1 - Value Added Method
While using this method utmost care must
Production stage Value of Value of Value
be taken to avoid multiple or double counting.
output ` input ` added `
To avoid double counting this method suggests
Cotton 150 0 150
two alternative approaches for the measurement Yarn 250 150 100
of GNP. Cloth 400 250 150
i) Final Goods Approach / The Final Product Shirt (final goods) 500 400 100
Approach : Final goods are those goods Total value 500
which are ready for final consumption. Value added at each stage is calculated by
According to this approach, value of all final deducting the value of inputs from the value of
goods and services produced in primary, output produced. The sum total added at different
secondary and tertiary sector are included stages make GNP. In the above table the value of
and the value of all intermediate transactions final good (Shirt) is ` 500. The sum total of value
are ignored. Intermediate goods are involved added at each stage of production is also ` 500.
in the process of producing final goods, that Thus the total value added is equal to the value of
is, the final flow of output purchased by final goods. (150 + 100 + 150 + 100 = 500)
64
Precautions : all added together, but income received in the
While estimating national income by output form of transfer payments are ignored. The data
method, following precautions should be taken: pertaining to income are obtained from different
1) To avoid double counting, only the value of sources, for instance, from income tax returns,
final goods and services must be taken into reports, books of accounts, as well as estimates
account. for small income.
2) Goods used for self consumption by GNP can be treated as the sum of factor
farmers should be estimated by a guess incomes, earned as a result of undertaking
work. Imputed value of goods produced economic activity, on the part of resource
for self consumption is included in national owners and reflected in the production of the
income. total output of goods and services during any
3) Indirect taxes included in the market prices given time period.
are to be deducted and subsidies given by Thus, GNP, according to income method, is
the government to certain products should calculated as follows:
be added for accurate estimation of national NI = Rent + Wages + Interest + Profit +
income. Mixed Income + Net income from abroad.
4) While evaluating output, changes in the NI = R + W + I + P + MI + (X–M)
price level between different years must be Precautions :
taken into account. While estimating national income by
5) Value of exports should be added and value income method, the following precautions
of imports should be deducted. should be taken.
6) Depreciation of capital assets should be 1) Transfer incomes or transfer payments like
deducted. scholarships, gifts, donations, charity, old
7) Sale and purchase of second hand goods age pensions, unemployment allowance
should be ignored as it is not a part of etc., should be ignored.
current production. 2) All unpaid services like services of a
 Output method is widely used in the housewife, teacher teaching her/his child,
underdeveloped countries. However, it should be ignored.
is less reliable because of the margin of 3) Any income from sale of second hand goods
error. In India, this method is applied to like car, house etc., should be ignored.
agriculture, mining and manufacturers, 4) Income from sale of shares and bonds
including handicrafts. But it is not applied should be ignored, as they do not add
for transport, commerce and communication anything to the real national income.
sectors in India. 5) Revenue received by the government
2) Income Method : through direct taxes, should be ignored, as
This method of measuring national income it is only a transfer of income.
is also known as factor cost method. This 6) Undistributed profits of companies, income
method estimates national income from the from government property and profits from
distribution side. public enterprise, such as water supply,
According to this method, the income should be included.
payments received by all citizens of a country, 7) Imputed value of production kept for self-
in a particular year, are added up, that is, consumption and imputed rent of owner
incomes that accrue to all factors of production occupied houses should be included.
by way of rents, wages, interest and profits are In India, the National Income Committee
65
 of the Central Statistical Organization, uses business sector for production of goods and
the income method for adding up the income services in any economy (G).
arising from trade, transport, professional 4) Net Foreign Investment/Net Exports : It
and liberal arts, public administration and refers to the difference between exports and
domestic services. imports of a country during a period of one
3) Expenditure Method : year.
This method of measuring national income 5) Net Receipts (R-P) : The difference
is also known as Outlay Method. between expenditure incurred by foreigners
According to this method, the total on domestic goods and services (R) and
expenditure incurred by the society, in a expenditure incurred abroad by residents
particular year, is added together. Income can on foreign goods and services (P).
be spent either on consumer goods or on capital Precautions:
goods. Thus, we can get national income by While estimating national income by
summing up all consumption expenditure and Expenditure Method, the following precautions
investment expenditure made by all individuals, should be taken.
firms as well as the government of a country
1) Expenditure on all intermediate goods and
during a year.
services should be ignored, in order to avoid
Thus, gross national product is found by adding
double counting.
up     NI = C + I + G + (X–M) + (R–P)
2) Expenditure on the repurchase of second
1) Private Final Consumption Expenditure hand goods, should be ignored, as it is not
(C) : Private Final Consumption Expenditure incurred on currently produced goods.
(C) by households on non-durable goods,
3) Expenditure on transfer payments
such as food, which are used immediately;
like scholarships, old age pensions,
expenditure on durable goods such as car,
unemployment allowance etc., should be
computer, television set, washing machine
ignored.
etc., which are generally used for a longer
4) Expenditure on repurchase of financial
period of time; and expenditure on services
assets such as shares, bonds, debentures etc.,
like transport services, medical services, etc.
should not be included, as such transactions
2) Gross Domestic Private Investment do not add to the flow of goods and services.
Expenditure (I) : It refers to expenditure 5) Indirect taxes should be deducted.
made by private businesses on replacement,
6) Expenditure on final goods and services
renewals and new investment (I).
should be included.
3) Government Final Consumption and 7) Subsidies should be included.
Investment Expenditure (G) :   Out of these methods, the Output Method
i) Government's final consumption and Income Method are extensively used.
expenditure refers to the expenditure In advanced countries like U.S.A. and U.K.
incurred by government on various the Income Method is popular. Expenditure
administrative services like, law and order, Method is rarely used by any country
defence, education, health etc. because of practical difficulties. In India,
ii) Government's investment expenditure refers the Central Statistical Organization (CSO)
to the expenditure incurred by government, adopts a combination of both output method
on creating infrastructural facilities like and income method to estimate national
construction of roads, railways, bridges, income of India.
dams, canals, which are used by the
66
 6) Valuation of Government Services :
You should know :
Government provides a number of public
Mixed income refers to the incomes of
services such as law and order, defence,
self employed persons who use their own
public administration, education, health
land, labour, capital and entrepreneurship
services etc. The calculation of these
to produce various goods and services.
services at market price is difficult, as the
Difficulties in the Measurement of National real value of these services is not known.
Income : Therefore, it is difficult to calculate national
There are various difficulties in the Income.
measurement of national income. 7) Changing price level : Difficulties in
A) Theoretical Difficulties or Conceptual calculating national income also arise due
Difficulties : to changes in price levels. For example,
1) Transfer payments : Individuals get when the price level rises, the national
pension, unemployment allowance etc. but income may show an increase even though
whether these transfer payments should the production may have decreased. Also,
be included in national income or not, is a when the price level falls, the national
major problem. On one hand they are a part income may show a decrease even though
of individual income and on the other hand, there may be an increase in production.
they are part of Government expenditure.
B) Practical Difficulties or Statistical
Hence, these transfer payments are not
Difficulties :
included in national income.
In practice, a number of difficulties arise
2) Illegal income : Illegal incomes like income
in the collection of statistical data required for
from gambling, black marketing, theft,
estimation of national income. Some of the
smuggling etc. are not included in national
practical difficulties are as follows :
income.
1) Problem of double counting : The greatest
3) Unpaid services : For the purpose of
difficulty in calculating national income is
calculating national income, only paid
of double counting. It arises from the failure
goods and services are considered. However,
to distinguish properly, between a final and
there are a number of unpaid services which
are not accounted for in the calculation of an intermediate product. For example, flour
national income. For example, services of used by a bakery is an intermediate product
housewives and the services provided out and that by a household is final product.
of love, affection, mercy, sympathy, charity 2) Existence of non-monetized sector : In
etc. are not included in national income. India, especially in rural areas, there exists
4) Production for self consumption : The the non-monetized sector. Agriculture, still
products kept for self consumption by the being in the nature of subsistence farming, a
farmers and other allied producers do not major part of production is partly exchanged
enter the market. Hence, it is not accounted for other goods and services. It is excluded
for in the national Income. while counting national income.
5) Income of foreign firms : According to 3) Inadequate and unreliable data : Adequate
IMF, income of a foreign firm, should and correct data on production and cost
be included in the national income of the data relating to crops, fisheries, animal
country, where the firm actually undertakes husbandry, forestry, construction workers,
the production work. small enterprises etc., are not available in
67
 a developing country. Besides this, data 1) For the Economy : National income data
on unearned incomes, consumption and are important for the economy of a country.
investment expenditure of rural and urban In present times, the national income data are
population are also not available. This does regarded as accounts of the economy, which
not reveal the actual size of national income. are known as ‘Social Accounts’. It tells us
4) Depreciation : Depreciation refers to wear how the aggregates of a nation's income,
and tear of capital assets, due to their use output and product result from the income of
in the process of production. There are no different individuals, products of industries
uniform, common or accepted standard and transactions of international trade.
rates of depreciation applicable to the 2) National policies : National income data
various capital assets. Thus, it is difficult to forms the basis of national policies such
make correct deductions for depreciation. as employment policy, industrial policy,
5) Capital gains or losses : Capital gains agricultural policy etc. These figures
or capital losses, which accrue to the enable us to know the direction in which
property owners by increase or decrease in the industrial output, investment and saving
the market value of their capital assets or etc., change. National Income also helps
changes in demand, are not included in the to generate economic models like growth
national income because these changes do model, investment models etc. Thus, proper
not result from current economic activities. measures can be adopted to bring the
economy to the right path.
6) Illiteracy and ignorance : Due to ignorance
and illiteracy, small producers do not keep 3) Economic planning : For economic
an account of their production. So they planning, data pertaining to national
cannot give information about the quantity income is very essential. This includes data
or value of their output. related to a country's gross income, output,
savings, investment and consumption which

7) Difficulties in the classification of
can be obtained from different sources.
working population : In India, working
population is not clearly defined. For 4) Economic Research : National income
instance, farmers in India are not engaged data are also used by the research
in agriculture round the year. Obviously, in scholars of economics. They make use of
the off season, they engage themselves in various data of the country's input, output,
alternative occupations. In such a case, it is income, savings, consumption, investment
very difficult to identify their incomes from employment etc., which are obtained from
a particular occupation. social accounts.
8) Valuation of inventories : Raw materials, 5) Comparison of Standard of Living :
intermediate goods, semi-finished and National income data helps us to compare
finished products in the stock of the the standards of living of people in different
producers are known as inventories. Any countries and of people living in the same
mistake in measuring the value of inventory, country at different times.
will distort the value of the final production 6) Distribution of Income : National income
of the producer. Therefore, valuation of statistics enables us to know about the
inventories requires careful assessment. distribution of income in the country from
the data related to wages, rent, interest and
Importance of National Income :
profits. We understand the disparities in the
The following points explain the importance
incomes of different sections of the society.
of the National Income :
68
 EXERCISE

Q. 1. Complete the following statements : d) Expenditure method – National Income = Rent

1) While estimating national income, we include         + Wages + Interest + Profit
only value of final goods and services in order Options : 1) a   2) b   3) c   4) d
to .........
Q. 4. Identify and Explain the following concepts :
a) make computation easier
1) Vrinda receives monthly pension of Rs.5,000/-
b) avoid double counting
from the State Government.
c) maximize national welfare of the people
2) Viru kept aside 100 kgs. out of 500 kgs. of
d) evaluate the total economic performance of a wheat produced in his farm for his family.
nation
3) Sheetal purchased wheat flour for her bakery
2) NDP is obtained by ......... from the flour mill.
a) deducting depreciation from GNP 4) Shobha collected data regarding the money
b) deducting depreciation from GDP value of all final goods and services produced
c) including depreciation in GDP in the country for the financial year 2018-2019.

d) including depreciation in GNP 5) Rajendra has a total stock of 500 gel pens in his
shop which includes the 200 gel pens produced
3) In India, national income is estimated using in the previous financial year.
.........
a) output method Q. 5. Answer the following :

b) income method 1) Explain the two sector model of circular flow of

national income.
c) expenditure method
2) Explain the importance of national income.
d) combination of output and income method
3) Explain the features of national income.
Q. 2. Complete the Correlation : 4) Explain the concept of Green GNP.
1) : C + I + G + (X-M) :: GNP : C + I + G
Q. 6. State with reasons, whether you agree or
+ (X-M) + (R-P).
disagree with the following statements :
2) Output method : :: Income method :
1) There are many theoretical difficulties in the
Factor cost method
measurement of national income.
3) Theoretical difficulty : Transfer payments ::
2) Under output method, value added approach is
: Valuation of Inventories
used to avoid double counting.
Q. 3. Choose the correct option :
Q. 7. Answer in detail :
1) Wrongly matched pair :
1) Explain the practical difficulties involved in the
a) National Income Committee – 1949
measurement of national income.
b) Financial year – 1st April to 31st March
2) Explain the income method and expenditure
c) Income method – National Income = Rent method of measuring national income.
+ Wages + Interest + Profit
+ Mixed income + Net 
Income from abroad

69
 8 Public Finance in India

Find out :
More examples of obligatory and
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 expenditure. Thus, ‘public finance’
Fig. 8.1 is nothing but a study of the principles of income
Introduction : and expenditure of the government at central,
Public finance is one of the old branches of state and local levels. This study is done under
economics which highlights the role and functions the public finance branch in economics.
of the government in an economy. Government Definitions of Public Finance :
is a formal or informal institution created by the
Different economists have defined public
people in a specific region to perform various
finance in their own ways. Let us study some of
functions such as protection from external
these definitions :
attacks, protection of private property of the
people, generation of employment, maintaining 1) According to Hugh Dalton : “Public
internal law and order, provision of social needs finance is one of those subjects which are
like education, health, etc. on the borderline between economics and
politics. It is concerned with the income and
These functions of the government can be
expenditure of public authorities and with
classified as :
the adjustment of one with the other.” Since
1) Obligatory functions : Protection from we study the activities of the governments
external attacks, maintaining internal law in political science too, public finance also
and order etc. are obligatory functions of constitutes a part of the study of political
the government. science.
2) Optional functions : Provision of education
2) According to Prof. Findlay Shirras :
and health services, provision of social
“Public finance is the study of the principles
security like pensions and other welfare
underlying the spending and raising of
measures etc. are optional functions of the
funds by public authorities.”
government.
70
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 income
expenditure volume and different ways of its and then determines the volume of
expenditure 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 :

The components or scope of public finance can be shown as below :

Structure of Public Finance at a Glance

I) Public II) Public III) Public IV) Fiscal V) Financial

Expenditure Revenue Debt Policy Administration

A) Tax B) Non-Tax
Internal External

Direct Indirect
(Revenue expenditure
and debit policy for
  1) Proportionate Goods and overall growth)
  2) Progressive Services Tax
(GST)   1) Fees
  3) Regressive
  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 :
71
I) Public Expenditure : in generation of employment, increase in
Public expenditure is that expenditure which production, price stability etc. is known as
is incurred by the public authority [Central, developmental expenditure. For example,
State and Local Bodies] for protection of their expenditure on health, education, industrial
citizens, for satisfying their collective needs and development, social welfare, Research and
for promoting their economic and social welfare. Development (R & D) etc.
Till 20th century, the majority of the D) Non-Developmental Expenditure : On the
governments had adopted a policy of laissez other hand, that government expenditure
faire. Under this policy, the functions of which does not yield any direct productive
government were restricted to the obligatory impact on the country is called non-
functions. But, the modern governments not developmental expenditure. For example,
only perform the obligatory functions such administration costs, war expenditure etc.
as defence and civil administration, but also These are unproductive in nature.
perform optional functions for promoting social
and economic development of their countries. Do you know?
Therefore, study of public expenditure is an Trends in Public Expenditure in India
important part of study of public finance. since Independence
Sr. No. Year Total Expenditure (` Cr.)
Classification of Public Expenditure :
1 1991-92 72,317
Different economists have classified public
2 2001-02 3,62,450
expenditure on different bases. We shall now
study some of the important classification of 3 2005-06 5,06,123
public expenditure. 4 2009-10 10,24,487
5 2015-16 11,95,025
A) Revenue Expenditure : Revenue
6 2016-17 13,74,203
expenditure of the government is for
incurred carrying out day-to-day functions 7 2017-18 14,35,233
of the government departments and 8 2018-19 17,29,682
Source - Economic Survey, Government of India- 2018-19
various services. It is incurred regularly.
For example, administration costs of the Given table shows trends in public
government, salaries, allowances and expenditure in India since 1991-92 for
pensions of government employees, medical select years. It can be clearly observed
and public health services etc. that there is tremendous growth in the total
public expenditure of the country over the
B) Capital Expenditure : Capital expenditure
period.
of the government is expenditure for
progress and development of the country. Reasons for Growth in Public Expenditure :
For example, huge investments in different It is observed that there is a continous
development projects, loans granted to growth in public expenditure in a developing
the state governments and government country like India.
companies, repayment of government Let us study some of the important reasuns :
loans etc.
1) Increase in the Activities of the
C) Developmental Expenditure : Government : As mentioned earlier,
Developmental expenditure is productive the modern government performs many
in nature. The expenditure which results functions for the social and economic
72
 development of the country. These functions production, employment and overall growth
include spread of education, public health, in the economy. Hence, the government
public works, public recreation, social makes huge efforts for implementing
welfare schemes etc. It is observed that various schemes and programmes for
new functions are continuously being industrial development. This results in
undertaken and old functions are being increase in government expenditure.
performed more efficiently on a large scale
8) Disaster Management : Many natural and
by the government. This leads to increase in
man-made calamities like earthquakes,
public expenditure.
floods, cyclones, social unrest etc. are
2) Rapid Increase in Population : Population occurring more frequently. The government
of developing countries like India is has to spend a huge amount for the
increasing fast. In 2011 Census, it was disaster management which increases total
121.02 crores. As a result, the government expenditure.
has to incur greater expenditure to fulfil the  Modern governments are working for
needs of the increasing population. ‘welfare state’. Hence, there is a continuous

3) Growing Urbanization : Spread of increase in the public expenditure.
urbanization is a global phenomenon
Find out :
of the day. This leads to increase in the
Reasons for growth in public expenditure
government expenditure on water supply,
other than given above.
roads, energy, schools and colleges, public
transport, sanitation etc.
Find out :
4) Increasing Defence Expenditure : In
Important social welfare schemes by the
modern times, defence expenditure of
Govt.
the government is increasing even in the
peace time due to unstable and hostile II) Public Revenue :
international relationships.
Public revenue means the aggregate
5) Spread of Democracy : Majority of the collection of income with the government
countries in the world are democratic in through various sources. Public revenue holds
nature. A democratic form of government is the permanent position in the study of public
expensive due to regular elections and other finance which is part of study of economics.
such activities. This results in the increase Thus, the necessity of public revenue arises due
in total expenditure of the government. to public expenditure.
6) Inflation : Just like a private individual, the The main sources of public revenue are as
government has to buy goods and services follows.
from the market for the spread of economic Sources of Public Revenue :
and social development. Normally, prices
A) Taxes B) Non-tax Revenue :
show a rising trend. Due to this, the
government has to incur increasing costs. A) Taxes :
1) According to Prof. Taussig : “The essence

7) Industrial Development : Industrial
of a tax as distinguished from other charges
development leads to an increase in
by government is the absence of a direct
73
 quid pro quo between the tax payer and the
this canon, every tax should be levied in
public authority.”
such a manner and at such a time that it
2) According to Prof. Seligman, “A tax is a
becomes convenient to the tax payer.
compulsory contribution from the person to
4) Canon of Economy : According to this
the government without reference to special
canon, the cost of tax collection should
benefits conferred.”
be the minimum. If a major portion
 A tax possesses following essential
of the tax proceeds is spent on the tax
characteristics :
collection itself, then such a tax cannot
  1) It is a compulsory contribution to the
be considered as a good tax.
government and every citizen of the country
is legally bound to pay the tax imposed upon Types of Taxes :
him. It is a major source of revenue to the    There are two main types of taxes. They are :
government. If any person does not pay a
1) Direct Tax and 2) Indirect Tax.
tax, he can be punished by the government.
Let us study in details :
  2) Tax is paid by a taxpayer to enable
government to incur expenses in the 1) Direct Tax : It is paid by the taxpayer on
common interests of the society. his income and property. The burden of tax
is borne by the person on whom it is levied.
  3) The payment of a tax by a person does
As he cannot transfer the burden of the tax
not entitle him to receive any direct and
to others, impact and incidence of direct
proportionate benefits or services from the
tax falls on the same person. For example-
government in return for the tax.
personal income tax, wealth tax etc.
  4) Tax is imposed on income, property or
commodities and services. 2) Indirect Tax : It is levied on goods or
services. It is paid at the time of production
You should know : or sale and purchase of a commodity or a
Canons (Principles) of Taxation : service. The burden of an indirect tax can
Adam Smith, the founder of Modern be shifted by the taxpayer (producers) to
economics propounded the following four other person/s. Hence, impact and incidence
canons of taxation : of tax are on different heads. For example,
1) Canon of Equity or Equality : Smith newly implemented Goods and Services
suggested that every person will pay the Tax [GST] in India has replaced almost all
taxes to the government in proportion to indirect taxes, custom duty.
his ‘ability to pay’. It means rich people Do you know?
should pay more tax compared to the poor. Direct taxes are further classified into
2) Canon of Certainty : According to three categories depending upon the rate of
Smith, the taxpayer should know in tax. These are :
advance how much tax he has to pay, 1) Proportionate tax : When a tax is levied
at what time he has to pay the tax and at the same and constant rate on all
in what form the tax is to be paid to the incomes, it is called proportional tax.
government. 2) Progressive tax : A tax, the rate of which
3) Canon of Convenience : According to increases with every increase in income

74
 violating traffic rules. However, the income
is called progressive tax. In India we
from this source is small.
have progressive tax rate system.
5) Gifts, Grants and Donations : The
3) Regressive tax : In regressive taxation,
government may also earn some income
the larger the income of a tax-payer, the
in the form of gifts by the citizens and
smaller is the proportion of the tax levied
others. The government may also receive
on him.
grants from the foreign governments and
B) Non-Tax Revenue Sources : institutions for general and specific purposes.
Foreign aid has become an important source
Public revenue received by the government
of development finance for a developing
administration, public enterprises, gifts and
country like India. However, this source of
grants etc. are called as non-tax revenue. These
revenue is uncertain in nature.
sources are different than the taxes. A brief
6) Special levies : This is levied on those
information about these sources are as follows :
commodities, the consumption of which
1) Fees : A tax is paid compulsorily without
is harmful to the health and well-being
any return service whereas, fee is paid in
of the citizens. Like fines and penalties,
return for certain specific services rendered
the objective is not to earn income, but to
by the government. For example- education discourage the consumption of harmful
fee, registration fee, etc. commodities by the citizens. For example-
2) Prices of public goods and services : duties levied on wine, opium and other
Modern governments sell various types of intoxicants.
commodities and services to the citizens. A 7) Borrowings : The government can borrow
price is a payment made by the citizens to from the people in the form of deposits,
the government for the goods and services bonds etc. It also gets loans from foreign
sold to them. For example- railway fares, governments and organizations such as
postal charges etc. IMF, World Bank etc. Loans are becoming
3) Special Assessment : The payment made more and more popular source of revenue
by the citizens of a particular locality for the governments in the modern times.
in exchange for certain special facilities
Do you know?
given to them by the authorities is known
Goods and Services Tax [GST]
as ‘special assessment.’ For example-
The Goods and Services Tax [GST]
local bodies can levy a special tax on the
came into effect in India on July 1, 2017. It
residents of a particular area where extra/
was proposed by the Kelkar Task Force on
special facilities of roads, energy, water
Implementation of the Fiscal Responsibility
supply etc. are provided.
and Budget Management [FRBM] Act
4) Fines and Penalties : The government in July, 2004. The 101st Amendment in
imposes fines and penalties on those who the Constitution Act, 2016 provided for
violate the laws of the country. The objective the constitution of the Goods and Services
of the imposition of fines and penalties is Tax Council[GSTC] comprising the
not to earn income, but to discourage the Union Finance Minister, the Minister of
citizens from violating the laws framed by State[Revenue] and the Finance Ministers
the Government. For example, fines for 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
  • Boost to foreign investments and ‘Make bank, financial institutions, business houses
in India’, campaign. etc. within the country, it is known as
  • Harmonization of laws, procedures and internal debt.
rates of tax. 2) External Debt : When a government
  • Boost export and manufacturing activity. borrows from foreign governments,
  • Improvement in the overall investment foreign banks or institutions, international
climate in the country. organizations like International Monetary
Fund, World Bank etc., it is known as
  • Simplifying the tax system in the country.
external debt.
76
 Table no. 8.1 shows the difference between Government Budget :
Internal debt and External debt. Budget is an important instrument of financial
Table 8.1 administration through which all the financial
affairs of the state are regulated. Budget is a
Differences between Internal and External Debt
financial statement showing the expected receipts
Sr. No. Internal Debt External Debt and proposed expenditures of the government in
1 Raised within the Raised outside the coming financial year. In India, a financial
economy the economy year is from 1st April to 31st March. Article 112
2 Voluntary or Voluntary in of the Constitution of India has a provision for
compulsory in nature nature
annual financial statement. In every budget, a set
3 Use of domestic Use of foreign
of seven budget documents describe the details of
currency currency
Government finance in India.
4 Less complex for More
management complex for The word ‘Budget’ is derived from the
management French word ‘Bougette’,which means a bag
or a wallet containing the financial proposals.
Try this : These financial proposals are in the form of the
Classify the following activities into Government expenditure and revenue.
Internal and External Debt :
Do you know?
1) Government selling bonds to its citizens.
The term ‘Budget’ is not used in the
2) Government of India borrowing funds
Constitution of India. It refers to the ‘Annual
from the World Bank for provision of
Financial Statement’ of the Government.
water supply.
3) Government of India takes loans from Revenue and Capital Budgets :
Nationalized Banks for developing Central Budget provisions are divided into-
infrastructure facilities in the country. 1) Revenue Budget and
4) Government of India takes loans from
2) Capital Budget.
World Bank for Mumbai Metro Train.
1) Revenue Budget : It consists of revenue
IV) Fiscal Policy : receipts and revenue expenditure of the
Fiscal policy is the means by which a government. Revenue receipts are divided
government adjusts its spending levels and into tax and non-tax revenue. Revenue
tax rates to monitor and influence a nation's expenditure comprises of interest paid on
economy. It deals with the public expenditure, Government borrowings, subsidies and
public revenue and public debt. In short, it grants given to the state governments.
is the financial policy implemented by the 2) Capital Budget : The capital budget
Government. consists of capital receipts and capital
V) Financial Administration : payments. Capital receipts are Government
A smooth and efficient implementation loans raised from the public and the Reserve
of revenue, expenditure and debt policy of Bank of India, divestment of equity holding
the Government, is referred to as financial in the public sector enterprises, loans
administration. This includes preparation and received from the foreign Governments and
implementation of the Government budgets other foreign bodies, State deposit funds,
along with overall growth of the country. special deposits etc.
77
 Capital payments refer to the capital of inflation, there is a tendency for prices
expenditures on various development to rise rapidly. This needs to be checked,
projects, investments by the Government, particularly in the interest of those who
loans given to the state Governments, have more or less a fixed income. The rise in
and Government companies, corporations prices can be checked by lowering the level
and other parties. Besides, it includes of effective demand in the economy. This
expenditure on social and community can be done by increasing taxes which would
development, defence and general services. increase the revenue of the government and
Types of Budget : reduce the purchasing power of the people.
The budgetary provisions of public As a result, the aggregate demand will fall
expenditure and revenue need to be at different leading to downward movement in the price
levels as per the changing needs of the economy. level. Thus, inflationary pressures can be
Accordingly, Government budget is of three controlled.
types :   However, a surplus budget should not be
1) Balanced Budget used in the situations other than inflation
as it may lead to unemployment and low
2) Surplus Budget
levels of output in an economy.
3) Deficit Budget
3) Deficit Budget : Government budget
1) Balanced Budget : Government budget
is said to be deficit, when anticipated
is said to be balanced, when estimated
Government receipts are less than the
revenue and expenditure of the government
estimated Government expenditure. That
are equal. That is, Government Receipts =
is anticipated Government Receipts <
Government Expenditure.
estimated Government expenditure.
 The concept of a balanced budget was
  A deficit budget may prove useful during
advocated by the classical economists like
the period of depression. In the period of
Adam Smith. It was considered as neutral
depression, all economic activities are at
in its effect on the working of the economy low level which results in unemployment.
and hence, they regarded it as the best. This can be checked by increasing
 However, modern economists believe Government expenditure, by borrowing
that the policy of balanced budget may money and through deficit financing. This
not always be suitable for the economy. will increase employment and aggregate
The modern Governments are welfare effective demand for goods and services
entities and hence, they cannot keep their which would encourage further investment.
expenditure at the level of their receipts. In modern times, deficit budget is the most
2) Surplus Budget : Government budget commonly implemented policy of any
is said to be surplus, when estimated Government.
Government receipts are more than the  Developing countries like India have
estimated Government expenditure. consistently resorted to deficit budget
i.e. anticipated Government Receipts > technique for economic development.
estimated Government Expenditure. Importance of Budget :
 A surplus budget may prove useful Union Budget is important because it
during the period of inflation. In the period affects people and economy in general in a
78
number of ways. Taxes are the most interesting because Governments use it as a medium for
part of any budget. Taxes determine the fate implementing economic policies in the country.
of businesses and individuals. The level of Budgetary actions of the Government affect
disposable income of the taxpayers depends on production, size and distribution of income and
the tax rates presented in the budget. Government utilization of human and material resources of
expenditure on various heads such as defence, the country.
administration, infrastructure, education and Thus, the scope and importance of public
health care etc. affects the lives of the citizens finance in a modern economy has undergone an
and overall economy. Also, budget is important immense change since last 100 years.

EXERCISE

Q. 1. A) Choose the correct option : c) Fees

1) Optional functions of Government : d) Special Levy
a) Protection from external attack Options : 1) b and c 2) a and c
b) Provision of education and health services 3) a, b, c and d 4) c and d
c) Provision of social security measures 5) Trends shown by Public expenditure of any
d) Collection of tax Government shows following trend.
Options : 1) b and c 2) a, b and c a) Constant b) Increasing
3) b, c and d 4) All of the above c) Decreasing d) Fluctuating
2) Obligatory functions of the Government : Options : 1) only a 2) only b
a) Provision of employment 3) only c 4) only d
b) Maintaining internal law and order
6) Identify the right group of pairs from the given
c) Welfare measures options.
d) Exporting goods and services i) Direct tax a) Non-tax revenue
Options : 1) c and d 2) a and b ii) Indirect tax b) Inflation
3) only b 4) a, c and d iii) Fees and Fines c) GST
3) "Definition - Public finance is one of those iv) Surplus budget d) Personal income tax
subjects which are on the borderline between
Options : a) i-d ii-c iii-b iv-a
economics and politics." ......... given by
  b) i-c ii-d iii-a iv-b
a) Adam Smith
  c) i-d ii-c iii-a iv-b
b) Alfred Marshall
  d) i-a ii-b iii-c iv-d
c) Prof. Hugh Dalton
Q. 2. Distingwish between following concepts :
d) Prof. Findlay Shirras
1) Public finance and Private finance.
Options : 1) only a 2) only b
2) Internal debt and External debt.
3) only c 4) only d

3)
Developmental expenditure and Non-
4) Non-tax sources of revenue : developmental expenditure.
a) Direct and Indirect Tax 4) Special assessment and Special levy.
b) Direct Tax and Fees 5) Direct Tax and Indirect tax.

79
Q. 3. State with reasons whether you agree or population was numerals enough and earning enough
disagree with the following statement : to generate the taxes to pay for the care of those
1) Obligatory function is the only function of the not working. This model is ill-suited for less, well-
Govenment. off India with growing life expectancy, increasing
2) Fines and penalties are a major source of urbanization and resultant migration. Social security
revenue for the Government. under urbanization will be different from social
3) The goods and services tax (GST) has replaced security in a static society.
almost all indirect taxes in India. 1) State the conventional notion of social security.
4) Democratic Governments do not lead to 2) What kind of conceptual change is suggested in
increase in public expenditure. the given paragraph.
5) Public finance is more elastic than private 3) What is a legacy of social security from the rich
finance. world?
4) Which features of India make the traditional
Q. 4. Read the given passage and answer the
model of social security ill-suited for the
questions :
economy?
“The conventional notion of social security is
that the government would make periodic payments Q. 5. Answer the following :
to look after people in their old age, ill-health, 1) State the types and importance of Government
disability and poverty. This idea should itself budget.
change from writing a cheque for the beneficiary to 2) Explain the principles of taxation.
institutional arrangements to care for beneficiaries,
3) Explain non-tax sources of revenue of the
including by enabling them to look after themselves,
Government.
to a large extent.
The write-a-cheque model of social security is Q. 6. Answer in detail :
a legacy from the rich world at the optimal phase 1) Explain various reasons for the growth of public
of its demographic transition, when the working expenditure.



80
 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, identify the
money. It includes funds needed by individuals, type of finance involved (Personal finance/
business houses and the Government for various Corporate finance /Public finance) :
purposes. Thus, finance is categorized as • Building a retirement corpus
personal finance, corporate finance and public • Raising share capital through sale of
finance. The financial system of the country is equity shares
responsible for the mobilization and allocation • Collection of tax revenue
of funds. It helps in creation of wealth which • Clearing home loan through EMI
is vital for the economic development of the (Equated Monthly Instalment)
country. The financial system in India comprises • Expenditure on social infrastructure such
of financial institutions, financial markets, as health and education
financial instruments and financial services. • Managing working capital needs
FINANCIAL INSTITUTIONS
A) Money Market in India :
FINANCIAL MARKETS
Meaning :
INDIAN
Money market is a market for lending and
FINANCIAL
SYSTEM FINANCIAL INSTRUMENTS borrowing of short term funds. It is a market for
“near money” i.e. short term instruments such
FINANCIAL SERVICES as trade bills, government securities, promissory
This chapter deals exclusively with notes etc. Such instruments are highly liquid,
financial markets in India. Financial markets less risky and easily marketable with a maturity
are an important component of the financial period of one year or less than one year.
system.
Do you know?
Meaning of Financial Market :
Some Financial Instruments :
Financial market refers to a market where
•  Bonds refer to debt instruments issued by
sale and purchase of financial assets such
companies or the government as a means of
as bonds, stocks, derivatives, government
borrowing long term funds.
securities, foreign currency etc. is undertaken.
•  Equity shares refer to shares of a
Financial markets operate through banks, non-
company held by an individual or a group.
banking financial institutions, brokers, mutual
•  Derivatives refer to a financial security
funds, discount houses etc. Financial markets
which derives its value/price from the
include two distinct markets i.e. the Money
underlying assets such as bonds, stocks,
market and Capital market.
currency, interest rates, commodities etc.
FINANCIAL MARKETS
•  Government securities refer to debt
instruments issued by a government with a
MONEY MARKET CAPITAL MARKET promise of repayment at maturity.

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

RBI

COMMERCIAL BANKS
ORGANIZED
CO-OPERATIVE BANKS
SECTOR
DEVELOPMENT FINANCIAL
INSTITUTIONS
DISCOUNT AND FINANCE Functions of Reserve Bank of India
HOUSE OF INDIA
1) Issue of Currency Notes : RBI has the
INDIGENOUS BANKERS sole right to issue currency notes of all
UNORGANIZED denominations, except one rupee note
MONEY LENDERS
SECTOR and coins. As per the ‘Minimum Reserve
UNREGULATED NON-BANK System’ of 1957, RBI is required to maintain
FINANCIAL INTERMEDIARIES minimum gold and foreign exchange
Fig. 9.1 reserves of Rs 200 crores, out of which at
82
 least ` 115 crores should be in gold and the 6) Collection and Publication of Data : RBI
remaining ` 85 crores should be in terms of collects and compiles statistical information
foreign currency and government securities. related to banking and other financial
2) Banker to the Government : RBI acts sectors of the economy.
as a banker, agent and advisor to the
7)
Promotional and Developmental
Government. It transacts the business of Functions : RBI also performs certain
both, the Central and State Governments. It promotional and developmental functions
accepts money as well as makes payments such as extending banking services to semi-
on behalf these Governments. It also urban and rural areas, providing security
undertakes the management of public debt. to depositors, development of specialized
It advises the Government on a wide range institutions for agricultural credit, industrial
of economic issues. finance etc.

3) Banker’s Bank : RBI exercises statutory 8) Other Functions : RBI acts as a clearing
control over the commercial banks. All house for settling the accounts between
scheduled banks are compulsorily required its member banks. As a lender of last
to maintain a certain minimum of cash resort, it also provides liquidity to banks
reserves with the RBI against their demand experiencing financial difficulty.
and time liabilities. RBI provides financial Find out :
assistance to banks in the form of discounting Names of the Central Banks of the
of eligible bills. Loans and advances are following countries :
also provided against approved securities.
• USA • UK (United Kingdom)

4)
Custodian of Foreign Exchange • CANADA • SWEDEN
Reserves : RBI acts as a custodian of the • RUSSIA • FRANCE
country’s foreign exchange reserves. It has
• GERMANY • JAPAN
to maintain the official rate of exchange of
• CHINA • AUSTRALIA
rupee as well as ensure its stability. RBI also
undertakes to buy and sell the currencies b) Commercial banks : Commercial banks act
of all the members of the International as intermediaries in the country’s financial
Monetary Fund (IMF). system to bring the savers and investors
5) Controller of Credit : As a supreme banking together. They are profit seeking financial
authority of the country, RBI has the power institutions. Acceptance of deposits and
to influence the volume of credit created granting loans and advances are the
by commercial banks. It also monitors primary functions of commercial banks.
the purpose or use of credit. Quantitative Commercial banks play an important role in
methods such as bank rate, open market mobilizing savings and allocating them to
operations, variable reserve ratios such various sectors of the economy. It includes
as Cash Reserve Ratio (CRR), Statutory both scheduled commercial banks and non-
Liquid Ratio (SLR) etc. control the volume scheduled commercial banks. Scheduled
of credit created. Qualitative methods commercial banks are those included in
such as fixing margin requirements, credit the second schedule of the Reserve Bank of
rationing, moral suasion etc. regulate the India Act, 1934. In terms of ownership and
purpose or use of credit. function, commercial banks in India can be

83
 classified into four categories: at regular intervals for a specified period of
• Public sector banks time.
• Private sector banks • Fixed deposits refer to a lumpsum amount
• Regional rural banks deposited by a customer for a specified
• Foreign banks period of time. Compared to all other
deposits, fixed deposits carry a high rate of
Popular Definitions of Commercial Bank :
interest.
Banking Regulation Act of 1949 : “Banking

2)
Providing loans and advances :
means the accepting, for the purpose of lending
Commercial banks mobilize savings
or investment, of deposits of money from the
and lend these funds to institutions and
public, repayable on demand or otherwise, and
individuals for various purposes. Based on
withdrawable by cheque, demand draft, order or
the tenure, loans include call loans, short
otherwise.”
term, medium term and long term loans.
Prof. Cairncross : “A bank is a financial Longer the duration of the loans, greater will
intermediary, a dealer in loans and debts.” be the rate of interest. Besides this, banks
Functions of Commercial Banks : also provide cash credit, overdraft facility
1) Acceptance of deposits : Deposits constitute as well as discount bills of exchange.
the main source of funds for commercial 3) Ancillary functions : Commercial banks
banks. Savings lead to the creation of also provide a range of ancillary services
deposits. Deposits are categorized as (i) such as transfer of funds, collection of
Demand deposits and (ii) Time deposits. money, making periodical payments on
i) Demand Deposits : Deposits that are behalf of the customer, merchant banking,
withdrawable on demand are known as foreign exchange, safe deposit lockers,
demand deposits. They are in the form D-mat facility, internet banking, mobile
of Current account and Savings account banking etc.
deposits. 4) Credit Creation : Credit creation is an
• Current account is usually opened by important function of commercial banks.
businessmen, corporations, industrial Commercial banks are creators of credit.
houses, trusts etc. They are provided Demand and time deposits constitute the
with overdraft facility. Overdraft means primary deposits of banks. After meeting the
withdrawal in excess of the balance in the reserve requirements out of the net demand
account. and time liabilities, the balance amount
is used for giving loans. Thus, secondary
• Savings account are operated by a large
deposits or ‘derivative deposits’ are
number of people, particularly the salaried
created out of the loans given by the banks.
class, small traders etc. who wish to save a
   For instance, when the bank provides loan
part of their income with the bank.
to its customer, the loan amount is credited
ii) Time deposits : Deposits that are repayable into the bank account of the customer. The
after a certain period of time are known bank that receives the loan amount as a
as time deposits. They are in the form of deposit, keeps aside a certain portion in the
recurring deposits and time deposits form of reserves. After meeting the reserve
• Recurring deposit refers to a deposit requirements, the bank lends the remaining
wherein a customer deposits a fixed amount amount. This procedure is followed by the
84
 entire banking system in the country, leading co-operative banks and state co-operative
to creation of credit. In short, commercial banks.
banks create deposits out of the loans given Fig. 9.3 explains the structure of co-
thereby leading to crediton. operative banks in India :
Three Tier Co-operative Credit Structure

State Co-operative Bank

State (Apex Bank)
Level

District District Central

Level Co-operative Bank

Primary Primary Co-operative

Level credit Societie

Fig. 9.3

Try this :
Collect information of Co-operative
banks operating in your region at different
levels.

d)
Development Financial Institutions
(DFIs) : Development financial institutions
Fig. 9.2
are agencies that provide medium and
Try this : long-term financial assistance. They help
Pair the logos given with their respective in the development of industry, agriculture
banks as given in the bracket below: and other key sectors. Industrial Finance
(State Bank of India, HSBC Bank, Union Corporation of India (IFCI) was the first
Bank of India, Axis Bank, Standard development financial institution to be
Chartered Bank, HDFC Bank) established in 1948.

Let's recall :
You have already studied in class
c) Co-operative Banks : Co-operative banks XI about NABARD which is the apex
came into existence with the enactment of institution in the rural credit structure. It
the Co-operative Credit Societies Act of provides credit for promotion of agriculture,
1904. Co-operative banks supplement the small-scale industries, cottage and village
efforts of commercial banks by meeting industries, handicrafts etc.
the credit needs of the local population.
Development financial institutions
It fulfills the banking needs of small and
have diversified their operations with the
medium income groups. The co-operative
advent of liberalization and globalization.
credit sector comprises of co-operative
They have set up subsidiaries to offer a
credit institutions such as primary co-
wide range of new products and services
operative credit societies, district central
85
 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 are the activities of the money lenders have been
in the process of converting themselves into restricted by RBI due to their exploitative
universal banks. RBI has issued guidelines tendencies.
for development financial institutions iii)
Unregulated Non-Bank Financial
to become commercial banks. For e.g. Intermediaries : They include Chit funds,
ICICI (Industrial Credit and Investment Nidhi, loan companies etc. Under Chit
Corporation of India) has become a funds, members make regular contribution
universal bank by a reverse merger with its to the fund. Bids or draws are made on the
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 Committee. benefit fund thriving on the contribution
It is jointly owned by the RBI, public sector of its members. Loans are provided to
banks and financial institutions to impart members at reasonable rates of interest.
liquidity to the money market instruments. Loan companies are finance companies.
2) Unorganized Sector : The unorganized They provide loans to traders, small-scale
money market in India comprises of industries and self-employed persons.
indigenous bankers, money lenders Being unregulated, they charge a high rate
and unregulated non-bank financial of interest on loans.
intermediaries. The activities of the NIDHI
UNREGULATED
unorganized money market are largely NON-BANK CHIT FUNDS
confined to the rural areas. FINANCIAL
INTERMEDIARIES LOAN COMPANIES
i) Indigenous bankers : They are financial
intermediaries that function similar to
banks. They mostly deal in indigenous Do you know?
short-term credit instruments such as Money market instruments :
hundi. The rate of interest differs from one The following instruments are traded in
market to another. Indigenous bankers are the money market :
mostly confined to certain social strata.
• Call / Notice Money Market : When
They are an important source of funds in
money is borrowed or lent for a day, it is
unbanked areas and provide loans directly
known as call (overnight) money. When
to agriculture, trade and industry.
money is borrowed or lent for more than
ii) Money lenders : They mostly operate in a day up to 14 days, it is known as notice
the villages. Money lenders usually charge money.
a high rate of interest. The loans provided • Treasury Bills (TBs) : They are short
by money lenders are for both productive term instruments issued by the RBI on
and unproductive purpose. Agricultural

86
 Government to fulfil its short term financial
behalf of the government to meet temporary
requirements on the basis of Treasury Bills.
liquidity shortfalls.
6) Implementation of Monetary policy :
• Commercial Papers (CPs) : It is an
Monetary policy is implemented by the
unsecured promissory note, negotiable and
central bank. It aims at managing the
transferable by endorsement and delivery
quantity of money in order to meet the
with a fixed maturity period.
requirements of different sectors of the
• Certificate of Deposits (CDs) : They are economy and to increase the pace of
unsecured, negotiable instruments in bearer economic growth. A well-developed money
form issued by commercial banks and market ensures successful implementation
development finance institutions. of the monetary policy. It guides the central
• Commercial Bills (CBs) : They are bank in developing an appropriate interest
short term, negotiable and self-liquidating policy.
instruments with low risk. 7) Economizes the use of cash : Money market
Role of Money Market in India : deals with various financial instruments
The following points outline the role of the that are close substitutes of money and not
money market in India : actual money. Thus, it economizes the use
of cash.
1) Short-term requirements of borrowers :
Money market provides reasonable access 8) Growth of Commerce, Industry and Trade:
for meeting the short-term financial needs Money market facilitates discounting bills of
of the borrowers at realistic prices. exchange to local and international traders
who are in urgent need of short-term funds. It
2) Liquidity Management : Money market
also provides working capital for agriculture
is a dynamic market. It facilitates better
and small scale industries.
management of liquidity and money in the
economy by the monetary authorities. This, Problems of the Indian Money Market :
in turn, leads to economic stability and Compared to advanced countries, the Indian
development of the country. money market is less developed in terms of
3) Portfolio Management : Money market volume and liquidity. Following points explain
deals with different types of financial the problems of the Indian Money Market :
instruments that are designed to suit the risk 1) Dual Structure of the Money Market :
and return preferences of the investors. This Presence of both, the organized and
enables the investors to hold a portfolio of unorganized sector in the money market
different financial assets which in turn, helps leads to disintegration, lack of transparency
in minimizing risk and maximizing returns. and increased volatility. The unorganized

4) Equilibrating mechanism : Through markets lack co-ordination and do not come
rational allocation of resources and under the direct control and supervision of
mobilization of savings into investment the RBI.
channels, money market helps to establish 2) Lack of uniformity in the rates of
equilibrium between the demand for and interest : The money market comprises
supply of short-term funds. of various entities such as commercial

5)
Financial requirements of the banks, co-operative banks, non-bank
Government : Money market helps the 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 savings. infrastructure.
Low per capita income, poor banking 5) Electronic dealing system was introduced
habits among the people, indulgence in to bring about technological upgradation.
wasteful consumption, inadequate banking
facilities in the rural areas etc. have also Do you know?
been responsible for the paucity of funds in Recent developments in banking sector :
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 : A payments bank is like
money market. any other bank, but operating on a smaller
5) Lack of financial inclusion : Banking scale without involving any credit risk. In
facilities in the country are still inadequate simple words, it can carry out most banking
and inaccessible to the vulnerable groups operations but can’t advance loans or issue
such as the weaker sections and the low credit cards. It can accept demand deposits
income groups. This shows lack of financial (up to ` 1 lakh), offer remittance services,
inclusion. 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 • Universal Banks : Universal banks refer
functioning of financial markets. Delays to those banks that offer a wide range of
in upgradation of technology hampers the financial services, such as, commercial
working of the money market. banking and investment banking and other
activities especially insurance. It is a multi-
Reforms introduced in the Money Market :
purpose and multi-functional financial
Following are some of the important
supermarket providing both banking and
reforms introduced in the money market :
financial services through a single window.
1) Introduction of new instruments such as
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 local
Mutual Funds (MMMFs). institutions especially private local banks
and make them available for investments
2) RBI Repos and Reverse Repos were
in the local areas. This helps to bridge the
introduced under the Liquidity Adjustment
gap in credit availability and strengthen the
Facility (LAF).
institutional credit from work in the rural
3) Interest rates to be largely determined by
and semi-urban areas.
market forces.
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 the securities. Such securities carry a fixed rate
country. It is also an important constituent of the of interest.
financial system. Development of an effective 2) Industrial Securities Market : It deals
capital market is necessary for promoting more with the shares and debentures issued by
investments as well as achieving economic old and new companies. It is further divided
growth. The demand for long term funds comes into Primary Market (New Issues) and
from agriculture, trade and industry. Individual Secondary Market (Old Issues). Primary
savers, corporate savings, banks, insurance market helps to raise fresh capital through
companies, specialized financial institutions are sale of shares and debentures. Secondary
the suppliers of long term funds. market deals with securities 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 premier stock
exchanges in the country.

3)
Development Financial Institutions
Fig. 9.4 (DFIs) : They provide medium term and
long term financial assistance to the private
Structure of Capital Market in India :
sector. They include Industrial Finance
The capital market in India comprises of
Corporation of India (IFCI), Industrial
the Gilt-Edged or the Government Securities
Investment Bank of India (IIBI), EXIM
Market, Industrial Securities Market,
Bank etc.
Development Financial Institutions and
Financial Intermediaries.
4) Financial Intermediaries : Financial
Fig. 9.5, explains the structure of India’s intermediary is an organization which
Capital Market. acts as a link between the investor and the
Indian Capital Market

Government Securities Industrial Securities Market Development Financial Institutions Financial Intermediaries

New Issues Market Old Issues Market

IFCI ICICI SFCs IDBI IIBI UTI

Merchant Banks Mutual Funds Leasing Companies Venture Capital Companies Others

Fig. 9.5
89
 borrower to meet the financial objectives of 2) Insider trading and price manipulation :
both the parties. They consist of merchant Insider trading means buying or selling of
banks, mutual funds, leasing companies, a security by someone who has access to
venture capital companies etc. non-public information or ‘unpublished
information’ for personal benefit. Price
Role of Capital Market in India :
manipulation or price rigging on the other
1) Mobilizes long term savings : There hand means to simply raise the prices of
is an increasing demand for investment shares through buying and selling of shares
funds by industrial organizations and within certain individuals themselves for
the government. But the availability of personal gains. Such illegal practices have
financial resources is insufficient to meet also affected the smooth functioning of
this growing demand. Capital market helps capital market.
to mobilize long term savings from various 3) Inadequate debt instruments : Debt
section of the population through the sale of instruments include bonds, debentures
securities. etc. There is not much trading in the debt
2) Provides equity capital : Capital market securities due to narrow investor base, high
provides equity capital or share capital cost of issuance, lack of accessibility to
to entrepreneurs which could be used to small and medium enterprises.
purchase assets as well as fund business 4) Decline in the volume of trade : Regional
operations. stock exchanges have witnessed a sharp
3) Operational efficiency : Capital market decline in the volume of trade because
helps to achieve operational efficiency by investors prefer to trade in securities listed
lowering the transaction costs, simplifying in premier stock exchanges like BSE,
transaction procedures, lowering settlement NSE etc.
timings in purchase and sale of stocks. 5) Lack of informational efficiency : A
4) Quick valuation : Capital market helps to market is said to be informationally efficient
determine a fair and quick value of both if a company’s stock prices incorporate all
equity (shares) and debt (bonds, debentures) the available information into the current
instruments. prices. However, the stock market in India
5) Integration : Capital market leads to lacks informational efficiency compared to
integration among real and financial advanced countries.
sectors, equity and debt instruments, Find out :
government and private sector, domestic List of regional stock exchanges in India.
and external funds etc.
Problems of the Capital Market : Reforms introduced in the Capital Market :
Following points explain the problems Following are some of the important
faced by the Indian Capital Market : reforms introduced in the capital market :
1) Financial Scams : Increasing number of 1) Securities and Exchange Board of India
financial frauds have resulted in irreparable (SEBI) was established in 1988 but given
loss for the capital market. Besides this, it statutory powers in 1992 to protect the
has also lead to public distrust and loss of interest of the investors and promote the
confidence among the individual investors. development of the securities market.

90
 2) National Stock Exchange (NSE), the leading 6) Investor Education and Protection Fund
stock exchange in India was established (IEPF) was established in 2001 to promote
in 1992. investors’ awareness and protecting the

3) Computerized Screen Based Trading interest of the investors.
System (SBTS) was introduced as a part of Do you know?
modernization. Economic Policy in an Economy
4) Demat account has been introduced since Monetary Policy Fiscal Policy
1996 to facilitate easy purchase and sale Implemented by Implemented by
of shares by the investors through the Central Bank Central government
electronic method. Deals with Money Deals with taxes,
5) Increased access to global funds by Supply expenditure etc.
Indian companies was permitted through Aims at financial Aims at economic and
stability social development
American Depository Receipts (ADRs) and
Global Depository Receipts (GDRs). Quantitative in nature Qualitative in nature

EXERCISE

Q. 1. Complete the following statements : b) accelerate the country's economic growth.

1) Development financial institutions were c) mobilise the savings and allocating them to
established to ............. various sectors of the economy.
a) provide short term funds. d) control the credit.
b) develop industry, agriculture and other key
Q. 2. Complete the correlation :
sectors.
1) Money market : Short term funds :: :
c) regulate the money market.
Long term funds
d) regulate the capital market.
2) : Central Bank :: SBI : Commercial
2) Money market faces shortage of funds due to Bank
...........
3) Co-operative banks : Organized sector ::
a) inadequate savings.  Indigenous bankers :
b) growing demand for cash. 4) Primary market : :: Secondary market
c) presence of unorganized sector.   : Old issues
d) financial mismanagement.
Q. 3. Find the odd word :
3) Individual investors have lost confidence in the
1) Types of Bank Accounts : Saving a/c, D-mat
capital market due to ...........
a/c, Recurring a/c, Current a/c
a) lack of financial instruments.  
2) Unregulated Financial intermediates : Mutual
b) high transaction costs.
fund, Nidhi, Chit fund, Loan Companies
c) low returns.
3) Financial Assets : Bonds, Land, Govt.
d) financial scams.
Securities, Derivatives
4) Commercial banks act as intermediaries in the 4) Quantitative Tools : Bank rate, Open market
financial system to ........... operations, Foreign Exchange rate, Variable
a) make profits reserve ratios

91
Q. 4. Assertion and Reasoning : Reasoning (R) : RBI has to maintain the
1) Assertion (A) : Money market economizes use official rate of exchange of rupee and ensure its
of cash stability.
Reasoning (R) : Money market deals with Options : 1) (A) is True, but (R) is False
financial instruments that are close substitutes 2) (A) is False, but (R) is True
of money
3) Both (A) and (R) are True and (R) is the
Options : 1) (A) is True, but (R) is False correct explanation of (A)
2) (A) is False, but (R) is True 4) Both (A) and (R) are True and (R) is not the
3) Both (A) and (R) are True and (R) is the correct explanation of (A)
correct explanation of (A)
Q. 5. Identify and explain the concepts from the
4) Both (A) and (R) are True and (R) is not the given illustrations :
correct explanation of (A) 1) Raghu’s father regularly invests his money in
2) Assertion (A) : Regional stock exchanges have stocks and bonds.
witnessed a sharp decline in the volume of 2) Sara makes a monthly contribution to a fund
trade. jointly created by her friends. The collected fund
Reasoning (R) : Investors prefer to trade in is then given to a chosen member through lucky
securities listed in premier stock exchanges like draw.
BSE, NSE etc. 3) Tina deposited a lumpsum amount of ` 50,000
Options : 1) (A) is True, but (R) is False in the bank for a period of one year.
2) (A) is False, but (R) is True 4) ABC bank provides d-mat facility, safe
3) Both (A) and (R) are True and (R) is the deposit lockers, internet banking facilities to its
correct explanation of (A) customers.
4) Both (A) and (R) are True and (R) is not the Q. 6. Distinguish between :
correct explanation of (A) 1) Money market and Capital market.
3) Assertion (A) : The unorganized sector of the 2) Demand deposit and Time deposit.
money market lacks transparency. 3) Organized sector and Unorganized sector of
Reasoning (R) : Activities of the unorganized money market.
sector are largely confined to rural areas. Q. 7. Answer the following :
Options : 1) (A) is True, but (R) is False 1) Explain the problems faced by the money
2) (A) is False, but (R) is True market in India.
3) Both (A) and (R) are True and (R) is the 2) Explain the functions of commercial bank.
correct explanation of (A) 3) Explain the role of capital market in India.
4) Both (A) and (R) are True and (R) is not the 4) Explain the problems of capital market in India.
correct explanation of (A) Q. 8. Answer in detail :
4) Assertion (A) : Foreign exchange management 1) Explain the role of money market in India.
and control is undertaken by commercial banks. 2) Explain the functions of RBI.


92
 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 foreign purchase of goods and services by one
trade did not permit industrialization at home. country from another country or inflow of
As a result the indigenous handicrafts suffered goods and services from foreign country
a severe blow. However, many underdeveloped to home country. For example, India
countries that won independence in the post imports petroleum from Iraq, Kuwait, Saudi
World War II period, viewed foreign trade as an Arabia, etc.
investment.
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
3) Entrepot Trade : Entrepot trade refers to
Bengal, Uttar Pradesh, Tamil Nadu etc, then it
purchase of goods and services from one
is known as internal trade.
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 :
Trade is an engine of growth of an economy,
Fig. 10.1
because it plays an important role for economic
Meaning of Foreign Trade : development. In developed countries it represents
Foreign Trade is trade between the different a significant share of Gross Domestic Product.
countries of the world. It is called as International Role of foreign trade can be justitied on the
Trade or External Trade. basis of the following points :
Definition : 1) To earn foreign exchange : Foreign trade
According to Wasserman and Hultman, provides foreign exchange which can be
“International Trade consists of transaction used for very productive purposes. Foreign
between residents of different countries”. trade is a remarkable factor in expanding
93
 the market and encouraging the production
Try this :
of goods.
Name the goods exported to and imported
2) Encourages Investment : Foreign trade from India to China and Japan in recent years
creates an opportunity for the producers
by India.
to reach beyond the domestic markets. It
encourages them to produce more goods Composition and Direction of India’s foreign
for export. This leads to an increase in total trade :
investment in an economy. Over the last 70 years, India’s foreign trade
3) Division of labour and specialization : has undergone a complete change in terms of
Foreign trade leads to division of labour composition and direction. Main feature of
and specialization at world level. Some composition of India’s foreign trade are as
countries have abundant natural resources, follows :
they should export raw material and import
1) Increasing share of Gross National
finished goods from countries which are Income : In 1990-91, share of India’s foreign
advanced in skilled manpower. Thus, trade (import-export) in gross national
foreign trade gives benefits to all countries
income was 17.55%. It increased to 25%
thereby leading to division of labour and
during 2006-07 and to 48.8% during 2016-17
specialization.
2) Increase in volume and value of trade :
4) Optimum allocation and utilization of
Since 1990-91, the volume and value of
resources : Due to specialization, resources
India’s foreign trade has gone up. India
are channelized for the production of only
now exports and imports goods which are
those goods which would give highest
several times more in value and volume.
returns. Thus, there is rational allocation
and specialization of resources at the 3) Change in the composition of exports :
international level due to foreign trade. Since Independence, the composition of
export trade of India has undergone a
5) Stability in price level : Foreign trade helps
to keep the demand and supply position change. Prior to Independence, India used
stable which in turn stabilizes the price to export primary products like jute, cotton,
level in the economy. tea, oil-seeds, leather, foodgrains, cashew
nuts and mineral products. With the passage
6) Availability of multiple choices : Foreign
of time, manufactured items like readymade
trade provides multiple choices of imported
garments, gems and jewellery, electronic
commodities. As foreign trade is highly
goods, especially computer hardware and
competitive it also ensures a good quality
and standard products. This raises the software occupy a prime place in India’s
standard of living of people. exports.

7) Brings reputation and helps earn 4) Change in the composition of imports :
goodwill : Exporting country can earn Prior to independence, India used to import
reputation and goodwill in the international consumer goods like medicines, cloth,
market. For example, countries like Japan, motor vehicles, electrical goods etc. A
Germany, Switzerland etc. have earned a part from petrol and petroleum, India is
lot of goodwill and reputation in foreign now importing mainly capital goods like
market for their qualitative production of high-tech machinery chemicals, fertilizers,
electronic goods. steel etc.
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 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 etc.
Afghanistan, Myanmar, Sri Lanka etc. The to reduce the burden on the exsiting ports.
share of India’s oceanic trade is around 68%.
6) Development of new ports : For its foreign Find out :
trade, India depended mostly on Mumbai, Recent share of India’s foreign trade in
Kolkata and Chennai ports. Therefore, Gross National Income.

Do you know?
Composition of India’s Imports
Years
Commodities
2015-16 2016-17
Sr. Expenditure Percentage Expenditure Percentage
No. (in million $) (in million $)
Petroleum, oil and
1 82,944 21.8 86,896 22.6
lubricants
2 Electronic goods 40,032 10.5 41,941 10.9
Pearls and precious
3 20,070 5.3 23,809 6.2
stones
4 Edible oils 10,492 2.8 10,893 2.8
5 Fertilizers 8,072 2.1 5,024 1.3
6 Foodgrains 276 0.1 1,429 0.4

Composition of India’s Exports

Years
Commodities
2015-16 2016-17
Sr. Expenditure Expenditure Percentage
(in million $) Percentage (in million $)
No.
Readymade
1 16,964 6.9 17,368 6.3
Garments
2 Iron ore 191 0.0 1,534 0.5
3 Cotton yarn 8,874 3.4 8,550 3.1
4 Petroleum products 31,209 11.9 32,416 11.7
Leather
5 5,554 2.1 5,308 1.9
manufactures
6 Engineering goods 7,220 23.0 65,267 23.7
Source : 1) Reserve Bank of India, Handbook of Statistics on Indian Economy 2016-17,
2) Government of India, Economic Survey 2017-18.

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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
Do you know? engineering goods was 25% in India’s total
Direction of India's Imports 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
1 OECD 28.1 instruments. During the period 2010-11 to
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
Direction of India's Exports
2001-02, due to which India turned as a
Year net exporter of petroleum refinery products.
Countries/Organisation
2016-17 Petroleum product had a share of 4.3% in
Sr. no. (Percentage) India’s total exports in 2000-01, which rose
1 OECD 37.9 steadily to 20.1% in 2013-14.
2 OPEC 16.4 3) Chemicals and chemical products : An
3 Eastern Europe 1.0 important export item that has performed
4 Developing Nations 43.5 reasonably well over the last few years
5 Others 1.2 is chemicals and chemical products. The
Source : Reserve Bank of India, Handbook of share of this item was 10.4% in 2014-15.
Statistics on Indian Economy.
4) Gems and Jewellery : Gems and jewellery
Trends in India’s foreign trade since 2001 : 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 5) Textiles and readymade garments :
exported products, and also in its geographical Textiles and garment exports together
composition. accounted for 11.3% of India’s exports
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 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 currently Fig. 10.3
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 2011-12 According to Bentham, “Balance of trade
to 27.5 billion dollars in 2013-14. This was of a country is the relation over a period between
primarily due to fall in international gold the values of her exports and imports of physical
prices and various policy measures taken by goods.”
the government to curb gold imports. According to Samuelson, “if export value is
3) Fertilizers : The share of fertilizers in greater than the import value it is called as trade
import expenditure declined from 4.1% in surplus and if import value is greater than export
1990-91 to only 1.3% in 2016-17. value, then it is called as trade deficit.”
It is clear from the above definitions that
4) Iron and Steel : The share of iron and steel
balance of trade includes the value of imports
in import expenditure declined from 4.9%
and exports of visible goods and invisible goods.
to 2.1% in 2016-17.
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
1) Internal trade and International trade. India's imports.
2) Trends in imports and Trends in exports of 5) How much is the percentage of increase in the
foreign trade. imports of developing nations in 2015-16 as
3) Balance of payments and Balance of trade. compared to 1990-91?

Q. 4. Answer the following : Q. 7. Answer in detail :

1) Explain the concept of foreign trade and its 1) Explain the meaning and role of foreign trade.
types. 2) Explain the recent trends in India’s exports.

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98
 GLOSSARY OF ECONOMIC TERMS

  • Advertising : Business of persuading people to   • Composition of foreign trade : Composition of

buy products or services. trade means a study of the goods and services
  • Antique goods : Something made in an earlier imported and exported by a country.
period that is collected and considered to have   • Consumer equilibrium : It is a state of balance
value because it is beautiful, rare and old or of that can be achieved by a consumer from the
a high quality. purchase of goods and services, given their
  • Arbitrary weights : Based on or determined present level of income and the current level of
by individual preference, rather than intrinsic prices.
nature of something.   • Copyrights : Copyright is a form of protection
  • Bank rate : The rate of interest set by a central provided by the laws of a country to the
bank in a country. This is the lowest rate creators of original works that includes literary,
at which central bank lends money against dramatic, musical, artistic and certain other
approved securities. creative works. A copyright holder can prevent
others from copying, performing or otherwise
  • Branded products : A branded product is one
using the work without his or her consent.
which is the made by a well-known manufacturer
  • Cost of living : It is the average amount of
and has the manufacturer's label on it.
money that people in a particular place need to
  • Canons of taxation : Canons of taxation define afford basic food, housing and clothing.
numerous rules and principles upon which a
  • Credit rationing : RBI imposes a ceiling on
good taxation system should be built.
the loans and advances offered by commercial
  • Capital gains : A capital gain is a rise in the banks to regulate and control the purpose of
value of a capital asset (investment or real credit.
estate) that gives it a higher worth than the
  • Cross elasticity : Cross elasticity of demand
purchase price.
is an economic concept that measures the
  • Capital losses : A capital loss is essentially the responsiveness in the quantity demanded of one
difference between the purchase price and the good when the price for another good (substitute
price at which the asset is sold, where the sale or complementary product) changes.
price is lower than the purchase price.
  • Deficit financing : It is a practice in which
  • Cardinal measurement : The exponents of a government spends more money than it
cardinal utility analysis regard utility to be a receives as revenue. The difference is made up
cardinal concept and hypothetically hold that by borrowing or minting new funds.
utility is a measurable and quantifiable entity.   • Deflating : Deflating in statistics means
  • Cash reserve ratio (CRR) : As per RBI Act counteracting the effect of inflation over a set
of 1934, every commercial bank has to keep of data to unravel their true values and make
certain minimum cash reserves with RBI. It them comparable.
varies between 3- 15% of the total demand and   • Dearness Allowances : It is a cost of living
time deposits. adjustment allowance paid to government
  • Ceteris paribus : It is a Latin phrase and a employees, public sector employees and
dominant assumption in mainstream economic pensioners. It is calculated as a percentage of
thinking when translated into English refers to basic salary to mitigate the impact of inflation.
“other things being equal or constant.”   • Direction of foreign trade : Direction of
  • Composite measure : In Statistics, composite foreign trade means the countries to which a
measures of variables refers to measurements particular country exports its goods and the
based on multiple data items. countries from which it imports.
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  • Disparities in income : It refers to a significant data from the past and present and analysis of
disparity or inequality in the distribution trends.
of income between individuals, groups,   • General price level : It is an index that
populations, social classes or countries. measures the change in price of goods in an
  • Division of labour : It means separation of a economy over time and hence the purchasing
work process into a number of tasks, with each power of the currency of the country.
task performed by a separate person or group of   • Illegal incomes : Income derived from illegal
persons. activities such as bookie/betting operations,
  • Double counting : It occurs when the costs theft, embezzlement and from other illegal
of intermediate goods used by a business to resources.
produce a finished good are included in the   • Imputed value : Imputed value is an assumed
computation of a nation's gross domestic value given to an item when the actual value is
product. not known or available.
  • Economic efficiency : Economic efficiency   • Impact of tax : Effect of a tax on production or
is achieved when all goods and factors of consumption of a product.
production in an economy are distributed or   • Incidence of tax: The incidence of a tax
allocated to their most valuable uses and waste refers to the extent to which an individual
is eliminated or minimized. or organisation suffers from the imposition of
  • Economic model : It is a simplified a tax.
representation of economic reality showing the   • Income tax returns : A tax return is
inter-relationships between selected economic documentation filed with a taxing authority that
variables. reports income, expenses and other relevant
  • Economic variable : It refers to any financial information.
measurement that helps to determine how   • Indivisible goods : A good is indivisible when
an economy functions. Population, poverty, the utility one derives from it depends on the
unemployment, inflation etc. are examples of number of users or individuals using it. This
economic variables. concept is used in public finance.
  • Economic welfare : It is the overall level   • Intermediate goods : An intermediate good is
of financial satisfaction and prosperity a good or service purchased by a manufacturer
experienced by participants in an economic to be used as an input in another product.
system.   • Laissez-faire : It is a policy of minimum
  • Effective demand : In Keynesian governmental interference in the economic
macroeconomic theory, effective demand is the affairs of individuals and society.
point of equilibrium where aggregate demand =   • Leasing Companies : They provide finance for
aggregate supply. acquiring plant and machinery especially for
  • Engineering goods : Engineering goods small and medium sized enterprises.
include metal products, industrial machinery   • Liquidity Adjustment facility (LAF) : It is a
and equipment, auto and its components and monetary policy tool used by RBI which allows
transport equipments. commercial banks to borrow money through
  • Financial proposal : A financial proposal is a repurchase agreements. It consists of Repo and
written report that provides details of the future Reverse Repo operations.
of a business by addressing its monetary needs   • Marginalism : Marginalism is concerned with
and budget. how much extra use is gained from incremental
  • Forecasting : It is a planning tool that helps increases in the number of goods created, sold,
management in its attempts to cope with the etc. and how these measures relate to consumer
uncertainty of the future, relying mainly on choice and demand.

100
  • Margin Requirements : It is used by RBI to or sell an invention for a particular number of
determine the loan value of a collateral security years.
offered by a borrower. It is used to control   • Perishable goods : They are a type of good
speculative activities. especially food products with limited shelf life.
  • Merchant Banks : Merchant banks in India   • Point of satiety : Point of satiety is defined
manage and underwrite new issues, advise as “the point where marginal utility of any
corporate clients on fund raising and other commodity is zero.”
financial aspects.
  • Potential supply : Stock is the basis of supply.
  • Mixed income : Remuneration of a self It constitutes the potential or total supply of
employed person is treated as mixed income. a commodity that can be offered for sale at a
It is defined as the income that is received, favourable time.
over a given reference period, by individuals,
  • Prestige goods : They are high end or luxury
for themselves or in respect of their family
goods that increases the status of the consumers
members, as a result of their current or former
who own or use them e.g. jewellery, luxury cars
involvement in self employment jobs.
etc.
  • Moral Suasion : It is a psychological instrument
  • Price discrimination : It is the act of of selling
of credit control which is used by RBI to
the same product at different prices to different
persuade commercial banks to co-operate with
buyers, in order to maximize sales and profits.
it in following a proper credit policy more
rigorously.   • Price illusion : It is also called money illusion.
It refers to the tendency of consumers to think
  • Mutual Funds : Mutual funds mobilize the
in terms of nominal rather than real monetary
savings of the general public and invest them in
values when making economic decisions. It is
stock market securities.
likely to occur when inflation is unanticipated.
  • National Electronic Fund Transfer (NEFT) :
  • Price quotations : Price quotation is a document
It is an electronic fund transfer process, through
(generally written) which a seller provides to
which money can be sent from one bank
the buyer for offering goods and services at a
account to another within the country in a safe
stated price, subject to terms and conditions
and hassle free manner.
specified therein.
  • Oceanic trade : It refers to expansion of trade
  • Principle of rationality : It is an economic
network of coastal countries beyond their land
principle that assumes that individuals always
territories.
make prudent and logical decisions that provide
  • Open market operations : Open market them with the highest amount of personal
operations is the sale and purchase of utility. These decisions provide people with
government securities and treasury bills by the greatest benefit or satisfaction, given the
RBI or the central bank of the country. It is choices available.
undertaken to regulate the money supply in the   • Public utilities : Public utilities are services
economy. provided by the government or state, such as
  • Optimum allocation : It refers to the allocation the supply of electricity and gas, or the train
of resources in the best possible manner to network.
achieve economic efficiency. It prevents misuse   • Quid pro quo : Quid pro quo is a Latin phrase
and avoids wastage of resources. which means a gift or a advantage that is given
  • Paradox of values : It is an observation that to someone in return for something that they
articles or goods critical to life (such as water) have done.
are very cheap, whereas others which have no   • Rational consumer : A consumer who makes
bearing on human existence (such as diamonds) his choices after considering all the other
are very expensive. alternative goods and services available in the
  • Patents : It is an official legal right to make market is called a rational consumer.
101
  • Rare goods : They are artistic or precious total demand and time liabilities. It has been
goods that have a limited supply. The supply revised by RBI from time to time.
of these goods cannot be increased according to   • Subsidies : It is a sum of money granted by
their demand or rising prices. the state or a public body to help an industry
  • Real Time Gross Settlement (RTGS) : 'Real or business to keep the price of a commodity or
Time' means the processing of instructions at the service low.
time they are received 'Gross settlement' means   • Tariff : Tariffs are used to restrict imports
that settlement of funds transfer instructions by increasing the price of goods and services
occurs individually. purchased from another country, making them
  • Rectangular hyperbola : Rectangular less attractive to domestic consumers.
hyperbola is a curve under which all rectangular   • Trademarks : It is a symbol, word or words
areas are equal.
legally registered or established by use as
  • Repo Rate : Rate at which RBI repurchases representing a company or product.
government securities from commercial banks
  • Transfer payments : It is a one-way payment
for a short period when a liquidity shortage is
of money for which no money, good or service
experienced. It injects liquidity into the banking
is received in exchange. Governments use such
system.
payments as means of income redistribution by
  • Reverse Repo Rate : Rate at which RBI sells giving out money under social welfare programs
dated government securities in the market such as social security, old age or disability
through auction at fixed cut-off rate of interest. pensions, student grants, unemployment
It absorbs liquidity and also provides short term compensation, etc.
avenue to banks to park their surplus funds.
  • Trends and Tendencies : A pattern of gradual
  • Sales proceeds : It refers to the amount of
change in a condition, output or process or an
money received from a particular event or
average or general tendency of a series of data
activity or when something is sold.
represented by a line or curve on a graph.
  • Samples: It is a subset containing the
  • Uncertainty : In economics, uncertainty
characteristics of a larger population.
implies that the future outlook for the economy
  • Self-consumption : Producers themselves is unpredictable. There is a high likelihood of
consume the entire or a part of the output they negative economic events to occur.
produce is self-consumption.
  • Undistributed profits of companies :
  • Social accounts : It is the process of measuring,
Undistributed profits are those earnings of
monitoring, and reporting to stakeholders
a corporation that have not been paid out to
the social and environmental effects of an
investors in the form of dividends.
organization’s actions.
  • Venture Capital Companies : They provide
  • Speculation : Speculation involves trading in
commercial support to new ideas and for
a financial instrument involving high risk, in
the introduction and adaptation of new
expectation of significant returns. The motive is
technologies.
to take maximum advantage from fluctuations
in the market.   • Welfare economics : It is that branch of
economics that seeks to evaluate economic
  • Standardized items : It means products of the
policies in terms of their effects on the well-
same type, having the same basic features.
being of the community.
  • Statutory Liquidity Ratio (SLR) : Under
Section 24 of Bankng Regulation Act, 1949,   • Window Display : It is a marketing strategy
commercial banks have to maintain liquid in which a systematic arrangement of articles
assets in the form of cash, gold and approved is done in such a way that they attract the
securities equal to not less than 25% of their attention of those who pass-by.

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102
 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
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103
 REFERENCES

• Ministry of Finance, Government of India (Oxford Press), Economic Survey 2017-18.

IMPORTANT WEBSITES/LINKS
• https://data.gov.in
• https://www.rbi.org.in - (Reserve Bank of India)
• mofapp.nic.in:8080/economic survey (Ministry of Finance, GoI)
• www.mospi.gov.in/national-sample-survey-office-nsso – (Ministry of Statistics and
Programme Implementation, GoI).
• https://stats.oecd.org
• https://www.bseindia.com
• https://www.nseindia.com
• https://www.finmin.nic.in
• https://www.incometaxindia.gov.in
• https://www.gst.gov.in
• https://www.sebi.gov.in
• https://dgft.gov.in

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