Subject-BE

Unit-2

By-K.R.Ansari

An economy is made up of all of the financial transactions between companies and consumers in
a region or country.
Trend, can be thought of as a pattern. In most contexts, trends are formed and interpreted from
sets of data.
Thus an economic trend is an indicator that shows how a region or country is doing financially.
The economy of India is the tenth-largest in the world by nominal GDP and the thirdlargest by purchasing power parity(PPP). The country is one of the G-20 major economies, a
member of BRICS and a developing economy that is among the top 20 global traders according
to the WTO. India was the 19th-largest merchandise and the 6th largest services exporter in the
world in 2013; it imported a total of $616.7 billion worth of merchandise and services in 2013, as
the 12th-largest merchandise and 7th largest services importer. India's economic growth slowed
to 4.7% for the 201314 fiscal year, in contrast to higher economic growth rates in 2000s. IMF
projects India's GDP to grow at 5.4% over 2014-15. Agriculture sector is the largest employer in
India's economy but contributes a declining share of its GDP (13.7% in 2012-13). Its
manufacturing industry has held a constant share of its economic contribution, while the fastestgrowing part of the economy has been its services sector - which includes construction, telecom,
software and information technologies, infrastructure, tourism, education, health care, travel,
trade, banking and others components of its economy.

Subject-BE

Unit-2

By-K.R.Ansari

Methods of Measurement
The national income of a country can be measured by three alternative methods: (i) Product
Method (ii) Income Method, and (iii) Expenditure Method.
1. Product Method:
In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final goods
here refer to those goods which are directly consumed and not used in further production
process. Goods which are further used in production process are called intermediate goods. In the
value of final goods, value of intermediate goods is already included therefore we do not count
value of intermediate goods in national income otherwise there will be double counting of value
of goods.
To avoid the problem of double counting we can use the value-addition method in which not the
whole value of a commodity but value-addition (i.e. value of final good value of intermediate
good) at each stage of production is calculated and these are summed up to arrive at GDP.
The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at
market price can be converted into by methods discussed earlier.
2. Income Method:
Under this method, national income is measured as a flow of factor incomes. There are generally
four factors of production labour, capital, land and entrepreneurship. Labour gets wages and
salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their
remuneration.
Besides, there are some self-employed persons who employ their own labour and capital such as
doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these
factor incomes is called NDP at factor costs.
3. Expenditure Method:
In this method, national income is measured as a flow of expenditure. GDP is sum-total of
private consumption expenditure. Government consumption expenditure, gross capital formation
(Government and private) and net exports (Export-Import)
Measurement of National Income in India
In India, a systematic measurement of national income was first attempted in 1949. Earlier, many
attempts were made by some individuals and institutions. The earliest estimate of Indias
national income was made by Dadabhai Naoroji in 186768. Since then many attempts were
made, mostly by the economists and the government authorities, to estimate Indias national
income. These estimates differ in coverage, concepts and methodology and are not comparable.
Besides, earlier estimates were mostly for one year, only some estimates covered a period of 3 to
4 years. It was therefore not possible to construct a consistent series of national income and
assess the performance of the economy over a period of time.
In 1949, A National Income Committee (NIC) was appointed with P.C. Mahalanobis as its
Chairman, and D.R. Gadgil and V.K.R.V. Rao as members. The NIC not only highlighted the
limitations of the statistical system of that time but also suggested ways and means to improve
data collection systems. On the recommendation of the Committee, the Directorate of National
Sample Survey was set up to collect additional data required for estimating national income.
Besides, the NIC estimated the countrys national income for the period from 194849 to 1950
52. In its estimates, the NIC also provided the methodology for estimating national income,
which was followed till 1967.

Subject-BE

Unit-2

By-K.R.Ansari

In 1967, the task of estimating national income was given to the Central Statistical Organization
(CSO). Till 1967, the CSO had followed the methodology laid down by the NIC. Thereafter, the
CSO adopted a relatively improved methodology and procedure which had become possible due
to increased availability of data. The improvements pertain mainly to the industrial classification
of the activities. The CSO publishes its estimates in its publication, Estimates of National
Income.
Methodology used in India
Currently, net output and factor income methods are used by the CSO to estimate the national
income of the country. The output method is used for agriculture and manufacturing sectors, i.e.,
the commodity producing sectors. For these sectors, the value added method is adopted. Income
method is used for the service sectors including trade, commerce, transport and government
services. In its conventional series of national income statistics from 1950-51 to 1966-67, the
CSO had categorized the income in 13 sectors. But, in the revised series, it had adopted the
following 15 break-ups of the national economy for estimating the national income; (i)
Agriculture; (ii) Forestry and logging; (iii) Fishing; (iv) Mining and quarrying; (v) Large-scale
manufacturing; (vi) Small-scale manufacturing; (vii) Construction; (viii) Electricity, gas and
water supply; (ix) Transport and communication; (xii) Real estate and dwellings; (xiii) Public
Administration and Defence; (xiv) Other services; and (xv) External transactions. The national
income is estimated at both constant and current prices.
What are the factors that determine national income?
Factors determining national income can be discussed as follows Quality and quantity of factors of production: the quality and quantity of land, the climate,
the rainfall, etc., determine the quantity and quality of agricultural production. This determines
the size of national income. The quantity of labour has double influence since labour is both a
factor of production as well as the consumer of what is produced. The quality of labour depends
upon intelligence, training, which in turn decides the volume of industrial productivity. This will
have decisive influence on output. Likewise, the quantity and quality of entrepreneurial ability is
also a main element in the determination of national income.
State of technical know-how: the extent of technical know-how and technology in
production determine the capital formation in the country. A country with abundant resources
will be dormant without any determination if the resources are not scientifically exploited.
Natural resources combined with advanced technology will go a long way in increasing the size
of national income.
Political stability: the key to increase the national income rests with important factors like
capital formation, natural resources, technical know-how and political stability.
Whatare the difficulties in calculation of national income?
The measurement of national income is beset with difficulties. In under developed countries
these difficulties are more prominent. The difficulties in calculation of national income can be

Subject-BE

Unit-2

By-K.R.Ansari

discussed as follows:

Conceptual difficulties: there has been a difference of opinion regarding the term nation
in the concept of national income. It has to define exactly, whether it is geographical entity of the
country or the nationals including those residing abroad. Since national income constitutes a
quantitative measure of economics activity rather than verbal description. Since everything has
to be equated to the money value, services produced in economy for love of humanity, affection
and philosophy could not be taken into consideration in calculating national income.

Overlapping of occupations: in backward economies there is an overlapping of

occupation in rural sector which makes it difficult to know the income by origin. A worker in a
peak season works in a farm, drives a country cart in off season. Takes up unskilled work, etc.
similarly, the village money lender combines his profession with the cultivating of his farm.

Difficulty in value estimation: in backward areas, the cultivators, artisans and cottage
industry workers do not have a fair idea of the expenses of their occupation. Hence the net value
of their products cannot be estimated precisely.

Non- monetized sector: barter dealing and non-monetized sector creates the problem of
inputting the value of their produce and services and by guess work and approximation.

Incomplete government records: due to ignorance and illiteracy in backward areas, the
data may not be available and if available, may be unreliable. Also, the figures furnished by
government officials may not be from reliable sources and data is not current.

Problems in agricultural sector: in agricultural activities there is a good deal of guess

work in data relating to cropwise production and in figures relating to animals and forest
products.

Problems in industrial sector: data relating to output, cost, etc. are available only in big
units. The small units do not maintain these figures correctly. The village money lenders and
indigenous bankers maintain absolute secret of their and they do not furnish correct information.

Non-applicability of a uniform formula: in a big country where wide disparities and

regional differences, a uniform formula cannot be applied. The data of one region cannot be
applied to another region with minor modification. Every region would be a separate entity
requiring specialized approach suited only to that region.

Double-counting: the error of double-counting is another obstacle to be avoided in the

calculation of national income.

Inefficient data collection: the machinery for collecting statistical data may not be
efficient. The investigators, preparation of adhoc figures, making sample surveys, etc.

Subject-BE

Unit-2

By-K.R.Ansari

Industry in India
Over the years agriculture has been the major source of livelihood of the Indian population.
However, after Independence the founding fathers saw the nation progressing with a decent
industrial base. This triggered the formulation of programs and strategies to construct a proper
infrastructure for speedy industrialization.
India has been successful in achieving autonomy in producing different basic and capital
products since independence. The productivity of the major Indian industries incorporates
aircraft, vessels, automobiles, steam engines, heavy electrical equipment, construction
machinery, chemicals, precision equipments, communication instrument, power generation and
transmission tools and computers.
Since 1956, the industrial development in India took place mainly in the four forms:
Wide diversification of industrial base: production of several new products.
Development of public sector
Restricted Imports and less dependence on them.
Globalization of industries and their progressive privatization.
Industrial Development during the Five Yearly Planning
Ist Five Year Plan (1951-56):

Main emphasis was given on agricultural sector. But attempts were made to lay
foundation of future industrial growth.
To encourage small scale industries a cess was imposed on the products of large scale
industries.
Total expenditure on development of large scale industries was Rs. 55 Crore.
5% of total plan outlay was allocated for the industries.
Growth rate of industrial production during the first plan was 7.5%

2nd Five Year Plan (1956-61)

It aimed at development of basic industries.
Most of the capital goods industries were set up and developed in the public sector. e.g.
three new steel plants were set up at Bhilai, Durgapur and Rourkela.
There was good progress in village and small scale industries. The small businessmen
were given technical, financial and marketing facilities.
24% of total plan outlay was allocated for the industries.
Annual growth rate of industrial development was 6.6%.

Subject-BE

Unit-2

By-K.R.Ansari

60 industrial estates were set up and 1000 small units were housed therein.
3rd Five Year Plan (1961-66)
Aim was to expand heavy industries so as to meet the need of the industries within its
own resources in the next ten years.
In this plan automobile, diesel engines, cement and heavy chemical units made
considerable progress.
The production capacity of many industries like iron and steel, machines etc. that were
set up in the 2nd plan was expanded.
Total expenditure on development of large scale industries was Rs. 1,726 Crore and Rs.
241 Crore on small scale industries.
23% of total plan outlay was allocated for the industries.
Growth rate of industrial production was 9% per annum.
One Year Plans (1966-69)
Due to the Indo-China war and Indo-Pak war, the fourth plan was unable to start in 1966.
Our economy was facing the shortage of funds.
Instead of Five year plan, three annual plans were formulated.
The prime aim was to focus on green revolution. Industrial development took a back seat.
The average industrial growth rate during these plans was 1.6% per annum.
4th Five Year Plan (1969-74):
The industrial development did not however match its target during the 4th plan.
No worth while change in the industrial production structure took place.
Total expenditure on development of large scale industries was Rs. 2,864 Crore and Rs.
243 Crore on small scale industries.
19.7% of total plan outlay was allocated for the industries.
Growth rate of industrial production was 4.5% per annum.
Number of industries increased to 465
5th Five Year Plan (1974-79):

Subject-BE

Unit-2

By-K.R.Ansari

The main aim was the attainment of self sufficiency and growth with justice.
Increased development of basic industries.
Development of export industries
Increase in the supply of mass consumption goods.
Development of industrially backward regions.
Application of modern technology in the development of industries.
Total expenditure on development of large scale industries and minerals was Rs. 8,989
Crore
24.3% of the total outlay was allocated to industries.
The industrial growth rate was 5.9% per annum.
6th Five Year Plan (1980-85)
The main objective was to make optimum utilization of existing capacity of industrial
production and to increase productivity.
To make maximum use of the existing industrial capacity and increased productivity.
To increase considerably the installed capacity of industries in the public and private
sectors not only to produce mass consumption goods but also intermediary and capital
goods.
To pay attention to the development of capital goods industry in general and electronic
industry in particular.
To realize the importance of superior technique for industrial progress, import of foreign
technology and technical know-how.
To develop industrially backward regions.
Total expenditure on development of large scale industries was Rs. 14,790 Crore and Rs.
1,945 Crore on small scale industries.
26.5% of total plan outlay was allocated for the industries.
Growth rate of industrial production was 6.4% per annum.
7th Five Year Plan (1985-90)
The main aim was to increase the production of consumer goods.

Subject-BE

Unit-2

By-K.R.Ansari

Adequate supply of consumer goods.

Maximum use of existing productive capacity. Industries were restructured to increase
their production capacity.
Those industries were developed more which met the rising demand of the domestic
market or were necessary for export.
A suitable policy has been adopted to achieve self-sufficiency in the important industries.
Labourers were given proper training.
Special attention was paid on the development of electronics and computer industry.

23.7% of total plan outlay was allocated for the industries.

Growth rate of industrial production was 8.5% per annum.

8th Five Year Plan (1992-97)
Private sector was given more importance.
Earlier capital goods were given priority but during this plan all industries were given
equal importance.
Foreign companies were assign important role
Modernisation of Industries was given importance.
Protection given to the domestic industries has been reduced to increase their efficiency.
Some areas reserved for public sector were opened for the private sector.
18.8% of total plan outlay was allocated for the industries.
Growth rate of industrial production was 6.8% per annum.
9th Five Year Plan (1997-2002).
Private sector was given more importance. More areas were opened for the private sector.
Special efforts were made for setting up new industries in backward areas. It was done to
reduce regional imbalances.
More stress was given on attracting foreign investments. The domestic economy was
open for the foreign companies.

Subject-BE

Unit-2

By-K.R.Ansari

Modernization and import of capital goods were considered important for improving the
efficiency of the industrial sector.
Companies under MRTP Act were given various concessions. E.g. such companies need
not to take special permission for mergers, diversification, expansion etc
Licensing policy was liberalised.
In some industries, foreign equity participation was increased to 100%.
Total expenditure on development of large scale industries was Rs. 33,587 Crore and on
the development of small scale industries was Rs. 8,384 Crores.
Growth rate of industrial production was 5% per annum. (due to slower growth of the
world economy)
10th Five Year Plan (2002-07)
The industrial sector will have to grow at over 10% to achieve the target of 8% growth
for GDP.
Special emphasis is given for the infrastructure development, power generation,
development of roads, railways, air-ports etc. it was thought that rapid industrial growth
can be achieved through improving the quality of infrastructure.
Special concessions were extended to ready-made garment industry like liberal import of
capital goods; tax-concessions etc. were extended. Apparel-parks have been established
to promote the same.
To make the industry more competitive, R&D, modernization and technological up
gradation activities have been emphasized.
Loss making public sector units have been disinvested
Special concessions were given to export oriented units in order to promote exports.
Special Economic Zones have been set up for promoting rapid industrialization of the
economy. For promoting agro based industrial units, agro export zones have been set up.
For promoting leather industry, leather industry development programmes have been
undertaken.
More privatization has been encouraged. The funds from global capital market are also
encouraged.
Foreign investments are encouraged in the service sector like banking, insurance etc

Subject-BE

Unit-2

By-K.R.Ansari

Four key industrial economic sectors are identified in India. The primary sector, largely extract
raw material and they are mining and farming industries. In the secondary sector, refining,
construction, and manufacturing are included. The tertiary sector deals with services and
distribution of manufactured goods. India's service industry accounts for 57.2% of the country's
GDP while the industrial and agricultural sector contribute 28% and 14.6% respectively.
Agriculture is the predominant occupation in India, accounting for about 52% of direct and
indirect employment. The service sector makes up a further 34%, and industrial sector around
14%. The labour force totals around half a billion workers. Industry accounts for 28% of the
GDP and employ 14% of the total workforce.
Achievements of Industrialization
Growth Rate of Industrial Production
Strong Industrial Base
Modernisation
Development of the Public Sector
Building up of the Infrastructure
Increasing Share of Industries in National Income & Export
Increase in Foreign Collaboration
Increase in Industrial Production
Weakness of Industrialization
Unregulated Increase in the Industrial Production
Excessive Capacity
Much Increase in Monopoly Power
Capital Investment in Low Priority Industries
Inefficient performance of the Public Sector
Growth of Regional Imbalance
Less Development of the Small Scale Industries
Industrial Sickness

Subject-BE

Unit-2

By-K.R.Ansari

Balance of Trade
The balance of trade is the difference between the monetary value of exports and imports of
output in an economy over a certain period. It is the relationship between a nation's imports and
exports. A positive or favorable balance of trade is known as a trade surplus if it consists of
exporting more than is imported; a negative or unfavorable balance is referred to as a trade
deficit or, informally, borrowed prosperity, living beyond a nation's means, or a trade gap. The
balance is said to be favorable when the value of the exports exceeded that of the imports
(i.e.exports exceed imports), and unfavorable when the value of the imports exceeded that of the
exports (i.e. imports exceed exports).
Factors that can affect the balance of trade include:

The cost of production (land, labour, capital, taxes, incentives, etc.) in the
exporting economy vis--vis those in the importing economy;
The cost and availability of raw materials, intermediate goods and other inputs;
Exchange rate movements;
Multilateral, bilateral and unilateral taxes or restrictions on trade;
Non-tariff barriers such as environmental, health or safety standards;
The availability of adequate foreign exchange with which to pay for imports; and
Prices of goods manufactured at home (influenced by the responsiveness of
supply)

Balance of Payment (BOP) - Concept & Definition

According to Kindle Berger, "The balance of payments of a country is a systematic record of all
economic transactions between the residents of the reporting country and residents of foreign
countries during a given period of time".
The balance of payment record is maintained in a standard double-entry book-keeping method.
International transactions enter in to the record as credit or debit. The payments received from
foreign countries enter as credit and payments made to other countries as debit.
Balance of Payment is a record pertaining to a period of time; usually it is all annual statement.
All the transactions entering the balance of payments can be grouped under three broad accounts;
(1) Current Account, (2) Capital and Financial Account
The Current Account pertains to goods and services, income, and current transfers.
The capital and financial account pertains to (i) capital transfers and acquisition or disposal of
nonproduced, nonfinancial assets and (ii) financial assets and liabilities.
The Current Account (CA)
A positive value for the current account is called a current account surplus; a negative value is
called a current account deficit. The current account mainly consists of 4 types of transactions:
1. Exports and imports of goods
{Exports of goods are credits (+) to the current account
{Imports of goods are debits (-) to the current account
The deference between exports and imports of goods is called the merchandise trade balance.
2. Exports and imports of services
{Exports of services are credits to the current account (+)
{Imports of services are debits to the current account (-).

Subject-BE

Unit-2

By-K.R.Ansari

This category consists of items such as tuition paid to universities by international students,
money spent on travel by tourists, banking, insurance, consulting services etc.
3. Interest payments on international investments.
{Interest, dividends and other income received on assets held abroad are credits (+)
{Interest, dividends and payments made on foreign assets held in are debits (-).
4. Current transfers
{Remittances by residence working abroad, pensions paid by foreign countries to their citizens
living in the country. aid offered by foreigners to the country count as credits (+).
{Remittances by foreigners working in the country., pensions paid by the country to its citizens
living abroad, aid offered to foreigners by the country count as debits (-)
As expected the country runs a deficit in current transfers.
The sum of these components is known as the current account balance. A negative number is
called a current account deficit and a positive number called a current account surplus. As
expected, given that it runs a surplus only in the services component of the current account, the
country runs a substantial current account deficit.
Intuitively, think of credits to the current account as transactions involving receipt of income to
country resident and debits to the current account as transactions involving payment of income to
foreigners. The transactions can involve goods, services, investment income, pension income or
other current transfers.
The Financial Account
The current account does not include the purchase and sale of financial and non-financial assets.
All such transactions are reflected in the financial account portion of the BOP accounts.
Once again, a positive value for the financial account is called a financial account surplus, a
negative value is called a financial account deficit.
The financial account is where the BOP accounts starts to get tricky. Since assets can be sold as
well as bought, we need to track the sale of assets as well as their purchase. The easiest way is to
record the sale of assets in the BOP in the exact opposite way we record the purchase of assets
(i.e. think of a $500 sale as a purchase of a -$500 asset). Therefore,
The financial account consists primarily of four types of transactions:
1. Foreign Direct Investment
Purchases of country capital assets (factories, machines, companies) by foreigners are credits (+)
Purchases of foreign capital assets (factories, machines, companies) by country residents are
debits (-)
Sales of country capital assets by foreigners count as debits to the financial account (-)
Sales of foreign capital assets by country residents count as credits to the financial account (+)
2. Portfolio Investment
Purchases of country securities (stocks, bonds, CDs, money-market accounts) by foreigners are
credits (+)
Purchases of foreign securities (stocks, bonds, CDs, money-market accounts) by country
residents are debits (-)
Sales of country securities by foreigners count as debits to the financial account (-)
Sales of foreign securities by country residents count as credits to the financial account (+)
3. Other Investments - Loans and Currency
Increases in loans & trade credits to country residents by foreigners (purchase of domestic IOUs
by foreigners) count as credits (+)

Subject-BE

Unit-2

By-K.R.Ansari

Increases in loans & trade credits to foreigners by country residents (purchase of foreign IOUs
by domestic residents) counts as debits (-)
Repayments of loans & trade credits to country residents by foreigners (sale of domestic
IOUs by foreigners) count as debits (-)
Repayments of loans & trade credits to foreigners by country residents (purchase of foreign
IOUs by domestic residents) counts as debits (+)
Increases in $ holdings by foreigners counts as a credit (+)
Increases in holdings of foreign currency by country residents counts as a debit (-)
Decreases in $ holdings by foreigners counts as a debit (-)
Decreases in holdings of foreign currency by country residents counts as a credit (+)
4. Reserve Assets
Increases in dollar reserves held by foreign central banks count as credits (+)
Increases in holdings of foreign currency reserves by country central banks count as debits (-)
Decreases in dollar reserves held by foreign central banks count as debits (-)
Decreases in holdings of foreign currency reserves by country central banks count as credits (+)
The Capital Account
The capital account is designed to capture one-sided financial transactions, i.e. transactions in
which one country gifts financial assets to another country with no expectation of receiving
anything in kind.
In today's world, this implies one major type of transaction - debt forgiveness and relief.
{Forgiveness of countrys debt by foreigners count as credits (+)
{Forgiveness of foreign debt by country entities count as debits (-)
Money is any item or verifiable record that is generally accepted as payment for goods and
services and repayment of debts in a particular country or socio-economic context.[1][2][3] The
main functions of money are distinguished as: a medium of exchange; a unit of account; a store
of value; and, perhaps, a standard of deferred payment.[4][5] Any item or verifiable record that
fulfills these functions can be considered money.
Functions of Money
Various functions of money can be classified into three broad groups:
(a) Primary functions, which include the medium of exchange and the measure of value;
(b) Secondary functions which include standard of deferred payments, store of value and transfer
of value; and
(c) Contingent functions which include distribution of national income, maximization of
satisfaction, basis of credit system, etc. These functions have been explained below:
1. Medium of Exchange:
The most important function of money is to serve as a medium of exchange or as a means of
payment. To be a successful medium of exchange, money must be commonly accepted by people
in exchange for goods and services. While functioning as a medium of exchange, money benefits
the society in a number of ways:
(a) It overcomes the inconvenience of baiter system (i.e., the need for double coincidence of
wants) by splitting the act of barter into two acts of exchange, i.e., sales and purchases through
money.

Subject-BE

Unit-2

By-K.R.Ansari

(b) It promotes transactional efficiency in exchange by facilitating the multiple exchange of

goods and services with minimum effort and time,
(c) It promotes allocation efficiency by facilitating specialization in production and trade,
(d) It allows freedom of choice in the sense that a person can use his money to buy the things he
wants most, from the people who offer the best bargain and at a time he considers the most
advantageous.
2. Measure of Value:
Money serves as a common measure of value in terms of which the value of all goods and
services is measured and expressed. By acting as a common denominator or numeraire, money
has provided a language of economic communication. It has made transactions easy and
simplified the problem of measuring and comparing the prices of goods and services in the
market. Prices are but values expressed in terms of money.
Money also acts as a unit of account. As a unit of account, it helps in developing an efficient
accounting system because the values of a variety of goods and services which are physically
measured in different units (e.g, quintals, metres, litres, etc.) can be added up. This makes
possible the comparisons of various kinds, both over time and across regions. It provides a basis
for keeping accounts, estimating national income, cost of a project, sale proceeds, profit and loss
of a firm, etc.
3. Standard of Deferred Payments:
When money is generally accepted as a medium of exchange and a unit of value, it naturally
becomes the unit in terms of which deferred or future payments are stated.
Thus, money not only helps current transactions though functions as a medium of exchange, but
facilitates credit transaction (i.e., exchanging present goods on credit) through its function as a
standard of deferred payments.
4. Store of Value:
Money, being a unit of value and a generally acceptable means of payment, provides a liquid
store of value because it is so easy to spend and so easy to store. By acting as a store of value,
money provides security to the individuals to meet unpredictable emergencies and to pay debts
that are fixed in terms of money. It also provides assurance that attractive future buying
opportunities can be exploited.
Money as a liquid store of value facilitates its possessor to purchase any other asset at any time.
It was Keynes who first fully realised the liquid store value of money function and regarded
money as a link between the present and the future. This, however, does not mean that money is
the most satisfactory liquid store of value. To become a satisfactory store of value, money must
have a stable value.
5. Transfer of Value:
Money also functions as a means of transferring value. Through money, value can be easily and
quickly transferred from one place to another because money is acceptable everywhere and to
all. For example, it is much easier to transfer one lakh rupees through bank draft from person A
in Amritsar to person B in Bombay than remitting the same value in commodity terms, say
wheat.

Subject-BE

Unit-2

By-K.R.Ansari

6. Distribution of National Income:

Money facilitates the division of national income between people. Total output of the country is
jointly produced by a number of people as workers, land owners, capitalists, and entrepreneurs,
and, in turn, will have to be distributed among them. Money helps in the distribution of national
product through the system of wage, rent, interest and profit.
7. Maximization of Satisfaction:
Money helps consumers and producers to maximize their benefits. A consumer maximizes his
satisfaction by equating the prices of each commodity (expressed in terms of money) with its
marginal utility. Similarly, a producer maximizes his profit by equating the marginal productivity
of a factor unit to its price.
8. Basis of Credit System:
Credit plays an important role in the modern economic system and money constitutes the basis of
credit. People deposit their money (saving) in the banks and on the basis of these deposits, the
banks create credit.
9. Liquidity to Wealth:
Money imparts liquidity to various forms of wealth. When a person holds wealth in the form of
money, he makes it liquid. In fact, all forms of wealth (e.g., land, machinery, stocks, stores, etc.)
can be converted into money.
Financial System
The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial intermediation
Role/ Functions of Financial System:
A financial system performs the following functions:
* It serves as a link between savers and investors. It helps in utilizing the mobilized savings of
scattered savers in more efficient and effective manner. It channelises flow of saving into
productive investment.
* It assists in the selection of the projects to be financed and also reviews the performance of
such projects periodically.
* It provides payment mechanism for exchange of goods and services.
* It provides a mechanism for the transfer of resources across geographic boundaries.
* It provides a mechanism for managing and controlling the risk involved in mobilizing savings
and allocating credit.
* It promotes the process of capital formation by bringing together the supply of saving and the
demand for investible funds.
* It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to
save more.
* It provides you detailed information to the operators/ players in the market such as individuals,

Subject-BE

Unit-2

By-K.R.Ansari

business houses, Governments etc.

Components/ Constituents of Indian Financial system:
The following are the four main components of Indian Financial system
1. Financial institutions
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.
Financial institutions:
Financial institutions are the intermediaries who facilitates smooth functioning of the financial
system by making investors and borrowers meet. They mobilize savings of the surplus units and
allocate them in productive activities promising a better rate of return. Financial institutions also
provide services to entities seeking advises on various issues ranging from restructuring to
diversification plans. They provide whole range of services to the entities who want to raise
funds from the markets elsewhere. Financial Institutions in India are divided in two categories.
The first type refers to the regulatory institutions and the second type refers to the intermediaries.
The regulators are assigned with the job of governing all the divisions of the Indian financial
system. These regulatory institutions are responsible for maintaining the transparency and the
national interest in the operations of the institutions under their supervision.
The regulatory bodies of the financial institutions in India are as follows:

Reserve Bank of India (RBI)

Securities and Exchange Board of India (SEBI)
Central Board of Direct Taxes (CBDT)

Central Board of Excise & Customs

Apart from the Regulatory bodies, there are the Intermediaries that include the banking and nonbanking financial institutions. Some of the specialized financial institutions in India
are as follows:

Unit Trust of India (UTI)

Securities Trading Corporation of India Ltd. (STCI)
Industrial Development Bank of India (IDBI)
Industrial Reconstruction Bank of India (IRBI), now (Industrial Investment Bank of India)
Export - Import Bank of India (EXIM Bank)
Small Industries Development Bank of India (SIDBI)
National Bank for Agriculture and Rural Development (NABARD)
Life Insurance Corporation of India (LIC)
General Insurance Corporation of India (GIC)
Shipping Credit and Investment Company of India Ltd. (SCICI)
Housing and Urban Development Corporation Ltd. (HUDCO)

Subject-BE

Unit-2

By-K.R.Ansari

National Housing Bank (NHB)

The banking institutions of India play a major role in the economy of the country. The banking
institutions are the providers of depository and transaction services. These activities are the
major sources of creating money. The banking institutions are the major sources of providing
loans and other credit facilities to the clients.
Financial Markets:
A financial market is a market in which people and entities can trade financial securities,
commodities, and other fungible items of value at low transaction costs and at prices that reflect
supply and demand. Securities include stocks and bonds, and commodities include precious
metals or agricultural goods.
The main functions of financial markets are:
1. to facilitate creation and allocation of credit and liquidity;
2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience
Financial Instruments
Another important constituent of financial system is financial instruments. They represent a
claim against the future income and wealth of others. It will be a claim against a person or an
institution, for the payment of the some of the money at a specified future date.
Financial Services:
Efficiency of emerging financial system largely depends upon the quality and variety of financial
services provided by financial intermediaries. The term financial services can be defined as
"activites, benefits and satisfaction connected with sale of money, that offers to users and
customers, financial related value"
Price is the quantity of payment or compensation given by one party to another in return
for goods or services.
In economics, inflation is a sustained increase in the general price level of goods and services in
an economy over a period of time. When the general price level rises, each unit of currency buys
fewer goods and services.
Features of Inflation
Following are the main features of inflation:
(i) Inflation is always accompanied by a rise in the price level. It is a process of uninterrupted
increase in prices.
(ii) Inflation is a monetary phenomenon and it is generally caused by excessive money supply.
(iii) Inflation is essentially an economic phenomenon as it originates in the economic system and
is the result of action and interaction of economic forces.
(iv) Inflation is a dynamic process as observed over the long period.
(v) A cyclical movement of prices is not inflation.

Subject-BE

Unit-2

By-K.R.Ansari

(vi) Pure inflation starts after full employment.

(vii) Inflation may be demand-pull or cost-push.
(viii) Excess demand in relation to the supply of everything is the essence of inflation.
Inflationrate. The inflation rate is a measure of changing prices, typically calculated on a month
-to-month and year-to-year basis andexpressed as a percentage.
Basic types of inflation
Different types of inflations can have widely different determinants, effects and remedies.
Hyperinflation is the most extreme inflation phenomenon, with yearly price increases of
three-digits percentage points and an explosive acceleration.
Extremely high inflation could range anywhere between 50% and 100%. High inflation is
a situation of price increase of, say, 30%-50% a year. Both kinds can be stable or dangerously
accelerate to enter in an hyperinflation condition.
Moderate inflation can be differently defined around the world, given the different inflation
histories. As an indication only, one could consider an inflation as moderate when it ranges from
5% to 25-30%. For some countries, the higher part of this range is already "high inflation".
Low inflation can be characterized from 1-2% to 5%. Around zero there is no inflation
(price stability). Below zero, a country faces deflation.
Causes of Price Rise (Inflation)
There are two main causes of price rise:
Demand-Pull
In the case of demand-pull, inflation is caused by aggregate demand being more than the
available supply. Aggregate demand is made up of consumer spending, investments, government
spending, and whatever is left after subtracting imports from exports. Factors that commonly
lead to demand-pull inflation include a sudden increase in the amount of money in an economy
and decreases in taxes on goods, which leaves consumers with more disposable income. Since
people have more money to spend, manufacturers raise the general prices of goods and services.
Another common cause of demand-pull situations is an increase in consumer spending because
of increased optimism caused by a boom in the economy. When people are more confident about
their financial future, they tend to spend more, contributing to a rise in prices. A dip in
currency exchange rates can lead to an increase in the value of imported goods, while causing a
reduction in the value of exports. When this happens, prices in the local market will go up as
importers and manufacturers transfer the cost to local consumers, causing the price of goods to
increase.
Cost-Push
Cost-push inflation occurs when manufacturers and businesses raise prices as a result of
shortages, or as a measure to balance other increases in production costs. An example of this is
rising labor costs. When workers demand wage increases, companies usually pass on these costs
to their customers. An increase in the taxes imposed on goods may lead to a cost-push situation
as well, since suppliers transfer the costs to consumers. This also often happens when one or
several companies has a monopoly in the market, and decides to raise their prices above demand
to increase their profit.

Subject-BE

Unit-2

By-K.R.Ansari

Effects of Inflation
Increase in production and investment: Inflation motivates producers increase production as
their goods or services will earn more profits (law of supply).
Greater inequality of income: Poor people more adversely affected by inflation. Inflation
widens the gap between rich and poor.
Balance of trade: Inflation will cause the prices of the goods and services to go up. It will make
the countrys exports less competitive in the international market and have a negative effect on
the balance of trade.
Exchange rate: High rate of inflation will affect the external value of money or the exchange
rate of the country. Other countries will find the currency more expensive and hence there will
be less demand for it and the value of currency will fall.
Measures to control inflation or Price Rise::
1. Monetary measures- Classical economists are of the view that inflation can be checked by
controlling the supply of money. Some of the important monetary measures to check the
inflation are as under:
Control over moneyIt is suggested that to check inflation government should put strict restrictions on the issue of
money by the central bank.
Credit controlCentral bank should pursue credit control policy .In order to control the credit it should increase
the bank rate ,raise minimum cash reserve ratio etc. It can also issue notice to other banks in
order to control credit
2.Fiscal measures- Measures taken by the government to control inflation.
A: Decrease in public expenditure- One of the main reasons of inflation is excess public
expenditure like building of roads ,bridges etc. Government should drastically scale down its non
essential expenditure.
B-Delay in payment of old debts: Payment of old debts that fall due should be postponed for
sometime so that people may not acquire extra purchasing power.
C-Increase in taxes : Government should levy some new direct taxes and raise rates of old taxes.
D-Over valuation of money: To control the over valuation of money it is essential to encourage
imports and discourage exports
Other measures
1 Increase in the production- One of the major causes of the inflation is the excess of demand
over supply ,so those goods should be produced more whose prices are likely to rise rapidly .In
order to increase production public sector should be expanded and private sector should be given
more incentives.
2 Proper commercial policy- Those goods which are in scarcity should be imported as much as
possible from other countries and their export should be discouraged.

Subject-BE

Unit-2

By-K.R.Ansari

3 Encouragement to savings During inflation government should come out with attractive
saving schemes. It may issue 5 or 10 year bonds in order to attract savings.