GOVERNMENT OF TAMIL NADU

HIGHER SECONDARY FIRST YEAR

ECONOMICS

A publication under Free Textbook Programme of Government of Tamil Nadu

Department of School Education

Untouchability is Inhuman and a Crime

First pages of 11th Economics.indd 1 26-02-2020 11:27:34

 Revised Edition - 2019, 2020

(Published Under New Syllabus)

The wise
possess all

II

First pages of 11th Economics.indd 2 26-02-2020 11:27:34

 HOW TO USE THE BOOK?

Chapter content It presents a complete overview of the chapter

Introduction Summary of the presentation in every chapter

Objectives Goals to transform the class room processes into learner

centric with a list of bench marks

Think and Amazing facts and rhetorical questions to lead students

Do to economic inquiries

Boxes Additional inputs to the content is provided

Directions are provided to students to conduct

Activity activities in order to explore and enrich the concept.

To motivate the students to further explore and enrich the concept

ICT To improve the computer based learning skills.

Give the values derived from functions which are graphed

Tables in the diagrams

Concept Conceptual diagrams that depict relationships between concepts

Diagrams to enable students to learn the content schematically.

Diagrams To illustrate the situations.

Glossary Explanation of scientific terms

Model Question
Papers For Evaluation

References List of related books for further details of the topic

Web links List of digital resources

III

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 CAREER GUIDANCE
CAREER PROSPECTS IN ECONOMICS

First pages of 11th Economics.indd 4

The career prospects for economics graduates are many. Numerous fields are waiting for economic graduates both in public as well as private sectors. In the government
sector, one may try for Indian Economic Services, jobs in Reserve Bank of India, PSUs and other public sector banks. All these jobs have wonderful career options. These
jobs give social prestige along with financial stability. Private sector also offers jobs for economic graduates in the fields like private banks, MNCs, BPOs, KPOs, Business
journals and newspapers. A good opportunity is also waiting for economic students in higher education. One can pursue Ph.D. in economics to enter into the field of
teaching in schools, colleges and universities and research in hundreds of Research Institutes and funding agencies – national & international.
One makes a successful career as a Corporate Lawyer after BA in economics followed by LLB. BA in economics and MBA placed one at a better position in the private
sector. Economic Journalism is another shining area for job perspective.

FAMOUS UNIVERSITIES AND COLLEGES OFFERING ECONOMICS

There are many institutes, colleges and universities that have economics in its BA, MA and Ph.D. level courses. Here are the lists of institutions offering economics.
One can easily see other information related with the respective universities/colleges/institutes with their given website.

Delhi School Sri Ram College University of Delhi, University of

of Economics of Commerce South Campus Agriculture Science

www.econdse.org www.srcc.edu www.south.du.ac.in www.uasbangalore.edu.in

IV
Jawaharlal Nehru St. Stephen University Ravenshaw
University, Delhi College, Delhi of Bombay University, Cuttack

www.jnu.ac.in www.ststephens.edu www.mu.ac.in www. ravenshawuniversity.ac.in

Gokhale Institute of
Madras School
IIT Kanpur BITS –Pilani Economics & Politics,
of Economics
Pune
www.jnu.ac.in www.mse.ac.in www.bits-pilani.ac.in www.gipe.ac.in

Indian Statistical
Presidency Symbiosis School of
IIT Madras Institute, Kolkata
College, Kolkata Economics
Bangalore
https://www.iitm.ac.in www.presiuniv.ac.in www. isical.ac.in www.sse.ac.in

Banaras University Centre for

IGIDR-Mumbai
Hindu University of Hyderabad Development Studies
Thiruvananthapuram
www.bhu.ac.in www.uohyd.ernet.in www.igidr.ac.in www.cds.edu

For world recognised institution in the field of economics, everybody wishes to join London School of Economics

26-02-2020 11:27:35
 Jobs in Economics Field
An array of employment opportunities is available in economics field. Meritorious candidates can get excellent job opportunities after successfully completing their BA or MA in
economics.
Government Sectors

First pages of 11th Economics.indd 5

Economics graduates can get prestigious jobs in the government sectors like
• Indian Civil Services • Indian Economic Services • Reserve Bank of India • National Sample Survey
• Ministry of Economic Affairs • Planning Board • Planning Commission (State & Central)
• National Council for Applied Economic Research and • National Institute of Public Finance and Policy.
Other than Government Sectors
Job opportunities are also waiting in the private sectors, NGOs and International Aid Agencies. The firms like World Bank, Asian Development Bank, IMF, and other Development
Banks, Aid agencies, Financial Consultancy firms are hiring the economic graduates for their various positions. One can assume in these organisations as economist, economic
advisor, executive, analyst, consultant, researcher, financial analyst, business analyst, economic research analyst and stock market analyst. As far as salary is concerned, lots of
candidates are hired through campus placement. The average salary is Rs. 4 to 8 lakh per annum. But for the deserving candidates, the field opens plethora of options and
remuneration is also beyond expectation. The filed like accountancy, actuarial, banking, insurance also open many jobs opportunities.
Economics Employment Opportunities
The various fields are offering better job opportunity after passing BA or MA in economics. Some of the high demand sectors are given below where job prospects are huge.

CAREERS FOR AN ECONOMIST

V
Government
Banking and Finance Education and Communications Business
and Public Sector

Commodities Broker Claims Examiner Professor Market Research Analyst

Bank Management Trainee Foreign Trade analyst Technical Writer Retail Buyer

Financial Analyst Tax Auditor Journalist/Columnist Staff Training and Development Specialist

Economic Forecaster Public Administrator Teacher Insurance Underwriting Trainee

Investment Banker Legislative Assistant Higher Education, Administration Management Consultant

Loan Counsellor Regional/Urban Planner Educational Television Advisor Strategic Planner

Securities Analyst Financial Planner Information Analyst Business Administrator

26-02-2020 11:27:35
 Table of Contents

ECONOMICS
Page
Chapter Contents Month
No.
Chapter......1 Introduction to Micro Economics 1 June

Chapter .....2 Consumption Analysis 25 June

Chapter .....3 Production Analysis 54 June

Chapter .....4 Cost and Revenue Analysis 80 July

Chapter .....5 Market Structure and Pricing

99 July
I Mid-term Lessons 1-5

Chapter .....6 Distribution Analysis 121 Aug

Chapter .....7 Indian Economy 143 Aug

Chapter..... 8 Indian Economy Before and

After Independence 166 Sep
Quarterly Lessons 1-8

Chapter .....9 Development Experiences in India 189 Oct

Chapter ...10 Rural Economy 205 Oct

Chapter ...11 Tamil Nadu Economy

225 Nov
II Mid-term Lessons 9-11

Chapter 12 Mathematical Methods for Economics 248 Nov

E - book Assessment DIGI links

Lets use the QR code in the text books ! How ?

• Download the QR code scanner from the Google PlayStore/ Apple App Store into your smartphone
• Open the QR code scanner application
• Once the scanner button in the application is clicked, camera opens and then bring it closer to the QR code in the text book.
• Once the camera detects the QR code, a url appears in the screen.Click the url and goto the content page.

VI

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 CH A P TER

1 Introduction to
Micro Economics

“Economics is everywhere, and understanding economics can

help you make better decisions and lead a happier life”
–Tyler Cowen

Learning Objectives

1 To acquire a fundamental knowledge on the subject of Economics and to

understand its nature and scope; and,

2  o understand the meaning of some of the basic concepts of Economics and

T
to observe how they are applied in the various definitions formulated on the
science of Economics

1.1 should have an explanation of the nature and

scope of the subject, i.e., whether the subject
Introduction
is traditional or modern, static or dynamic.
The readers should be in a position to clearly
A subject should have a name or a title that classify the subject as belonging to either
facilitates a clear and correct understanding arts alone, or to science alone or to both. The
of its contents. In a subject like Economics, significance of all the branches of the subject
there are many books available with titles should find a place in it. As they go through
such as ‘Introductory Economics’, ‘Economics: the introduction, the readers should be
An Introduction’, ‘Basic Economics’, ‘Elements able to understand the relationships of the
of Economics’, ‘Elementary Economics’, subject with other subjects. Newer areas
‘Fundamentals of Economics’ etc. But these incorporated into the subject and the newer
books have the same contents, though each ways of comprehending its contents are to
is intended to serve readers of a different be highlighted in the introduction. The
levels of interest and capacity. methodologies applied in the derivation
A good introduction to a subject, of its laws are to be stated in such an
besides containing the meaning of its title, introduction.

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 1.2 variety of definitions paves the way to
arrive a near-complete agreement on the
Economics: Meaning
subject-matter of Economics.

The term or word ‘Economics’ comes from A science grows stage by stage,
the Ancient Greek oikonomikos (oikos and at every stage, its newer definition
means “households”; and, Nemein means emerges and a concept associated with it
“management”, “custom” or “law”). Thus, receives some special emphasis. However,
the term ‘Economics’ means ‘management the study of a subject is made possible
of households’. The subject was earlier when it possesses its clear cut definition
known as ‘Political Economy’, is renamed and boundary.
as ‘Economics’, in the late 19th century by Four definitions, each referring to
Alfred Marshall. particular stage of the growth of the subject
of Economics, are presented here. They are:
01. Smith’s Wealth Definition,
1.3 representing the Classical era;
Economics: Its Nature 02. Marshall’s Welfare Definition,
representing the Neo-Classical era;
The nature of a subject refers to its 03. Robbins’ Scarcity Definition,
contents and how and why they find representing the New Age; and,
a place in the subject. This nature is
04. Samuelson’s Growth Definition,
understood by studying the various
representing the Modern Age.
definitions given by the notable
economists. The existence of multiplicity
of the definitions makes some scholars 1.3.1  ealth Definition:
W
comment that a search for a clear definition Adam Smith
of Economics is an exercise in futility. (The classical era)
J. M. Keynes, for example, observes that
Adam Smith (1723-
“Political Economy is said to have strangled
1790), in his book “An
itself with definitions”. Their presence
Inquiry into Nature and
makes studying a subject interesting, Causes of Wealth of
exciting, enjoyable, or worthwhile. In fact, Nations” (1776) defines
their presence in a social science subject “Economics as the
is a clear sign of the growth of the science. science of wealth”. He
It indicates that there exists freedom for explains how a nation’s wealth is created
people associated with such as science and increased. He considers that the
to formulate fresh definitions. These individual in the society wants to promote
associates appreciate and make use of the his own gain and in this process, he is
opportunity afforded to them and come guided and led by an “invisible hand”. He
up with a plethora of definitions saying: states that every man is motivated by his
‘The more, the merrier’. Each definition self interest. This means that each person
represents a unique generalisation. A wide works for his own good.
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 Smith favours the introduction attainment and with the use of the material
of “division of labour” to increase the requisites of well-being. Thus, it is on one side
quantum of output. Severe competition a study of wealth; and on the other, and more
in factories and society helps in bettering important side, a part of the study of man.”
the product. Supply force is very active The important features of
and a commodity is made available to Marshall’s definition are:
the consumers at the lowest price.
a. Economics does not treat wealth as
the be-all and end-all of economic
The publication of Adam Smith’s activities. Man promotes primarily
“The Wealth of Nations” in 1776, has welfare and not wealth.
been described as “the effective birth b. The science of Economics contains
of economics as a separate discipline”. the concerns of ordinary people who
are moved by love and not merely
guided or directed by the desire to get
Criticism maximum monetary benefit.
For Smith, Economics consists of ‘wealth- c. Economics is a social science. It studies
getting’ activities and ‘wealth-spending’ people in the society who influence
activities. An undue emphasis is given to one another.
material wealth. Wealth is treated to be
an end in itself. This view leads him to Criticism
ignore human welfare as an essential part
of Economics. Smith gives his definition a. Marshall regards only material things.
when religious and spiritual values are He does not consider immaterial
held high. Ruskin and Carlyle regards things, such as the services of a doctor,
Economics as a ‘dismal science’, as it a teacher and so on. They also promote
teaches selfishness which is against ethics. people’s welfare.
b. In the theory of wages, Marshall ignores
the amount of money that goes as
1.3.2  elfare Definition:
W reward for the services of ‘immaterial’
Alfred Marshall services.
(The Neo- classical era)
c. Marshall’s definition is based on the
Alfred Marshall concept of welfare. But it is not clearly
(1842-1924) in his defined. Welfare varies from person
book “Principles of to person, country to country and one
Economics” (1890) period to another. Marshall clearly
defines Economics thus: distinguishes between those things
“Political Economy” or that are capable of promoting welfare
Economics is a study of of people and those things that are not.
mankind in the ordinary business of life; it Things like liquor that are not capable
examines that part of individual and social of promoting welfare but command
action which is most closely connected with the

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 a price, come under the purview of Economics, according to Robbins, is a
Economics. science of choice.
d. However, welfare means happiness or
comfortable living conditions of an Criticism
individual or group of people. The a. Robbins does not make any distinction
welfare of an individual or nation is between goods conducive to human
dependent not only on the stock of welfare and goods that are not. In
wealth possessed but also on political, the production of rice and alcoholic
social and cultural activities of the drink, scarce resources are used.
nation. But the production of rice promotes
human welfare, while that of alcoholic
1.3.3  carcity Definition:
S drinks does not. However, Robbins
Lionel Robbins concludes that Economics is neutral
(The New Age) between ends.
b. Economics deals not only with the
Lionel Robbins
micro-economic aspects of resource-
published a book “An
allocation and the determination
Essay on the Nature
of the price of a commodity, but
and Significance of
also with the macro-economic
Economic Science” in
aspects like how national income
1932. According to
is generated. But, Robbins reduces
him, “Economics is a
Economics merely to theory of
science which studies human behaviour
resource allocation.
as a relationship between ends and
scarce means which have alternative c. Robbins’ definition does not cover
uses”. the theory of economic growth and
development.
The major features of Robbins’
definition are:
1.3.4  rowth Definition:
G
a. Ends refer to human wants. Human
Samuelson
beings have unlimited number of
(The Modern Age)
wants.
b. On the other hand, resources or means
Paul Samuelson
that go to satisfy the unlimited human published a book "An
wants are limited or scarce in supply. Intradictory Analysis"
The scarcity of a commodity is to in 1948. He defines
be considered only in relation to its Economics as “the
demand. study of how men and
society choose, with
c. Further, the scarce means are capable
or without the use of money, to employ
of having alternative uses. Hence, an
scarce productive resources which could
individual grades his wants and satisfies
have alternative uses, to produce various
first his most urgent want. Thus,
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 commodities over time, and distribute
1.4.1  conomics: Its Subject-
E
them for consumption, now and in the
Matter
future among various people and groups of
society”.
The major implications of this
definition are as follows:

a. Like Robbins, Samuelson states that

the means are scarce in relation to
unlimited ends and that such means
could be put to alternative uses.
b. Samuelson makes his definition
dynamic by including the element of
time in it. Therefore, his definition
„„Economics focuses on the behaviour
covers the theory of economic
and interactions among economic
growth.
agents, individuals and groups
c. Samuelson’s definition is applicable belonging to an economic system.
also in a barter economy, where money It deals with the activities such as
is not used. the consumption and production
d. His definition covers various aspects of goods and services and the
like production, distribution and distribution of income among the
consumption. factors of production. The activities
e. Samuelson treats Economics as a of the rational human beings in
social science, whereas Robbins the ordinary business of life under
regards it as a science of individual the existing social, legal and
behaviour. institutional arrangement are
included in the Science of Economics;
Of all the definitions discussed the abnormal persons and the socially
above, the ‘growth’ definition stated unacceptable and unethical activities
by Samuelson appears to be the most are excluded.
satisfactory. „„Economics studies the ways in which
people use the available resources to
satisfy their multiplicity of wants.
1.4 Scarcity is a problem indicating the
Scope of Economics gap between what people want and
what they are able to get. This scarcity
The scope of the subject of Economics refers can be eliminated either by limiting
to on the subject-matter of Economics. the human wants or by increasing the
It throws light on whether it is an art or supply of the goods that satisfy the
a science and if science, whether it is a
positive science or a normative science.
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 human wants. The method of getting co-relationship between cause and effect.
more is resorted to, rather than the Scientific laws derived are tested through
method of wanting less. experiments; and future predictions
„„Economics is concerned with activities are made. These laws are universally
of human being only. Human beings applicable and accepted. Economists like
are related to one another and the Robbins, Jordon and Robertson argue
actions of one member affect those that Economics is a science like Physics,
of the other members in the society. Chemistry etc., since, it has several similar
Hence, Economics is called a Human characteristics. Economics examines the
Science or Social Science. relationships between the causes and the
effects of the problems. Hence, it is rightly
„„The activities of rational or normal
considered as both an art and a science. In
human beings are the subject-matter
fact, art and science are complementary to
of Economics.
each other.
„„All human activities related to wealth
constitute the subject-matter of
Economics. Thus, human activities 1.4.3  conomics: Positive
E
not related to wealth (non-economic Science and Normative
activities) are not treated in Economics. Science
For example, playing cricket for
Positive science deals with what it is, means,
pleasure, mother’s child care.
it analyses a problem on the basis of facts and
examines its causes. For example, at the time
It is customary to clarify whether
of a price increase, its causes are analysed.
Economics is an art or a science; and if it
is a science, to observe its specific features.

Positive Normative
1.4.2 Economics is an Art and is,was,will be ought to, should

a Science If the price of Price should go up to

reduce petrol
petrol rises,people
will buy less consumption

i. Economics as an Art
Can be Cannot be
Art is the practical application of proved proved

knowledge for achieving particular goals. Connects cause Makes recommendations

& effects Not based on facts
Economics provides guidance to the Descriptive Tells you should be/have

solutions to all the economic problems. Based on facts

Tells you what is
been
Prescriptive
Objective Subjective
A. C. Pigou, Alfred Marshall and
others regard Economics as an art.

ii. Economics as a Science On the other hand, normative

Science is a systematic study of knowledge. science responds to a question like
All its relevant facts are collected, classified what ought to be. Here, the conclusions
and analyzed with its scale of measurement. and results are not based on facts, but
Using these facts, science develops the on different considerations belonging
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 to social, cultural, political, religious is necessary when the theories associated
realms. They are basically subjective in with them are studied. Only a preliminary
nature. acquaintance is now attempted here.
In short, positive science is concerned
with ‘how? and why?’ and normative science 1.5.1 Goods and Services
with ‘what ought to be’. The distinction Both goods and services satisfy human
between the two can be explained. An wants. In Economics, the term ‘goods’
increase in the rate of interest, under implies the term ‘services’ also, unless
positive science, would be looked into as specified otherwise.
to why and how can it be reduced, whereas
under normative science, it would be seen
as to whether it is good or bad.
Three statements about each type
are given below:

Positive Economics
a. An increase in money supply implies a
price-rise in an economy.
b. As the irrigation facilities and application
of chemical fertilizers expand, the Goods (also called ‘products’, ‘commodities’,
production of food-grains increases. ‘things’ etc)
c. An increase in the birth rate and a a. as material things, they are tangible;
decrease in the death rate reflect the b. have physical dimensions, i.e., their
rate of growth of population. physical attributes can be preserved
over time;
Normative Economics
c. exist independently of their owner;
a. Inflation is better than deflation. d. are owned by some persons;
b. More production of luxury goods is not e. are transferable;
good for a less-developed country.
f. have value-in exchange;
c. Inequalities in the distribution of wealth
and incomes should be reduced.
Kinds of Goods (and Services)
a. Free and Economic goods
1.5 Free goods are available in nature and in
Basic Concepts in abundance. Man does not need to incur
Economics any expenditure to own or use them. For
example air, and sun shine. Water was also
Like other sciences, Economics also an example in the past, but at present it has
has concepts to explain its theories. A exchange value. So it is not a free good.
complete and clear grasp of their meaning
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 Milton Friedman, a Nobel laureate, Capital-goods (also called
popularises a saying: “There is no such producer’s goods) don’t directly satisfy the
thing as a free lunch”. He means that it is consumer wants. They help to produce
impossible to get something for nothing. consumer goods. For example, machines
Even those offered ‘free’ always costs a do not directly satisfy the consumers, but
person or the society as a whole. Its cost, in factories, the manufacturers need them.
however, is hidden. It is an externality.
Someone can benefit from an externality or
from a public good, but someone-else has
to pay the cost of producing these benefits.
In Economics, it refers to ‘opportunity cost’.

PUBLIC VS PRIVATE GOODS

PUBLIC GOODS
A good available to everyone to consume, c. Perishable goods and Durable goods:
Regardless of who pays and who doesn’t.
Perishable goods are short-lived. Their
Spillover benefits;
life-span is limited. For example fish,
Non -rival in consumption and non- excludable;
fruits, flower etc., do not have a long life.
E.g:National defence,Law enforcement.
PRIVATE GOODS
A good consumed by a single person or
Household;
No spillover benefits;
Rival in consumption and excludable;
E.g:food and drink

On the other hand, economic

goods are not available in plenty.
They are scarce in supply. Man has to
spend money to own or use them. Durable goods and semi-durable
b. Consumer goods and Capital goods:
goods have a little longer life-time than
the Perishable goods. For example,
Consumer goods directly satisfy human
a table, a chair etc.
wants, TV, Furniture, Automobile etc.

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 Services
Along with goods, services are produced
and consumed. They are generally, possess
the following:
„„Intangible: Intangible things are
not physical objects but exist in
connection to other things, for
example, brand image, goodwill etc.
But today, the intangible things are
converted and stored into tangible
items such as recording a music piece
into a pen-drive. They are marketed as
a good.
„„Heterogeneous: Services vary across
b. Characteristics of Utility
regions or cultural backgrounds. They
can be grouped on the basis of quality 1. Utility is psychological. It depends

standards. A single type service yields on the consumer’s mental attitude.

multiple experiences. For example, For example, a vegetarian derives
music, consulting physicians etc. no utility from mutton;

„„Inseparable from their makers: 2. Utility is not equivalent to

Services are inextricably connected to usefulness. For example, a smoker
their makers. For example, labour and derives utility from a cigarette; but,
labourer are inseparable; and, his health gets affected;

„„Perishable: Services cannot be stored 3. Utility is not the same as pleasure.

as inventories like assets. For example, A sick person derives utility from
it is useless to possess a ticket for a taking a medicine, but definitely, it
cricket-match once the match is over. is not providing pleasure;
It cannot be stored and it has no value- 4. Utility is personal and relative. An
in-exchange. individual obtains varied utility
from one and the same good in
different situations and places;
1.5.2 Utility
5. Utility is the function of the
a. Meaning intensity of human want. An
individual consumer faces a
‘Utility’ means ‘usefulness’. In
tendency of diminishing utility;
Economics, utility is the want-
satisfying power of a commodity 6. Utility is a subjective concept it
or a service. It is in the goods and cannot be measured objectively and
services for an individual consumer it cannot be measured numerically;
at a particular time and at a particular 7. Utility has no ethical or moral
place. significance. For example, a cook
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 derives utility from a knife using 6. Knowledge Utility: It is the utility
which he cuts some vegetables; and, derived by having knowledge of a
a killer wants to stab his enemy particular thing. Advertisement
by that knife. In Economics, a serves as a source of information
commodity has utility, if it satisfies on an object.
a human want;
d. Measurability of Utility
c. Types of Utility Wants of a person are satisfied by the act
The following are the types of utility of consumption. The consumer derives
utility, measured in terms of ‘Utils’.
1. Form Utility: An individual
An ‘Util’ is a unit of measurement of
consumer obtains utility from a
utility. An individual pays a price for
good or service only when it is
the unit of the good, equal to the utility
available in a particular form. Raw
derived. Marshall states that utility
materials in their original form may
can be measured indirectly using the
not possess utility for a consumer.
‘measuring rod of money’.
But in their changed forms as they
become finished products, they
provide utility to him. For example, 1.5.3 Price
cotton as a raw material may not Price is the value of the good expressed in
possess utility for a consumer; but terms of money. Price of a good is fixed
as it gets a new form as a cloth, it by the forces of demand for and supply
yields the consumer utility. of the good. Price determines what goods
2. Time Utility: A sick man derives are to be produced and in what quantities.
time utility from blood not at the It also decides how the goods are to be
time of its donation, but only at the produced.
operation-time, i.e., when it is used.
3. Place Utility: A student derives 1.5.4 Market
place utility from a book not at the
Generally, market means a place where
place of its publication (production
commodities are bought and sold.
centre) but only at the place of his
education (consumption centre). But, in Economics, it represents
where buyers and sellers enter into an
4. Service Utility: An individual
exchange of goods and services over a
consumer derives service utility from
price.
a service made available at the time
when he most needs it. For example,
clients obtain service utility from 1.5.5 Cost
their lawyers, patients derive service Cost refers to the expenses incurred to
utility from the doctors and so on. produce or acquire a given quantum of a
5. Possession Utility: When a student good. Together with revenue, it determines
buys a book or dictionary from a the profit gained or the loss incurred by a
book seller, then only it gives utility. firm.
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 b. Particular Equilibrium and General
1.5.6 Revenue
Equilibrium
Revenue is income obtained from the sale An equilibrium, when it pertains to a
of goods and services. Total Revenue (TR) single variable, may be called particular
represents the money obtained from equilibrium.
the sale of all the units of a good. Thus,
TR = P × Q, where TR is Total Revenue; An equilibrium, on the other
P is the price per unit of the good; and, hand, when it relates to numerous
Q is the Total Quantity of the goods sold. variables or even the economy as a whole,
final
may be called general equilibrium.

1.5.7 Equilibrium
1.5.8 Income
a. Stable Equilibrium Income represents the amount of
Prof. Stigler states that “equilibrium monetary or other returns, either earned

UNIT 1 is a position from which there is no

net tendency to move”. Its absence
is referred to as disequilibrium.
or unearned small or big, accruing
over a period of time to an economic
unit. Nominal income refers to income,
Consumer’s equilibrium occurs expressed in terms of money. It is termed
Y
when heProduction
gets maximum satisfaction.
Possibilities Curve as the money income.
The
A1
equilibrium of the Producer Real income is the amount of goods
occurs
A when he gets maximum profit. that can be purchased with money as income.
Goods-Y

Growth of resources
A resource is in equilibrium when It is the purchasing power of income which
it gets fully employed and gets its is based on the rate of inflation.
maximum payment. Where, static
equilibrium is based on given and
constant
0 prices, quantities, E E1income,
1.6
X
Goods-X
technology, population etc. Economics: Its
Diagram 1.3 Methods, Facts,
Theories and Laws

Y
Market 1.6.1  ethods of Economics:
M
S
D Deduction and Induction
E Like any other science, Economics
price

also has its laws or generalisations.

D These laws govern the activities in the
S various divisions of Economics such as
Consumption, Production, Exchange
O M X
and Distribution. The logical process of
Quantity demanded & supplied
arriving at a law or generalization in a
Diagram 1.1
science is called its method.
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 b. Inductive Method of Economic
Analysis
Inductive method, also called empirical
method, is adopted by the “Historical
School of Economists”. It involves the
process of reasoning from particular facts
to general principle.
Economic generalizations are
derived in this method, on the basis of
Economics uses two methods:
deduction and induction. (i) Experimentations;

a. Deductive Method of Economic (ii) Observations; and,

Analysis (iii) Statistical methods.

It is also named as analytical or

abstract method. It consists in deriving „„Step 1: Data are collected about a
conclusions from general truths; certain economic phenomenon. These
it takes few general principles and are systematically arranged and the
applies them to draw conclusions. The general conclusions are drawn from
classical and neo-classical school of them.
economists notably, Ricardo, Senior, „„Step 2: By observing the data,
J.S.Mill, Malthus, Marshall, Pigou, conclusions are easily drawn.
applied the deductive method in their „„Step 3: Generalization of the data and
economic investigations. then Hypothesis Formulation
„„Step 4: Verification of the hypothesis
Steps of Deductive Method (eg.Engel’s law)
„„Step 1: The analyst must have a clear
and precise idea of the problem to be
According to Engel’s Law “The
inquired into.
proportion of total expenditure
„„Step 2: The analyst clearly defines the incurred on food items declines as
technical terms used in the analysis. total expenditure [which is proxy for
Further, assumptions of the theory are income] goes on increasing.”
to be precise.
„„Step 3: Deduce hypothesis from the Economists today are of the
assumptions taken. view that both these methods are
„„Step 4: Hypotheses should be verified complementary. Alfred Marshall
through direct observation of has rightly remarked: “Inductive and
events in the real world and through Deductive methods are both needed for
statistical methods. (eg) There exists scientific thought, as the right and left foot
an inverse relationship between price are both needed for walking”.
and quantity demanded of a good.
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 1.6.2  conomics: Facts,
E Importance of Micro
Theories Economics
Using the methods, the economist „„To understand the operation of an
observes facts, such as, changes in the price economy
of a commodity. Similarly, the quantity „„To provide tools for economic
demanded of that commodity also varies. policies
And he observes these movements and
„„To examine the condition of
comes up with a theory that these two
economic welfare
movements are inversely related, i.e.,
when the price increases, the quantity „„Efficient utilization of resources
demanded of that commodity decreases „„Useful in international trade
and vice versa. Thus, he formulates his „„Useful in decision making
theory of demand.
„„Optimal resource allocation
He tests his theory by collecting „„Basis for prediction
further facts and when his theory stands the
„„Price determination
test of time and obtains universal acceptance,
the theory is raised to the status of a law.
A physical scientist carrying out
controlled experiments in his laboratory can
1.6.3 Nature of Economic Laws test the scientific laws very easily by changing
A Law expresses a causal relation between the conditions obtaining there. Changes
two or more than two phenomena. in Economics science cannot be brought
Marshall states that the Economic laws about easily. As a result, prediction regarding
are statement of tendencies, and those human behaviour is likely to go wrong. There
social laws, which relate to those branches are exceptions to the Law of Demand. Thus,
of conduct in which the strength of economic laws are not inviodable.
the motives chiefly concerned can be As unpredictability is invariably
measured by money price. associated with the economic laws. Marshall
In natural sciences, a definite result compares them to the laws of tides. Just as it
is expected to follow from a particular cannot be predicted and said with certainty
cause. In Economic science, the laws that a high tide would follow a low tide,
function with cause and effect. The unpredictability prevails in Economics.
consequences predicted by the data, Human behaviour is volatile. Economic
necessarily and invariably follow. laws are not assertive but they are indicative.
However, Economic laws are not The Law of Demand, for example, states that
as precise and certain as the laws in the other things remaining the same, the quantity
physical sciences. Marshall holds the demanded of a commodity increases, as its
opinion that there are no laws of economics price decreases and vice versa.
which can be compared for precision with The use of the assumption ‘other
the law of gravitation. things remaining the same’ (ceteris
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 paribus) in Economics makes the of production namely Land, Labour,
Economic laws hypothetical. It might be Capital and Organization and also the
argued that the laws in other sciences relationship between inputs and output.
can also be called hypothetical. It should
be admitted however that in the case of 1.7.3 Exchange
Economics, the hypothetical elements in
its laws are a little less pronounced than in Exchange is concerned with price
the laws of physical sciences. determination in different market forms.
This division covers trade and commerce.
But since money is used as the Consumption is possible only if the
measuring rod, laws in economics are produced commodity is placed in the
more exact, precise and accurate than the hands of the consumer.
other social sciences. As the value of the
measuring- rod money is not constant,
1.7.4 Distribution
there is always an hypothetical element
surrounding the laws of Economics. Production is the result of the coordination
Some economic laws are simply of factors of production. Since a
truisms. For example, saving is a function commodity is produced with the efforts
of income. Another example of truism is: of land, labour, capital and organization,
human wants are unlimited. the produced wealth has to be distributed
among the cooperating factors. The
reward for factors of production is studied
1.7 in this division under rent, wages, interest
Economics: Its Sub and profit. Distribution studies about the
Divisions pricing of factors of production.

Economics has been divided into some 1.8

branches.
Economics: Its Types

1.7.1 Consumption Economics is a rapidly growing subject and its

Human wants coming under consumption horizon has been expanding. The basic thrust
is the starting point of economic activity. of the subject is that there should be efficient
In this section the characteristics of human allocation of the available scarce resources to
wants based on the behaviour of the obtain maximum welfare to the people on
consumer, the diminishing marginal utility a sustainable basis. Given below are some
and consumer’s surplus are dealt with. of the major branches of the subject, where
such efficient resource allocation is made.
1.7.2 Production
1.8.1 Micro-economics
Production is the process of transformation
of inputs into output. This division covers Micro Economics is the study of the
the characteristics and role of the factors economic actions of individual units say
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 households, firms or industries. It studies
how business firms operate under different The terms ‘micro economics’ and
market conditions and how the combined ‘macro economics’ were first used in
actions of buyers and sellers determine economics by Norwegian economist
prices. Micro economics covers Ragner Frisch in 1933. After Prof. Frisch,
the terms earned popularity when J.M.
(i) Value theory (Product pricing and
Keynes clearly distinguished between
factor pricing)
the terms through his book entitled
(ii) Theory of economic welfare ‘General theory of ‘Employment, Interest
and Money’ published in 1936.

1.8.2 Macro-economics Macro Economics Vs Micro Economics

Macro economics is the obverse of
micro economics. It is concerned with
the economy as a whole. It is the study
of aggregates such as national output,
inflation, unemployment and taxes. The
General Theory of Employment, Interest
and Money published by Keynes is the
basis of modern macro economics.

Difference between Micro Economics and Macro Economics

Micro Economics Macro Economics
1. It is that branch of economics which 1. It is that branch of economics which
deals with the economic decision- deals with aggregates and averages of
making of individual economic agents the entire economy. E.g., aggregate
such as the producer, the consumer etc. output, national income, aggregate
savings and investment, etc.
2. It takes into account small components 2. It takes into consideration the economy
of the whole economy. of the country as a whole.
3. It deals with the process of price 3. It deals with general price-level in any
determination in case of individual economy.
products and factors of production.
4. It is known as price theory 4. It is also known as the income theory.
5. I t is concerned with the optimization goals 5. It is concerned with the optimization of
of individual consumers and producers the growth process of the entire economy.

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 1.8.3 International Economics 1.8.7  nvironmental
E
In the modern world, no country can Economics
grow in isolation. Every country is having Depletion of natural resources stock and
links with the other countries through pollution result from rapid economic
foreign capital, investment (foreign direct development. Hence the need for the study
investment) and international trade. of Environmental Economics which analyse
the inter relationship between economy and
1.8.4 Public Economics environment. Environmental Economics
(Public Finance) is a study of inter disciplinary tools for
the problems of ecology, economy and
Public finance is concerned with
environment.
the income or revenue raising and
expenditure incurring activities of the
public authorities and with the adjustment 1.9
of the one with the other. The scope of Basic Economic
Public Finance covers Public expenditure, Problems
Public revenue, Public debt, Financial
administration and federal Finance. If resources are abundant and wants are
so few, then there would be no economic
1.8.5  evelopmental
D problem. But this situation can never
Economics exist. Resources are always scarce and
our wants are numerous. Hence in every
The countries have been classified society certain choices have to be made.
into developed, developing and under
developed on the criteria of Per Capita
Income, Human Development Index
and Happiness Index. The Development
Economics deals with features of developed
nations, obstacles for development,
Economic and Non-economic factors
influencing development, various growth
models and strategies.

1.8.6 Health Economics

What and how much to
Health Economics is an area of applied
produce?
economics. It covers health indicators,
preventive and curative measures, Every society must decide on what goods
medical research and education, Rural it will produce are and how much of these
Health Mission, Drug Price control, Neo it will produce. In this process, the crucial
natal care, Maternity and Child health, decisions include:
Budgetary allocation for health etc.
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 a. Whether to produce more of food, a minimum amount of consumption be
clothing and housing or to have more ensured for everyone in the society. Due
luxury goods to the scarcity of resources, a society
b. Whether to have more agricultural faces the compulsion of making choice
goods or to have industrial goods and among alternatives. It faces the problem
services of allocating the scare resources to the
production of different possible goods and
c. Whether to use more resources in
services and of distributing the produced
education and health or to use more
goods and services among individuals
resources in military services
within the economy.
d. Whether to have more consumption
goods or to have investment goods
e. Whether to spend more on basic 1.10
education or higher education
Production
Possibility Curve

The problem of choice between relatively

scarce commodities due to limited
productive resources with the society
can be illustrated with the help of a
geometric device, is known as production
possibility curve. Production possibility
curve shows the menu of choice along
which a society can choose to substitute
one good for another, assuming a given
state of technology and given total
resources.
How to Produce?
The explanation and analysis of
Every society has to decide whether it will
production possibility curve is based
use labour-intensive technology or capital
upon certain assumptions, some of them
intensive technology; that is whether to
are following
use more labour and less machines and
vice versa. (i) The time period does not change. It
remains the same throughout the
For whom to produce? curve.
Every society must also decide how (ii) Techniques of production are fixed.
its produce be distributed among the (iii) There is full employment in the
different sections of the society. It must economy.
also decide who gets more and who gets (iv) Only two goods can be produced
less. It should also decide whether or not from the given resources.

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 (v) Resources of production are fully
mobile.
(vi) The factors of production are given
in quantity and quality
(vii) The law of diminishing returns
operates in production.
Every production possibility curve is
based upon these assumptions. If some of
these assumptions changes or neglected,
then it affects the nature of production
possibility curve.
To draw this curve we take the help of We can obtain a production possibility
production possibilities schedule, as curve by drawing production possibilities
shown below. schedule graphically. The quantity of food
is shown on x-axis and the number of
cars is shown on y-axis, the different six

UNIT 1
Production possibilities
production possibilities are being shown
schedule
as point P1 P2 P3 P4 P5 & P6.
Production Quantity No of car
possibilities of food production
Y production Y
Production Possibilities Curve
in tonsCurve
Production Possibilities
A1
I 0 25
25 A
Goods-Y

Growth of resources
No of Cars

II 100 23
20
15 III 200 20
10 IV 300 15
5
V 400 8
0 0 E E1 X
100 VI200 300 400 500 500 X 0 Goods-X
Food Production
Diagram 1.3
Diagram
Diagram 1.21.2
This schedule suggests that if all resources
are thrown into the production of food,
a maximum of 500 tons of food can be Food
Y
production
Wants
produced, given the existing technology. If we assume thatMarket
innumerable production
S
If on the other hand, all resources are possibilities
D exist between any two-
Consumption Efforts
instead used for producing cars, 25 cars production possibilities
E
schedule, we
can be produced. In between these two get the production possibility curve P1
price

extreme possibilities exist. If we are to p6. This shows the locus of points of
Distribution Production
& to give up some
willing food, we can have D
the different possibilities of production
S
Exchangesome cars. of two commodities, which a firm or an
O M X
Quantity demanded & supplied
Introduction to Micro-Economics 18
Diagram 1.1

Chapter-01.indd 18 20-02-2020 11:43:49

 economy can produce, with the help of resources between the goods for the higher
given resources and the techniques of income group and the lower income
production. Points outside the production group and the goods for the defense and
possibility (e.g. point p) are unattainable the civilians. Since PPC is the locus of the
as society’s resources of production are combination of the goods the problem of
not sufficient to give output beyond choice will not arises when we choose any
the curve. Points lying inside the curve point on PPC.
like P₇ are attainable by the society but (ii) The Notion of Scarcity
at these points resources production
We can explain the notion of scarcity
are not fully employed. For example,
with the help of PPC. We know that every
if society is producing at point P 4 then
society possesses only a specific amount of
it can increased the production of food
resources, which can produce only limited
keeping the no of cars constant or it can
amount of output even with the help of
increase the production of cars keeping
best technology, economic scarcity of best
the food grain output constant or it can
fact of life. The production possibility
increased the output of both the goods
curve reflects the constraints imposed by
simultaneously.
the element of economic scarcity.
Shift of production possibility curve
(iii) Solution of central problems
The PPC shifts upward or downward due to:
The central problems of an economy can
1. The change in the supply of be explained with the help of PPC. The
productive resources and solution of problem of what to produce
2. The change in the state of technology. involves the decision regarding the choice
The production capacity of an economy of location on the production possibility
grows overtime through increase in curves. A production combination
resource supplies and improvement of represented by any point inside the
technology. This enables PPC to shift PPC indicates that the economy is using
upward from AE to A1E1 as shown in figure inefficient methods of production and
below. This outward shift of the PPC is the inefficient combination of resources.
basic feature of economic growth.
1.11 Conclusion
Uses of production possibility
This chapter has given a broad overview
curve
of economics. Moreover the present
Through the device of PPC can be used certain common characteristics of
for many analytical purposes. We shall economics definitions of Wealth,
discuss below some of its popular uses. Welfare, Scarcity & Growth free essential
(i) The problem of choice questions an economy must solve; what to
produce, how to produce and for whom
The problem of choice arise because of
to produce and also looked at division of
the given limited resources and unlimited
economics, distinguishing between Micro
wants, may relate to the allocation of
and Macroeconomics. It has introduced
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 some basic concepts frequently appearing
Value Power of a commodity
throughout the lessons.
to command other
It is perhaps both importance, the commodities in an
study of economics is an intellectually exchange
fascinating adventure highly relevant and
it affects people’s life. Every now and then Price Value of a commodity
after learning lesson, think of economic expressed in terms of
activities in and around you. Perhaps in money
this way learning of economics makes to Income The amount of monetary
think like an economist. or other returns, either
earned or unearned,
GLOSSARY accruing over a period of
time
Scarcity The gap between what
people want and what Deductive Deduction is a process
people can get Method in logic facilitating or
arriving at an inference,
Production Creation of utility moving from general to
Distribution Share of the national particular
income reaching the four Inductive Induction is a process
factors of production Method in logic facilitative or
Services Services, like goods, are arriving at an inference,
economic entities; and moving from particular
are inseparable from their to general
owners and are intangible,
perishable in nature

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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. ‘Economics is a study of mankind in 5. Find the odd one out:

the ordinary business of life’ -It is the a. “An inquiry into the nature and the
statement of causes of the Wealth of Nations”
a. Adam Smith b. “Principles of Economics”
b. Lionel Robbins c. “Nature and Significance of
c. Alfred Marshall Economic Science”
d. Samuelson d. “Ceteris paribus”

2. The basic problem studied in 6. The equilibrium price is the price at

Economics is which
a. Unlimited wants a. Everything is sold
b. Unlimited means b. Buyers spend their money
c. Scarcity c. Quantity demanded equals
d. Strategy to meet all our wants quantity supplied
d. Excess demand is zero
3. Microeconomics is concerned with
a. The economy as a whole 7. Author of “An Inquiry into the Nature
and Causes of Wealth of Nations”
b. Different sectors of an economy
a. Alfred Marshall
c. The study of individual economic
units behaviour b. Adam Smith

d. The interactions within the entire c. Lionel Robbins

economy d. Paul A Samuelson

4. Which of the following is a 8. “Economics studies human behaviour

microeconomics statement? as a relationship between ends and
a. The real domestic output increased scarce means which have alternative
by 2.5 percent last year. uses” is the definition of economics of

b. Unemployment was 9.8 percent of a. Lionel Robbins

the labour force last year. b. Adam Smith
c. The price of wheat determines its c. Alfred Marshall
demand d. Paul A Samuelson
d. The general price level increased
by 4 percent last year.

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 9. Who is the Father of Economics? c. Economics is the study of material
a. Max Muller welfare

b. Adam Smith d. Economics deals with unlimited

wants and limited means
c. Karl Marx
14. Growth definition takes into account
d. Paul A Samuelson
a. The problem of choice in the
10. “Economics is a science” The basis of dynamic framework of Economics
this statement is—
b. The problem of unlimited means
a. Relation between cause and effect in relation to wants
b. Use of deductive method and c. The production and distribution of
inductive method for the wealth
formations of laws
d. The material welfare of human
c. Experiments beings
d. All of the above
15. Which theory is generally included
11. Utility means under micro economics ?
a. Equilibrium point at which a. Price Theory
demand and supply are equal b. Income Theory
b. Want-satisfying capacity of goods c. Employment Theory
and services
d. Trade Theory
c. Total value of commodity
16. ....................... have exchange value
d. Desire for goods and services
and their ownership rights can be
12. A market is established and exchanged
a. Only a place to buy things a. Goods
b. Only a place to sell things b. Services
c. Only a place where prices adjust c. Markets
d. A system where persons buy and d. Revenue
sell goods directly or indirectly
17. Identify the correct characteristics of
13. Which one of the following is not utility
a point in the Welfare Definition of a. It is equivalent to ‘usefulness’
Economics?
b. It has moral significance
a. Study of an ordinary man
c. It is same as pleasure
b. Economics does not focus on
wealth alone d. It depends upon consumer’s
mental attitude

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 18. Who has given scarcity definition of b. Inductive method
economics? c. Positive economics
a. Adam Smith d. Normative economics
b. Marshall
20. Total revenue is equal to total output
c. Robbins sold multiplied by
d. Robertson a. Price
19. The process of reasoning from b. Total cost
particular to general is c. Marginal revenue
a. Deductive method d. Marginal cost

Answers Part-A

1 2 3 4 5 6 7 8 9 10
c c c c d c b a b d
11 12 13 14 15 16 17 18 19 20
b d d a a a d c b a

Part-B Answer the following questions in one or

two sentences.

21. What is meant by Economics? 25. Name any two types of utility.

22. Define microeconomics. 26. Define positive economics.

23. What are goods? 27. Give the meaning of deductive

method.
24. Distinguish goods from services.

Part-C Answer the following questions in one paragraph.

28. Explain the scarcity definition of 31. What are the different features of
Economics and assess it. services?

29. What are the crucial decisions involved 32. What are the important features of utility?
in ‘what to produce?’
33. Distinguish between microeconomics
30. Explain different types of economic and macroeconomics.
activities.
34. Compare positive economics and
normative economics.

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 Part-D Answer the following questions in about a page

35. Compare and contrast various 37. Elaborate the nature and scope of
definitions of Economics. Economics.

36. Explain various Steps of Deductive 38. Explain basic problems of the economy
and Inductive methods. with the help of production possibility
curve.

ACTIVITY
Meet ten of your class-mates and prepare a Report on the
advantages of studying Economics.

References

„„Shashi kumar – Micro Economics (2004) - Anmol Publication Pvt Ltd

„„Ben S.Bernake – Principles of Micro Economics (2001) - MC Graw Hill Education
„„M.L.Seth – Micro Economics (2012) - Lakshmi Narain Agarwal Publication
„„M.L. Jhingan – Modern Micro Economics (Fourth Edition) (2012) - Virnda
Publication Pvt Ltd
„„Ryan C. Amacher – Principles of Micro Economics (1980) - South-Western Pub.Co
„„http://wikieducator.org/Introduction_to_Economics_and_Microeconomic_Theory

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 CH A P TER

2 Consumption Analysis

“Consumption is the sole end and object of economic activity”

– J. M. Keynes

Learning Objectives

1 To understand the consumer behaviour when price changes.

2 To perceive the consumer equilibrium in terms of cardinal and ordinal approaches.

2.1 2.2
Introduction Human Wants

Consumption is an essential economic

In ordinary language desire and want
activity. The quantity and quality of
mean the same thing. But in economics
consumption determine the standard of
they have different meanings. Wants are
living of the people. Consumption is the act
the basis for human behaviour to buy and
of satisfying one’s wants. Consumption is
consume goods.
defined as “the use of goods and services for
satisfying wants”. In economics, consumption
2.3
is studied both at micro level and macro level.
Characteristics of Human
Consumption is the beginning Wants
of economic science. In the absence of
consumption, there can be no production,
a. Wants are unlimited
exchange or distribution. Consumption is
also an end of production. Producers produce Human wants are countless in
goods to satisfy the wants of the people. number and various in kinds. When
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 one want is satisfied another want 2.4
crops up. Human wants multiply
with the growth of civilization and Classification Of
development. Goods
b. Wants become habits
Goods are broadly classified into three
Wants become habits; for example, categories.
when a man starts reading news paper
in the morning, it becomes a habit.
Same is the case with drinking tea or
chewing pans.
c. Wants are Satiable
Though we cannot satisfy all our
wants, at the same time we can satisfy
particular wants at a given time. When
one feels hungry, he takes food and
that want is satisfied. Necessaries
d. Wants are Alternative Goods which are indispensable for the
There are alternative ways to satisfy human beings to exist in the world are
a particular want eg. Idly, dosa or called “Necessaries”. For example, food,
chappathi. clothing and shelter.
e. Wants are Competitive
Comforts
All our wants are not equally
important. So, there is competition Goods which are not indispensable for
among wants. Hence, we have to life but to make our life easy, convenient
choose more urgent wants than less and comfortable are called “Comforts”.
urgent wants. Example: TV, Fan, Refrigerator and Air
conditioner.
f. Wants are Complementary
Sometimes, satisfaction of a
particular want requires the use of
more than one commodity. Example:
Car and Petrol, Ink and Pen.
g. Wants are Recurring
Some wants occur again and again.
For example, if we feel hungry, we take
food and satisfy our want. But after
sometime, we again feel hungry and
want food.

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 Luxuries 3. The consumer should be a rational
consumer and his aim is to attain
Goods which are not very essential but
maximum satisfaction with
are very costly are known as “Luxuries”.
minimum expenditure.
Example: Jewellery, Diamonds and Cars.
However, for people with higher income 4. The units of the commodity consumed
they may look necessaries or comforts. must be reasonable in size.
5. The commodity consumed should
be homogeneous or uniform in
character like weight, quality, taste,
2.5
colour etc.
Cardinal Utility
6. The consumption of goods must take
Analysis
place continuously at a given period
of time.

2.5.1 The Law of Diminishing 7. There should be no change in the

Marginal Utility (DMU) taste, habits, preferences, fashions,
income and character of the
consumer during the process of
Introduction consumption.
H.H.Gossen, an Austrian Economist was
the first to formulate this law in Economics Explanation
in 1854. Therefore, Jevons called this law The Law of Diminishing Marginal Utility
as “Gossen’s First Law of Consumption”. states that if a consumer continues to
But credit goes to Marshall, because he consume more and more units of the same
perfected this law on the basis of Cardinal commodity, its marginal utility diminishes.
Analysis. This law is based on the This means that the more we have of a thing,
characteristics of human wants, i.e., wants the less is the satisfaction or utility that we
are satiable. derive from the additional unit of it.

Definition Illustration
Marshall states the law as, “the additional The law can be explained with a simple
benefit which a person derives from a illustration. Suppose a consumer wants to
given increase of his stock of a thing, consume 7 apples one after another. The
diminishes with every increase in the utility from the first apple is 20. But the
stock that he already has”. utility from the second apple will be less
than that of the first (say 15), the third less
Assumptions than that of the second (say 10) and so
1. Utility can be measured by cardinal on. Finally, the utility from the fifth apple
numbers such as 1, 2, 3 and so on. becomes zero and the utilities from sixth
and seventh apples are negative (or disutility
2. The marginal utility of money of the
or disliking). This tendency is called the
consumer remains constant.
Consumption Analysis 27

Chapter-02.indd 27 20-02-2020 11:46:21

 “The Law of Diminishing Marginal Utility’. In Table 2.1, we find that the total utility
This is illustrated in table 2.1. goes on increasing but at a diminishing rate.
Table 2.1 The Law of On the other hand, marginal utility goes
Diminishing Marginal Utility on diminishing. When marginal utility
becomes zero, the total utility is maximum
Units of Total Marginal
and when marginal utility becomes
Apple Utility Utility
negative, the total utility diminishes.
1 20 20
2 35 15 (35-20) Criticism
3 45 10 (45-35) 1. Utility cannot be measured
4 50 5 (50-45) numerically, because utility is
5 50 0 (50-50) subjective.
6 45 -5 (45-50) 2. This law is based on the unrealistic
assumptions.
7 35 -10(35-45)
3. This law is not applicable to
indivisible commodities.
Y Y
Y
Q Exceptions to the Law
50 M P

40 1. Hobbies 2. Drunkards 3. Misers B3

MU of Apple

4. Music and
A1 Poetry and 5. Readings
TU / MU

30 B1
MU of Apple

B TU
20
ImportanceA3or Application of
10
C the Law of DMU
1 2 3 4 5 6 7 X
0
Units 1. The Law of DMU is one of the
Zero Utility
Negative Utility
MU fundamental
A A2 laws Nof consumption.
X 0 B2 B1

Diagram 2.1
It has applications
Units of Apple in several fields of Units of O
study.
Diagram 2.2
Consumption Analysis 28

Chapter-02.indd 28 20-02-2020 11:46:22

 2. This law is the basis for other Equilibrium”, “Gossen Second Law” and
consumption laws such as Law of “The Law of Maximum Satisfaction”.
Demand, Elasticity of Demand,
Consumer’s Surplus and the Law of Definition
Substitution etc. Marshall states the law as, “If a person has
3. The Finance Minister taxes a more- a thing which he can put to several uses, he
moneyed person more and a less- will distribute it among these uses in such a
moneyed person less. When a way that it has the same marginal utility in
person’s income rises, the tax-rate all. For, if it had a greater marginal utility
rises because the MU of money in one use than another he would gain by
to him falls with every rise in his taking away some of it from the second use
income. Thus, the Law of DMU is the and applying it to first”.
basis for progressive taxation.
Assumptions
4. This law emphasises an equitable
distribution of wealth. The MU of 1. The consumer is rational in the
money to the more-moneyed is low. sense that he wants to get maximum
Hence, redistribution of income satisfaction.
from rich to poor is justified. 2. The utility of each commodity is
5. Adam Smith explains the famous measurable in cardinal numbers.
“diamond-water paradox”. Diamond 3. The marginal utility of money
is scarce, hence, its MU is high and remains constant.
its price is high, even though it is 4. The income of the consumer is given.
not very much needed. Water is 5. There is perfect competition in the
abundant, hence, its MU is low and market
its price is low, even though it is very
6. The prices of the commodities are given.
much essential.
7. The law of diminishing marginal
utility operates.
2.6
Explanation
The Law of
The law can be explained with the help of
Equi-Marginal Utility
an example. Suppose a consumer wants to
spend his limited income on Apple and
The law of diminishing marginal utility
Orange. He is said to be in equilibrium,
is applicable only to the want of a single
only when he gets maximum satisfaction
commodity. But in reality, wants are
with his limited income. Therefore, he
unlimited and these wants are to be
will be in equilibrium, when,
satisfied. Hence, to analyze such a situation,
the law of diminishing marginal utility Marginal utility of Apple
is extended and is called “Law of Equi- Price of Apple
Marginal Utility”. It is also called the “Law Marginal utility of Orange
 K
of Substitution”, “The Law of Consumers Price of Orange
Consumption Analysis 29

Chapter-02.indd 29 20-02-2020 11:46:22

 MUA MUO MUA MUo
i.e.,= PA  PO  K In case is less than
Eg. 50/10= 20/4=5 PA Po
he would transfer the money from Apple
K- Constant Marginal Utility of Money to Orange till it is equal. This process
In views of this equilibrium, this Law is also of substitution gives him maximum
called the “Law of Consumers Equilibrium”. satisfaction both from Apple and Orange.
Hence, this Law is also called “Law of

Table 2.2 The Law of Equi-Marginal Utility

Apple Orange
Units of
Commodities Total Marginal MUA Total Marginal MUO
Utility Utility PA Utility Utility PO
1. 25 25 25/2 = 12.5 30 30 30/1 = 30
2. 45 20 20/2 = 10 41 11 11/1 = 11
3. 63 18 18/2 = 9 49 8 8/1 = 8
4. 78 15 15/2 = 7.5 54 5 5/1 = 5
5. 88 10 10/2 = 5 58 4 4/1 = 4
6. 92 4 4/2 = 2 61 3 3/1 = 3

Y Y

M P
MUm of Orange

B3
A1 B1
MUm of Apple

A3

0 A A2 N X 0 B2 B1 Q X
Units of Apple Units of Orange

Diagram 2.2

Substitution”. Eg. For Apple 50/25; for this entire income (i.e., ₹14) on Apple and
Orange 20/4. In such situation, spending Orange. The price of an Apple is ₹2 and the
more money on orange is wiser. price of an Orange is ₹1. This law can be
illustrated with the help of Table 2.2
Illustration
This Law can be illustrated with the help of If the consumer wants to attain
table 2.2. Let us assume that the consumer maximum utility, he should buy 5 units of
has a given income of ₹14. He wants to spend

Consumption Analysis 30

Chapter-02.indd 30 20-02-2020 11:46:22

 apples and 4 units of oranges, so that he rather than go without the thing, over that
can get (88+54) 142 units. which he actually does pay is the economic
MUA MUo 10 5 measure of this surplus satisfaction. This
Here = ie, = =5 may be called consumer’s surplus”.
PA PO 2 1
A2 A3 and B2 B3 lines have not been
Assumptions
used for explanation.
1. Marshall assumed that utility can be
Diagrammatic Illustration measured.
In diagram 2.2, X axis represents the 2. The marginal utilities of money of
amount of money spent and Y axis the consumer remain constant.
represents the marginal utility of Apple 3. There are no substitutes for the
and Orange respectively. If the consumer commodity in question.
spends ₹10 on Apple and ₹4 on Orange, 4. The taste, income and character of
the marginal utilities of both are equal the consumer do not change.
i.e.,AA 1=BB 1 (5=5). Hence, he gets
5. Utility of one commodity does
maximum utility.
not depend upon the other
Criticisms commodities.

1. In practice, utility cannot be

Explanation
measured, only be felt.
2. This Law cannot be applied to The concept of consumer’s surplus can
durable goods. be explained with help of an example.
Suppose a consumer wants to buy an
apple. He is willing to pay ₹4, rather than
2.7 go without it and the actual price of the
Consumer’s Surplus apple is ₹2. Hence the consumer’s surplus
is ₹2(₹4 – ₹2). Thus, consumer’s surplus
The concept of consumer surplus was is the difference between the price that a
originally introduced by classical economists consumer is willing to pay (potential price)
and later modified by Jevons and Jule and what he actually pays. Therefore,
Dupuit, the French Engineer Economist in
1844. But a most refined form of the concept Consumer’s = What a person is
of consumer surplus was given by Alfred surplus willing to pay – What
Marshall. This concept is based on the Law he actually pays.
OR
of Diminishing Marginal Utility.
Consumer’s = Potential price–
surplus Actual price.
Definition
Alfred Marshall defines consumer’s Mathematically,
surplus as, “the excess of price which a Consumer’s surplus = TU – (P x Q)
person would be willing to pay a thing

Consumption Analysis 31

Chapter-02.indd 31 20-02-2020 11:46:23

 Table 2.3 Consumer’s Surplus
Willingness to pay or Consumer’s Surplus
Actual

UNIT 2
Potential Price (Marginal = Potential Price –
Units of commodity (Apple) Price
Utility) Actual Price
1 6 2 6-2=4
2 5 2 5-2=3
3 4 2 4 - 2= 2
4 3 2 3-2=1
5 2 2 2-2=0
Total 20 10 10

where, Y
Y
TU = Total Utility, P = Price and
Y
D 5
Q= Quantity of the commodity
P 4
The Consumer’s Surplus
B3 measurement of consumer’s
MU of Apple

Price

surplus is illustrated in Table 2.3. 3

Price (in ₹)
B1
In Table 2.3 the consumer is willing C
2
P
to pay rupees 6, 5, 4, 3 and 2 for purchasing D1 1
the successive units of apples. Hence, he
is willing to pay (Potential Price Total 0
Utility) ₹20 for apples. But, he actually 0 Q X
N X pays
0 ₹10 B2 (₹2 Q
B1 x 5)) for getting 5 apples.
X Quantity Demanded
Hence, Units of Orange Diagram 2.3
DiagramConsumer’s
2.2 Surplus = Total Utility (Actual
Price x units of
Commodity) Hence, actual price is OPCQ (OP x OQ).
Potential Price (Total Utility) is ODCQ.
= TU – (P x Q)
Therefore,
= 20 –(2 x 5)
Consumer’ Surplus = ODCQ – OPCQ
= 20-10 = 10. = 20-10 = 10
The concept of Consumer’s Surplus = PDC (the shaded area) Y
can also be explained
d' d with the help of a d d'
Y
diagram. Criticism
Y
1. Utility cannot be measured, because
In the diagram 2.3, X axis shows the utility is
B A A subjective.
B
amount P1 demanded and Y axis represents P
Price

P1
2. Marginal utility of money does not
the price. DD1 shows the utility which
Price

remain constant.
Price

the consumer derives from the purchase

of different amounts of commodity. When
d 3. Potential price is internal, dit' might be
D price is OP, the amount demanded d' is OQ.
known to the consumer d
himself. O
O Q
Q2
Consumption Analysis Q1 32 O Q1 Q2
X X X
Quantity Demanded Quantity Demanded

Chapter-02.indd 32
Diagram 2.8 20-02-2020 11:46:23
 2.8 Definitions
Law of Demand The Law of Demand says as “the quantity
demanded increases with a fall in price
Demand is essential for the creation, survival and diminishes with a rise in price”.
and profitability of a firm. “Demand in –Marshall
economics is the desire to possess something “The Law of Demand states that people will
and the willingness and the ability to pay a buy more at lower price and buy less at higher
certain price in order to possess it”. prices, other things remaining the same”.
–J. Harvey - Samuelson

“Demand in economics means desire Assumptions of Law of Demand

backed up by enough money to pay for the 1. The income of the consumer remains
good demanded” constant.
–Stonier And Hague 2. The taste, habit and preference of the
consumer remain the same.
2.8.1 Characteristics of
3. The prices of other related goods
Demand
should not change.
„„Price : Demand is always related to price. 4. There should be no substitutes for
„„Time : Demand always means demand the commodity in study.
per unit of time, per day, per week, per 5. The demand for the commodity
month or per year. must be continuous.
„„Market : Demand is always related to 6. There should not be any change in
the market, buyer and sellers. the quality of the commodity.
„„Amount: Demand is always a specific Given these assumptions, the law of demand
quantity which a consumer is willing operates. If there is change even in one of
to purchase. these assumptions, the law will not operate.

2.8.2 Demand Function Table 2.4 Demand Schedule

Price Quantity Demanded
Demand depends upon price. This means (₹) (Units)
demand for a commodity is a function of 5 1
price. Demand function mathematically is 4 2
denoted as, 3 3
D = f (P) where, D = Demand, f = function 2 4
P = Price 1 5

2.8.3 Law of Demand Explanation

The Law of Demand was first stated by The law of demand explains the relationship
Augustin Cournot in 1838. Later it was between the price of a commodity and the
refined and elaborated by Alfred Marshall. quantity demanded of it. This law states
Consumption Analysis 33

Chapter-02.indd 33 20-02-2020 11:46:23

 price falls, the demand expands and when
price rises, the demand contracts.

Market Demand for a

Commodity

A's Demand B's Demand

that quantity demanded of a commodity

expands with a fall in price and contracts
with a rise in price. In otherY words, a Y Y Y
A’s Demand B’s Demand C’s Demand Total Dem
rise in price of a commodity is4 followed 4 C's Demand 4 Market Demand 4
by a contraction demand and3 a fall in 3 3 3
2 2 2 2
price is followed by extension in demand.
1 1 1 1
Therefore, the law of demand states that D(A) D(B) D(C)

there is an inverse relationshipO between

2 4 6 8 10 X O 2 4 6 8 10 X O 2 4 6 8 10 X O 5 10 15

the price and the quantity demanded of a

Diagram 2.5
commodity.
D
The market demand curve for a commodity
3 4 5 X
Y D is derived by adding the quantum demanded
emanded (in units) 5 of the commodity by all the individuals
ram 2.4 constituting the market. In the diagram
4
given above, the final market demand curve
Price (in ₹)

3 represents the addition of the demand curve

2 of the individuals A, B and C at the same price.
1 When Price is ₹3, the Market demand is
D 2+2+4 = 8
0 1 2 3 4 5 X When Price is ₹1, the Market demand is
Quantity Demanded (in units) 6+8+8 = 22
Diagram D As in the case of individual demand
Y e2.4
=o
schedule, the Market Demand Curve is at
P1 a price, at a place and at a time.
In the diagram 2.4, X axis represents
the quantity demanded
P2 and Y axis
Price

D 2.8.4 Determinants of
represents the Pprice of the commodity.
3
DD is the demand curve, which has a Demand
negative slope i.e., slope downward from 1. Changes in Tastes and Fashions: The
D
left to right which
O indicates that when demand for some goods and services
Q X
X
nded Consumption Analysis
Quantity Demanded
34

.9 Diagram 2.10
Chapter-02.indd 34 20-02-2020 11:46:24
 Y
Q
50
40

TU / MU
30
is very susceptible to changes in tends to decrease B the demand TU
20
tastes and fashions (if other things remain constant).
10
2. Changes in Weather: An unusually C

dry summer results in a increase in 1 to

2.8.5 Exceptions
0 2 the3 law 4 5of 6 7 X
Units
the demand for cool drinks. demand Zero Utility MU
Negative Utility
3. Taxation and Subsidy: If fresh Normally, the demand Diagram curve slopes
2.1
taxes are levied or the existing rates downwards from left to right. But there
of taxation on commodities are are some unusual demand curves which
increased their prices go up. The do not obey the law and the reverse occurs.
subsidies will bring down the prices. A fall in price brings about a contraction
Therefore taxes reduce demand and of demand and a rise in price results in an
subsidies raise demand. extension of demand. Therefore the demand
4. Changes in Expectations: Expectations curve slopes upwards from left to right. It is
also bring about a change in demand. known as exceptional demand curve.
Expectation of rise in price in future
results in increase in demand.
Y D Y
5. Changes in Savings: Savings and
P1
demand are inversely related. E1
6. State of Trade Activity: During the P2 P2

Price
periods of boom and prosperity, the E
Price

P3
P1
demand for all commodities tends
to increase. On the contrary, during D
times of depression there is a general
O Q1 Q2 X
slackening of demand. O
Quantity
7. Advertisement: In advanced
capitalistic countries advertising is a Diagram 2.6
powerful instrument increasing the
In the diagram 2.6, DD is the demand
demand in the market.
curve which slopes upwards from left to
8. Changes in Income: An increase right. It shows that when price is OP1,
in family income may increase the OQ1 is the demand and when the price
demand for durables like video risesYto OP2, demand also extends to OQ2. Y
recorders and refrigerators. Equal e >1 D
distribution of income enables poor P1
P1
2.8.6 
Reasons for Exceptional
to get more income. As a result P2
Demand Curve
consumption level increases. D P2
Giffen Paradox: The Giffen good or
Price

1.
Price

9. Change in Population: The demand

for goods depends on the size of inferior good is an exception to the law
population. An increase in population of demand. When the price of an inferior
tends to increase the demand for good falls, the
O Q0
poor willQ buy less and vice
1 X
goods and a decrease in population versa. For Example: Rice, Ragi O Q0
Quantity Demanded
Consumption Analysis 35 Diagram 2.11

Chapter-02.indd 35 20-02-2020 11:46:24

 2. Veblen or Demonstration effect:
D
D
Veblen
Y has explained the exceptional Y
B
demand curve through his doctrine P1
E1
of conspicuous consumption. Rich A
P2 P2
people buy certain goods because it

Price
C

Price
E
Price

gives P3
P1 social distinction or prestige.
For example, diamonds.
D D
3. Ignorance: Sometimes, the quality of
the O
commodity isQjudged Q2 by it’s
X price. O Q1 Q2 Q3
1
X
ConsumersQuantity
think that the product is
Quantity
superior if the price is high. As such
Diagram 2.6 Diagram 2.7
they buy more at a higher price.
4. Speculative effect: If the price of the to OP1 (movement from A to B) quantity
commodity is increasing then the demanded decreases to OQ1.
consumers will buy more of it because
of the expectation that it will increase 2.8.9 Shift in the Demand
Y
still
Y further. Eg stock markets. Curve
e >1 D e <1
5. Fear of shortage: During times of A shift
P1 in the demand curve occurs with a
P1
emergency or war, people may expect change in the value of a variable other than
P2
shortage of a commodity and D so buy its price
P2 in the general demand function.
more. An increase or decrease in demand due to
Price
Price

changes in conditions of demand is shown

2.8.7 Extension and by way of shifts in theDdemand curve.
Contraction of Demand
O Q0 Q1
X
On the left hand side of the diagram
The changes Quantity
in the Demanded
quantity demanded 2.8, O original
the Q0 Q1demand curve is dd, the X
for a commodity due to the change in price is OP1 and the Demanded
Quantity quantity demanded
Diagram 2.11
its price alone are called “Extension and Diagramin2.12
is OQ1. Due to change the conditions of
Contraction of Demand”. In other words, demand (change in income, taste or change
buying more at a lower price and less at a in prices of substitutes and /or complements)
higher price is known as “Extension and the quantity demanded decreases from OQ1
Contraction of Demand”. to OQ2. This is shown in the demand curve
Y
to the left. The new demand curve is d1d1.
2.8.8 Movement along This is called decrease in demand.
Demand
Y Curve Y
On the Y right hand side of the
diagram 2.8, the original price is OP1 and
CommoditY Y

In the diagram 2.7, at point A, the price

Commodity Y

Commodity Y

OP 2 and quantity demanded is OQ 2. B the quantity demanded is OQ B 1 . Due to

When price falls toA OP3 B(movement along changes in other conditions, the quantity
A purchased has increased Ato OQ2 . Thus
the demand curve A to C) the quantity
demanded increases to OQ3. If price rises the demand curve shifts to the right d1d1.
This is called increase in demand.
0
0
0 Commodity X X Commodity X X 0 Commodity X X
Consumption Analysis 36

Diagram 2.17
Chapter-02.indd 36 20-02-2020 11:46:24
 Y
Y
d'' d d d''
d d d d' d Y
Y d' d Y d
Y Y
Y Y

B A A B
B A A B P

Price
P1 B A P1 A B P

Price
P1 P1 P

Price
P1 P1
Price
Price

Price
Price

Price
Price
d d''
d d
d d'
D d'' d O
D d d O
D d' d O
O O
X O Q2 Q1 X O Q1 Q2 Q
X O Q2 Q1 X O Q1 Q2 X
X Q2 QuantityQDemanded X Q1 Q2 X
Quantity
1
Demanded Quantity Demanded X
Quantity Demanded Quantity Demanded
Quantity Demanded
Diagram
Diagram 2.8
Diagram
Diagram 2.82.82.8
‘Extension’ and ‘Contraction’ of demand follow a change in price. Increases and
decreases in demand take place when price remains the same and the other factors bring
about demand changes.
Y
Y
Y Y
Y
Y R ep=α
2.9 R
R ep=α
ep=α
P0
e =1 P0
Elasticity
P0 Dof Demand
D e =1
e =1 Upper
D Upper ep>1
P1 Upper Segment ep>1
P1 Segment
ep>1 Q

Price
P Segment ep=1

Price
Price

The Law of Demand explains the direction Q ep=1

Price
Price

1
Q ep=1p
Price

of change in demand due to change in the p ep<1

p ep<1
ep<1SS
price. It fails to explain the rate D
of change
D S
D Lower Segment ep=0
in demand due to a given change in price. Lower Segment
Lower Segment ep=0
ep=0
Elasticity of Odemand 0 M
O Q0 explains
Q the rate of
0
0 Quantity M M
X Q0 Q11 X Quantity X
X change in quantity
O Q Q demanded
Quantity due to Xa
Demanded X Quantity
X 0 1
Quantity Demanded
Quantity Demanded
given change in price. Diagram
amount due to a little rise in the price.
Diagram 2.14
Diagram 2.13 Diagram 2.13 Diagram 2.14 2.14
Diagram 2.13 To be more scientific, Elastic demand is
“Elasticity of demand is, therefore,
called as “More Elastic Demand”.
a technical term used by the Economists
to describe the degree of responsiveness
of the Quantity demand for a commodity 2.9.1 Types of Elasticity of
to a change
Y in its price”. Demand
Y Y
Y Y
Y
- Stonier And Hague A
A
oditYYY

A
CommoditY Y

oditYYY

Elastic demand or More Elastic

CommoditY

CommoditY Y

demand
CommoditY
Comm

Demand for a commodity is said to be

Comm

C A IC2
“Elastic” when the quantity
C
C
A demanded
A
IC2
IC2
increases by a large amount due toB a little IC
IC11 IC
B IC1 IC
fall in the
0 price and decreases by a large
B
0
IC
X 0 Commodity
Commodity X
X X 0 Commodity X
B
B X
X
XX X 0 Commodity X X
X 0 Commodity XB X
X
Consumption Analysis 37 Commodity X
Diagram 2.18 Diagram
Diagram 2.19
Diagram
Diagram 2.18 2.18 Diagram 2.19 2.19

Chapter-02.indd 37 20-02-2020 11:46:24

 Price Elasticity of Demand Proportionate change in Quantity
Price elasticity of demand is commonly Demand for a product
EY 
known as elasticity of demand. This is Proportion
nate change
because price is the most influential factor in Income
affecting demand. “Elasticity of demand
measures the responsiveness of the quantity For most of the goods, the income
demanded to changes in the price”. elasticity of demand is greater than
one indicating that with the change
1. Price Elasticity of Demand: The price
in income the demand will also
elasticity of demand, commonly known
change and that too in the same
as the elasticity of demand refers to the
direction, i.e. more income means
responsiveness and sensitiveness of
more demand and vice-versa.
demand for a product to the changes
in its price. In other words, the price 3. Cross Elasticity of Demand: The
elasticity of demand is equal to cross elasticity of demand refers to
the percentage change in quantity
Proportionate change in demanded for one commodity as a
Quantity Demanded result of a small change in the price
Ep 
Proportionate change of another commodity. This type
in Price of elasticity usually arises in the
Numerically, case of the interrelated goods such
Q P as substitutes and complementary
Ep  X
P Q goods. The cross elasticity of demand
ΔQ = changes in demand. for goods X and Y can be expressed as:

ΔP = changes in price. Proportionate change in demand

P = original price. of Commodity X
Ec =
Q = original quantity. Proportionate change in price
of Commodity Y
where, ΔQ = Q1 –Q0, ΔP = P1 – P0,
Q1= New quantity, 4. Advertising Elasticity of Demand: The
responsiveness of the change in demand
Q0= Original quantity, P1 = New price,
due to the change in advertising or
P0 = Original price.
other promotional expenses, is known
2. Income Elasticity of Demand: The as advertising elasticity of demand. It
income is also a factor that influences can be expressed as:
the demand for a product. Hence, the
Proportionate change
degree of responsiveness of a change
in demand for a product due to the in Demand
Ea 
change in the income is known as Proportionate change in
income elasticity of demand. The Advertising Expenditure
formula to compute the income
elasticity of demand is:
Consumption Analysis 38

Chapter-02.indd 38 20-02-2020 11:46:25

 D

Pr
D1 1
D
0 1 2 3 4 5 X
X Quantity Demanded (in units)
d
2.9.2 Levels or Diagram
Degrees2.4 of Price D
Elasticity of Demand Y Ep = o

Definition: The Price Elasticity of Demand P1

is commonly known as the elasticity of
P2

Price
demand, which refers to the degree of
responsiveness of demand to the change in P3

the price of the commodity.

D
1. Perfectly Elastic Demand (Ep = ∞): O
Q D X
Y Y e=o
Y Quantity Demanded
e=
88

Ep = P1
Diagram 2.10
P2

Price
P D
i.e. quantity OQ remains unchanged
Price

P D P3
Price

at different prices, P1, P2, and P3.

d' 3. Relatively Elastic Demand

D (Ep>1): The
O
O Q X
X
O Quantity Demanded X Y
Quantity Demanded Ep >1Quantity Demanded
X
Diagram 2.9 P1 Diagram 2.10
P2
The demand is said to be perfectly elastic D
when a slight change in the price of a
Price

commodity causes an infinite change in

its quantity demanded. Such as, even a
small rise in the price of a commodity
Y can O Q0 Q1 Y
X
α result in greater fall in demand even to
Quantity Demanded
zero. In some cases a little fall
P0 in the price
Diagram 2.11
er
can result in the increase in demand to
ORANGE

ment ep>1 infinity. In perfectly elastic3demand the R

ORANGE

Q demand is relatively elastic when the

ep=1 demand curve is a horizontal straight
p 2S proportionate change in the demand
ep<1 line parallel to x axis.
S T for a commodity is greater than the
1
2. Perfectly Inelastic Demand (Ep =0): proportionate
IC change in its price.
Lower Segment ep=0
When there is no change 0 in the Here, the demand curve is gradually
M X 1 2 3
Quantity demand for a product due to the sloping which 0
X shows that a proportionate
APPLE APPLE
change in the price, then the demand change in quantity from 5 to 10 is greater
Diagram 2.14 Diagram 2.15 than the proportionate change in the Diagram 2.16
is said to be perfectly inelastic. Here,
the demand curve is a vertical price from 11 to 10. Change in demand
straight line which shows that is: 10–5/5 × 100 = 100%
the demand remains unchanged Change in price =10%. Hence, it is
irrespective of change in the price., more elastic demand.
Consumption Analysis 39
Y Y
A
itY Y

Chapter-02.indd 39 20-02-2020 11:46:25

Budget Line
 4. Relatively Inelastic Demand (Ep<1): 5. Unitary Elastic Demand (Ep =1):
Y Y
D
Ep<1
P1
D
Ep=1
P2 P0 R0
Price

Price
P1 R1

D D

O Q1 Q2 X O Q0 Q1
X
Quantity Demanded Quantity Demanded
Diagram 2.12 Diagram 2.13

When the proportionate change The demand is unitary elastic

in the demand for a product is less when the proportionate change
than the proportionate change in in the price of a product results in
the price, the demand is said to be the same propionate change in the
relatively inelastic. It is also called quantity demanded. Here the shape
as the elasticity less than unity. Here of the demand curve is a rectangular
the demand curve is steeply sloping, hyperbola, which shows that area
which shows that the change in under the curve is equal to one.
the quantity from OQ0 to OQ1 is Here OP0 R0Q0 = OP1 R1Q1
relatively smaller than the change in
the price from OP1 to Op2.

Table 2.5 Degrees of Price Elasticity of Demand

Shape of the
Numerical Value Terminology Description
Demand curve
ep = ∞ Perfectly Change in demand is infinite at a Horizontal
elastic given price

ep = 0 Perfectly Demand remains unchanged Vertical

inelastic whatever be the change in price

ep = 1 Unitary % Q  % P Rectangular
elastic Hyperbola

0 < ep < 1 Inelastic % Q  % P Steeper

∞ > ep > 1 Elastic % Q  % P Flatter

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 2.9.3. Determinants of Here, a rise in the price of lubricating
Elasticity of Demand oil may not reduce the demand for
lubricating oil. Hence, the complementary
There are many factors that determine
good, here, lubricating oil, will be price
the degree of price elasticity of demand.
inelastic.
Some of them are described below:
e) Time: In the long run, the price
a) Availability of Substitutes:
elasticity of demand for many goods
If close substitutes are available for a will be larger. This is so because, in
product, then the demand for that product the long run many substitutes can be
tends to be very elastic. If the price of discovered or invented. Therefore,
that product increases, buyers will buy its the demand is generally more elastic
substitutes; hence fall in its demand will in the long run, than in the short
be very large. Hence, price elasticity will run. In the short run bringing out
be larger. Eg. Vegetables. new substitutes is difficult.
For salt no close substitutes are available.
Hence even if price of salt increases the 2.9.4 Measurement of
fall in demand may be zero or less. Hence Elasticity of Demand
salt is price inelastic.
There are three methods of measuring
b) Proportion of consumer’s income price elasticity of demand.
spent’ if smaller proportion of
1. The Percentage Method
consumer’s income is spent on
particular commodity say X, price
ep =
∆Q P
elasticity of demand for X will be
×
∆P Q
smaller. Take for example salt, people
spend very small proportion of their It is also known as ratio method,
income on salt. Hence, salt will have when we measure the ratio as:
small elasticity of demand, or inelastic.
ep =
Q where,
c) Number of uses of commodity: P
If a commodity is used for greater number %Q= percentage change in demand
of uses, its price elasticity will also be
larger. For example, milk is used as butter %P = Percentage change in price
milk, curd, ghee and for making ice cream 2. Total Outlay Method
etc. Hence, even the small fall in the price Marshall suggested that the simplest
of milk, will tempt the consumers to use way to decide whether demand is
more milk for many purposes. Hence milk elastic or inelastic is to examine the
has greater price elasticity of demand. change in total outlay of the consumer
d) Complementarity between goods: or total revenue of the firm.
For example, along with petrol, lubricating Total Revenue = ( Price x Quantity Sold)
oil is also used for running automobiles. TR = (P x Q)

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 Y Y
A’s Demand
4
Y
5 D 3
D
2

Consumer’s Surplus 4 1
D(A)
Table 2.6 Total Outlay Method3 L
Price

Price (in ₹)
O
lower segment 2 4 6 8 1

Price Q u a n t i t y Total Elasticity ep = =

P
C
Demanded Outlay
2
U upper segment
D1 1
Where ‘ep’ stands for point elasticity, ‘L’
150 3 450 e>1 D
0 1 2 stands
3 4 for5 the lower
X
segment and ‘U’ for
125 4 500 e=1 the upper segment.
0 Q X Quantity Demanded (in units)
100Demanded
Quantity 5 500 e <1
Diagram Diagram 2.4
75 2.3 6 450
2.9.5 Importance of Elasticity
Where there is inverse relation between of Demand
Price and Total Outlay, demand is elastic. The concept of elasticity of demand is of
Direct relation means inelastic. Elasticity is much practical importance.
unity when Total Outlay is constant.
1. Price fixation: Each seller under
3. Point or Geometrical Elasticity monopoly and imperfect competition
When the demand curve is a straight has to take into account elasticity D
Y Y e=o
d d' line, it is said to be linear. Graphically, of demand while fixing the price
Y the point elasticity of a linear demand e= for his product. If the demand for
8
P1
curve is shown by the ratio of the the product is inelastic, he
P2 can fix a

Price
A B higher price.
D
segments of the line to thePright and to
Price

P1 P3
the left of the particular point. 2. Production: Producers generally
Price

decide their production level on the

Lower segment of the d' D
basis of demand for the product.
O
d demand curve
O X
Q
Point Quantity 3. Distribution: Elasticity of demand
Demanded Quantity Demanded
Xbelow the given point
O Q Q
Elasticity 
1 2
also helps in the determination of
Quantity Demanded Upper segment of Diagram 2.9 Diagram 2.10
rewards for factors of production.
m 2.8 the demand curve 4. International trade: Elasticity of
above the given point demand helps in finding out the
terms of trade between two countries.
Terms of trade depends upon the
Y Y Y
elasticity of demand for the goods of
R ep=α
the two countries.
P0

Upper 5. Public finance: Elasticity of demand

ORANGE

ep>1
Segment helps the Rgovernment in formulating
ORANGE

3
Price

Q ep=1
p tax
2
policies.S For example, for
ep<1
S imposing tax on aTcommodity.
1
Lower Segment ep=0 6. Nationalization: The ICconcept
0
of elasticity of3 demand enables
0 M X 1 2 X 0
Quantity
the government
APPLE to decide over
Diagram 2.14 nationalization
Diagramof2.15
industries.

Consumption Analysis 42

Y
Chapter-02.indd 42 Y Y
20-02-2020 11:46:27
A A
 2.10 Scale of Preference

Ordinal Analysis (or) This theory is also based on scale of

Ordinal Utility Approach preference. A rational consumer usually
(or) Hicks and Allen prefers the combination of goods which
Approach (or) Indifference gives him maximum level of satisfaction.
Curve Analysis Thus, the consumer can arrange goods
and their combination in order of their
Introduction satisfaction. Such an arrangement of
combination of goods in the order of
level of satisfaction is called the “Scale of
Preference”.

Assumptions
1. The consumer is rational and his aim
is to derive maximum satisfaction.
2. Utility cannot be cardinally
measured, but can be ranked or
compared or ordered by ordinal
F.W.EdgeWorth (English Economist) number such as I, II, III and so on.
and Vilfredo Pareto (Italian Economist)
3. The Indifference Curve Approach is
criticised the Cardinal Utility Approach.
based on the concept “Diminishing
They assumed that utility cannot be
Marginal Rate of Substitution”.
measured absolutely, but can be compared
or ranked or ordered by ordinal numbers 4. The consumer is consistent.
such as I, II, III and so on. Edgeworth first This assumption is called as the
developed a more scientific approach to assumption of transitivity. If the
the study of consumer behaviour, known consumer prefers combination A to
as “Indifference Curve Approach” in1881. B and B to C, then he should prefer
In 1906, Vilfredo Pareto modified the A to C. If A>B and B>C, then A>C.
“Edgeworth Approach”. Again J.R.Hicks and
R.G.D.Allen refined the Indifference Curve An Indifference Schedule
Approach in 1934. Later, in 1939 J.R.Hicks An indifference schedule may be defined
in his book “ Value and Capital” gave a final as a schedule of various combinations
shape to this “Indifference Curve Analysis”. of two commodities which will give the
same level of satisfaction. In other words,
Indifference Schedule is a table which
The theory of indifference curve was
shows the different combination of two
given by J R Hicks and RJD Allen, ‘A
goods that gives equal satisfaction to the
reconsideration of the theory of value’,
consumer.
Economics in 1934.

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 Y Y Y Y
A’s Demand B’s Demand C’s Demand
Y 4 4 4 4
5 D 3 3 3 3
2 2 2 2
4 1 1 1 1
D(A) D(B) D(C)
3 Table 2.7: Indifference Schedule an2 4indifference
6 8 10 X Ocurve 2 4 is6 the
8 10 locus 2 of4
Price (in ₹)

O X O 6 8 10 X O

all combinations of commodities from

2 Apple Oranges Points Diagram
which the consumer derives the2.5same
1 1 20 R
level of satisfaction. It is also called “Iso-
2 D 15 S
0 1 2 3 4 53
Utility Curve” or” Equal Satisfaction
X 12 T
Curve”. Indifference Curve is illustrated
Quantity Demanded (in4units) 10 U
in diagram 2.15. X axis represents apple
5 9 V
Diagram 2.4 and Y axis represents orange. Point ‘R’
Table has five combinations of two represents combination of 1 apple and 20
commodities Apple and Orange. Each of oranges, at ‘S’ 2 apples and 15 oranges and
these combinations give the consumer at ’T’ 3 apples and 12 oranges. Similarly
the same level of satisfaction without U,V points are obtained. These five points
discrimination. In the schedule, the give the same level of satisfaction. The
combinations are arranged in such a way consumer will be neither better off nor
that the consumer is indifferent among worse off in choosing any one of these
the combinations. Hence, this Y schedule D points. When one joins all these five points
e=o
is called as, “Indifference Schedule”. He R, S, T, U, V one can get the Indifference
e= will neither be better off norP1 worse off Curve ‘IC’.
8

whichever combination he chooses.

P2
Price

D
P3
2.12
2.11 An Indifference Map
An Indifference Curve D
O
Q One can draw
X several indifference
X
Quantity Demanded curves each representing an indifference
Quantity Demanded
Y IC
schedule. Hence, an Indifference Map is a
Diagram 2.9 R Diagram 2.10
20 family or collection or set of indifference
curves corresponding to different levels
S
of satisfaction. The Indifference Map is
ORANGE

15

12 T illustrated in Diagram 2.16.

10 U
V
9
Y IC Y
0 1 2 3 4 5
X
P0 APPLE
Diagram 2.15
ORANGE

R
ORANGE

3
Different combinations of two
2 S
commodities (as foundT
in Indifference
IC3
Schedule) can be presented in a diagram.
1 IC2
IC
Then consumer gets different points IC1
0
X and when 1such2 points
3 are connected,
X 0 X
APPLE
a curve is obtained. The said curve is APPLE
Diagram 2.15
called as “Indifference Curve”. Therefore, Diagram 2.16

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 B
P1
E1
A
P2 P2
C

Price
E

Price
P3
P1
In D
the diagram 2.16, the indifference Since y decrease as X increases, the
D
Curves IC1, IC2 and IC3 represent the change in Y is negative i.e., –Δy, so the
Indifference
O Map,QUpper
1
Q2 IC representing
X equation
O is Q1 Q2 Q3 X
higher levelQuantity
of satisfaction compared to ∆Y
Quantity
MRS =− and
lower IC. xy
∆X
Diagram 2.6 Diagram 2.7
Marginal Rate of Substitution However, as with price elasticity of
The shape of an indifference curve provides demand the convention is to ignore the
useful information about preferences. minus sign in
Indifference curve replaces the concept ∆Y
MRSx y =
isMRS
of marginal utility with the concept of the Y ∆X
Y
marginal rate of substitution.
e >1 D e <1
According to Leftwich “The P
2.14
P1 1

marginal
P2 rate of substitution of X for
Properties of the
Y (MRSxy) is defined as the D maximum P2
Indifference Curves
amount of Y the consumer is willing to give Price
Price

up for getting an additional unit of X and

still remaining on the same indifference Indifference curvesD are subjective and
curve”. unique to each person. Nevertheless they
O Q0 Q1
X
have in common the following properties:
2.13 Quantity Demanded O Q0 Q1 X
1. Indifference curve must have
Diminishing Quantity
slope Demanded
Diagram Marginal
2.11 Rate negative
of Substitution Diagram 2.12
An indifference curve has a negative
slope, which denotes that if the quantity
It explains the concepts of diminishing of commodity (y) decreases, the quantity
marginal rate of substitution. of the other (x) must increase, if the

Y Y Y
CommoditY Y

Commodity Y

Commodity Y

B
B
A B
A A

0 0
Commodity X X Commodity X X 0 Commodity X X

Diagram 2.17

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 P1 ep>1
P1
1
Segment

Pr
Price

Price
Q ep=1

Price

Price
p
d d' ep<1
S
D
D d' d Segment O
Lower ep=0
O Q
Q2 Q1 O Q1 Q
X X 0 M
O consumer
Q Q1 is to stay on the same level of At the point of2 intersection,
X
Quantity
C=B X
Quantity Demanded X Quantity
on IC1 Demanded
0
satisfaction.
Quantity (a necessary consequence
Demanded and C=A on IC2. So A=B
of theDiagram
non satiety Diagram
IC and2.14
2.13postulate). Diagram 2.8 whereas, A is in upper B is on
The curves that do not have negative lower IC. This is not possible.
slopes such as those shown in diagram 2.17 4. Indifference curves do not touch
cannot be indifference curves, in all three the horizontal or vertical axis.
cases combination B is clearly preferable Y
Y
to combination A.
Y Y
R ep=α
2. Indifference
P0 Curves are convex to A
e =1
the origin
CommoditY Y

D Upper
ep>1

CommoditY Y
Segment
Indifference
P1 curves are not only

Price
Q ep=1
Price

negatively sloped, but are also p

convex to the origin. The convexity ep<1
S
of the indifference
C A D2
IC
curves implies
Lower Segment ep=0
that not only the two commodities
IC1
B 0 IC M
areO substitutes
Q0 Q1 for each other but Quantity
X
X 0 X 0
also the factX
Commodity that the
Quantity marginal
X
Demanded rate Commodity X
B X
Diagram 2.14
of substitution (MRS) between the
Diagram 2.18Diagram 2.13 Diagram 2.19
goods decreases as a consumer
moves along an indifference curve.
If they touch the axis, it violates the
3. Indifference curve cannot intersect basic assumption that the consumer
purchases two commodities in a
Y combination.
Y Purchasing only one
commodity
A means monomania
that is consumers’ lack of interest
CommoditY Y

in the other commodity or his

CommoditY Y

insistence on purchasing only one

commodity.
C A IC2

IC1 2.15
B IC
0 Commodity X Price line
0 or Budget line B
X X Commodity X X

Diagram 2.18 Demand for a goodDiagram 2.19 upon

depends
(i) preference for that good and (ii)
IC 1 is lower indifference curve purchasing power. The preference pattern
denoting lesser satisfaction. is represented by set of indifference
Combination C and B fall on IC1. curves. The purchasing power depends on
IC 2 is upper indifference curve his money income and price of the goods.
denoting higher satisfaction. C and The money income and price level are
A combinations are on IC2. represented by budget line. The budget
Consumption Analysis 46

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 T is the point of equilibrium as budget
Y
A line AB is tangent on indifference curve
IC3 the upper IC which implies maximum
CommoditY Y

possible level of satisfaction.

Budget Line
At equilibrium point, the slope of
IC refers to MRSXY and the slope of BL
(Budget Line) refers to ratio of price of X
to price of Y ie Px/Py . Therefore MRSx,y =
Px/Py.
0 Commodity X B X
2.17
Diagram 2.20
Conclusion
line is a downward sloping straight line
connecting X axis and Y axis as follows. An understanding of consumer behaviour
is an important part of comprehending
BA is the budget line with a given
income (C). C/OA is the price of commodity the allocation of resources by individuals.
Y and C/OB is the price of commodity X. Consumption decisions are made based
The budget line is the line joining various upon a logical process of valuing utility,
combinations of the two goods which the price and income alternatives. Demand
consumer can buy at given prices and income. analysis enables the producers to
understand consumer behaviour and take
2.16 proper decisions accordingly.

Consumer Equilibrium

GLOSSARY
The consumer reaches equilibrium at the
point where the budget line is tangent on Consumption: The use of goods and
the indifference curve. services for satisfying
one’s wants.
Y
A
Demand: Demand is desire
backed by sufficient
purchasing power and
willingness to spend
N T on it.
Tea

Needs: It is defined as goods

IC4
IC3
or services that are
IC2 required. This would
IC1 include the needs for
0 M B X food, clothing, shelter
Coffee and health care.
Diagram
Diagram2.21
2.21

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 Utility: Utility is the capacity of Indifference A set of indifference
a commodity to satisfy Map: curves upper ICs
human wants. denoting higher and
Marginal Marginal utility is the lower ICs lesser level
utility: utility derived from of satisfaction.
the last or Marginal Price line or The line joining various
unit of consumption. Budget line: combination of the
Elasticity of The Elasticity of two goods which the
Demand: Demand refers to consumer can buy
the rate of change in at given prices and
demand due to a given income.
change in price. Consumer’s It refers to a situation
Consumer’s The difference Equilibrium: under which a consumer
Surplus: between the potential spends his entire income
price and actual price. on purchase of a goods
Indifference ICs means all those in such a manner that
Curves: combinations of any it gives him maximum
two goods which give satisfaction and he has
equal satisfaction to the no tendency to change
consumer. it.

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 ICT CORNER
Inverse Relation Between Price and Consumer’s Surplus

Inverse Relation helps

in the study of Relation
Between Price and
Consumer’s Surplus.

Steps:
• Open the Browser type the URL given (or) Scan the QR Code.
• GeoGebra Work book called “XI STD ECONOMICS” will appear. In
this several work sheets for Economics are given, Open the worksheet
named “Inverse Relation Between Price and Consumer’s Surplus”
• This work sheet is to give an Idea about the Consumer’s Surplus
and an Inverse relation. In this worksheet Green coloured triangle
is the Consumer’s Surplus. The vertical line shows the price and the
Horizontal line shows the Quantity.
• Move the point C so that the triangle area is increased when the
price is decreased and the triangle area is decreased when the price
increases. This is called the Inverse relation between the price and
Consumer’s Surplus.

Step1 Step2 Step3 Step4

Pictures are indicatives only*

URL:
https://ggbm.at/ddY3wkjp
(or) scan the QR Code

Consumption Analysis 49

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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. Pick the odd one out 6. Gossen’s first law is known as.
a. Luxuries a. Law of equi-marginal utility.
b. Comforts b. Law of diminishing marginal
c. Necessaries utility

d. Agricultural goods c. Law of demand.

d. Law of Diminishing returns.
2. Choice is always constrained or
limited by the _____ of our resources. 7. The basis for the law of demand is
related to
a. Scarcity
a. Law of diminishing marginal
b. Supply
utility
c. Demand b. Law of supply
d. Abundance c. Law of equi-marginal utility.
3. The chief exponent of the Cardinal d. Gossen’s Law.
utility approach was
8. The concept of consumer’s surplus is
a. J.R.Hicks associated with
b. R.G.D.Allen a. Adam Smith
c. Marshall b. Marshall
d. Stigler c. Robbins
4. Marginal Utility is measured by using d. Ricardo
the formula of
9. Given potential price is Rs.250 and
a. TUn-TUn-1 the actual price is Rs.200. Find the
b. TUn-TUn+1 consumer surplus.
c. TUn+TUn+1 a. 375 b. 175
d. TUn-TUn+1 c. 200 d. 50

5. When marginal utility reaches zero, 10. Indifference curve approach is based
the total utility will be on
a. Minimum a. Ordinal approach
b. Maximum b. Cardinal approach
c. Zero c. Subjective approach
d. Negative d. Psychological approach

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 11. The concept of elasticity of demand 16. Indifference curve was first introduced
was introduced by by
a. Ferguson a. Hicks
b. Keynes b. Allen
c. Adam Smith c. Keynes
d. Marshall d. Edgeworth

12. Increase in demand is caused by 17. Elasticity of demand is equal to one

a. Increase in tax indicates
b. Higher subsidy a. Unitary Elastic Demand
c. Increase in interest rate b. Perfectly Elastic Demand
d. decline in population c. Perfectly Inelastic Demand

13. The movement on or along the given d. Relatively Elastic Demand

demand curve is known as____
18. The locus of the points which gives
a. Extension and contraction of same level of satisfaction is associated
demand. with
b. shifts in the demand. a. Indifference Curves
c. increase and decrease in demand. b. Cardinal Analysis
d. all the above c. Law of Demand
14. In case of relatively more elastic d. Law of Supply
demand the shape of the curve is
19. Ordinal Utility can be measured by
a. Horizontal
a. Ranking
b. Vertical
b. Numbering
c. Steeper
c. Wording
d. Flatter
d. None of these
15. A consumer is in equilibrium when
marginal utilities from two goods are 20. The indifference curve are
a. Minimum a. vertical
b. Inverse b. horizontal
c. Equal c. positive sloped
d. Increasing d. Negatively sloped

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 Answers (Part- A)

1 2 3 4 5 6 7 8 9 10
d a c a b b a b d a
11 12 13 14 15 16 17 18 19 20
d b a d c d a a a d

Part-B 
Answer the following questions in one or two sentences.

21. Define Utility. 25. State the meaning of indifference

curves.
22. Mention the classifications of wants.
26. Write the formula of consumers
23. Name the basic approaches to
surplus.
consumer behaviour.
27. What are Giffen goods? Why it is
24. What are the degrees of price elasticity
called like that?
of Demand?

Part-C Answer the following questions in one paragraph.

28. Describe the feature of human wants. 32. Distinguish between extension and
contraction of demand.
29. Mention the relationship between
marginal utility and total utility. 33. What are the properties of indifference
curves?
30. Explain the concept of consumer’s
equilibrium with a diagram. 34. Briefly explain the concept of
consumer’s equilibrium.
31. Explain the theory of “consumer’s
surplus” .

Part-D Answer the following questions in about a page

35. Explain the law of demand and its 37. Explain the law of Equi-marginal
exceptions. utility.

36. Elucidate the law of diminishing 38. What are the methods of measuring
marginal utility with diagram. Elasticity of demand?

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 ACTIVITY
1. Prepare a budget line on the basis of your family income to
purchase any two commodities.
2. Visit a vegetable market in your locality and write a report about
the level of price and demand for a particular commodity over
a period of time.

References

„„Shashi kumar – Micro Economics (2004) - Anmol Publication Pvt Ltd

„„Ben S.Bernake – Principles of Micro Economics (2001) - MC Graw Hill Education
„„M.L.Seth – Micro Economics (2012) - Lakshmi Narain Agarwal Publication
„„M.L. Jhingan – Modern Micro Economics (Fourth Edition) (2012) - Virnda
Publication Pvt Ltd
„„Ryan C. Amacher – Principles of Micro Economics (1980) - South-Western Pub.Co
www.managedstudy.com
http://slideplayer.com/slide/7656075/.
http://www.brainkart.com/subject/Economics_14/
http://www.yourarticlelibrary.com/consumers/measurement-of-utility-cardinal-
utility-and-ordinal-utility/46782

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 CH A P TER

3 Production Analysis

“Production is any activity diverted to the satisfaction of other

people’s wants through exchange”.
- J R Hicks

Learning Objectives

1 To understand the various factors of production and its characteristics.

2 To understand the short run and long run production function.

3 To understand the concept of supply.

3.1 Production may be at varying

levels. The scale of production
Introduction
influence the cost of production. All
manufacturers are aware that when
Production is a process of using various production of a commodity takes place
material and immaterial inputs in order to on a larger scale, the average cost of its
make output for consumption. Production production is low. This is the reason
process creates economic well-being. why the entrepreneurs are interested
The satisfaction of needs originates from in enlarging the scale of production
the output. Production is the result of of their commodities. They stand to
cooperation of four factors of production benefit from the resulting economies
(land, labour, capital and organisation). of scale. There is also the possibility of
In Economics, production refers to the making their products available in the
creation or addition of value. It simply market at lower prices.
transforms the inputs into output.

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 3.2
Features of the Factors of
Production

Factors of production means resources

used in the process of production of
commodities. There are of four types viz.,
land, labour, capital and organization or
enterprise. Here, land represents natural wealth are determined by the nature of
resources (such as soil, mineral deposits, soil, climate and rainfall. The agricultural
seas, rivers, natural forests, fisheries etc). products are the basis of trade and industry.
Labour represents human resources. Industry survives on the availability of
Together, these two factors are called the coal-mines or waterfall for electricity
‘primary factors of production’. production. Hence, all aspects of economic
life like agriculture, trade and industry are
These two factors produce
generally influenced by natural resources
some units of goods for the purpose
which are called as “Land” in economics.
of consumption. And as consumption
of these goods takes place, there is the
Characteristics of Land
possibility of some of these goods getting
left over. Thus, saving is production minus „„Land is a primary factor of production.
consumption. This saved amount is called „„Land is a passive factor of production.
as capital, which serves as investment in „„Land is the free gift of Nature.
the production process. Also, organisation
„„Land has no cost of production.
or enterprise is a special form of labour.
The third and the fourth factors are called „„Land is fixed in supply. It is inelastic
‘secondary factors of production’. in supply.
„„Land is permanent.
These four factors depend on each
other. They have a coordinated impact on „„Land is immovable.
production of goods and services. „„Land is heterogeneous as it differs in
fertility.
3.2.1 Land „„Land has alternative uses.
In ordinary sense ‘land’ refers to the soil „„Land is subject to Law of Diminishing
or the surface of the earth or ground. Returns.
But, in Economics, land means all gifts of
Nature owned and controlled by human
3.2.2 Labour
beings which yield an income. Land is the
original source of all material wealth. The Labour is the active factor of production.
economic prosperity of a country depends In common parlance, labour means
on the richness of her natural resources. manual labour or unskilled work. But in
The quality and quantity of agricultural Economics the term ‘labour’ has a wider
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 „„Labour is a means as well as an end.
It is both the cause of production and
consumer of the product.
„„Labour units are heterogeneous.
Labour differs in ability.
„„Labour-supply determines its reward
(wage).
„„Labour has weak bargaining power.

meaning. It refers to any work undertaken 3.2.3 Capital

for securing an income or reward. Such
work may be manual or intellectual. For
example, the work done by an agricultural
worker or a cook or rickshaw puller or a
mason is manual. The work of a doctor or
teacher or an engineer is intellectual. In
short, labour in economics refers to any Marshall says “capital
type of work performed by a labourer for consists of all kinds of
earning an income. wealth other than free
According to Marshall, labour gifts of nature, which
represents services provided by the factor yield income”. Bohm-
labour, which helps in yielding an income Bawerk defines it as
to the owner of the labour-power. ‘a produced means
of production’. As
Characteristics of Labour said earlier, capital
is a secondary means of production. It
„„Labour is the animate factor of
refers to that part of production which
production.
represents ‘saving used as investment’
„„Labour is an active factor of in the further production process. For
production. example, the entire mango is not eaten; a
„„Labour implies several types: it may part of that (its nut) is used to produce
be manual (farmer) or intellectual more mangoes.
(teacher, lawyer etc). It is a stock concept. All capital
„„Labour is perishable. is wealth but all wealth is not capital.
„„Labour is inseparable from the For example, tractor is a capital asset which
Labourer. can be used in cultivation (production) of
farm, but due to some reason the same
„„Labour is less mobile between places
is kept unused (idle) for some period.
and occupations.
It cannot be termed as capital for that
period. It is only wealth.

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 Characteristics of Capital The man behind
organizing the business
„„Capital is a man-made factor.
is called as ‘Organizer’
„„Capital is mobile between places and or ‘Entrepreneur’. An
persons. organiser is the most
„„Capital is a passive factor of important factor of
production. production. He represents a special type
„„Capital’s supply is elastic. of labour. Joseph Schumpeter says that an
„„Capital’s demand is a derived demand. entrepreneur innovates, coordinates other
factors of production, plans and runs a
„„Capital is durable.
business. He not only runs the business,
„„Capital yields Income. but also bears the risk of business. His
„„Capital depriciates. reward is residual. This residual is either
positive (profit) or negative (loss) or zero.
Capital may be tangible or intangible.
For example, buildings, plants and Functions of an Organizer
machinery, factories, inventories of (Entrepreneur)
inputs, warehouses, roads, highways
„„Initiation: An organizer is the initiator
etc are tangible capital. The examples
of the business, by considering the
for intangible capital are investment on
situation and availability of resources
advertisement, expenses on training
and planning the entire process of
programme etc.
business or production.
„„Innovation: A successful entrepreneur
Financial Capital means the assets is always an innovator. He introduces
needed by a firm to provide goods new methods in the production process.
and services measured in term of „„Coordination: An organizer applies a
money value . It is normally raised particular combination of the factors
through debt and equity issues .The of production to start and run the
prime aim of it is to a mass wealth in business or production.
terms of profit.
„„Control, Direction and Supervision:
An organiser controls so that nothing
3.2.4. Organization prevents the organisation from
achieving its goal. He directs the factors
to get better results and supervises
for the efficient functioning of all

An entrepreneur is a person who

combines land, labour and capital in
the production process to earn a profit.

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 the factors involved in the process of The short-run is the period where
production. some inputs are variable, while others are
„„Risk-taking and Uncertainty-bearing: fixed. Another feature is that firms do not
There are risk-taking and uncertainty- enter into the industry and existing firms
bearing obstacles. Risks may be insured may not leave the industry.
but uncertainties cannot be insured. Long run, on the other hand, is the
They reduce the profit. period featured by the entry of new firms
to the industry and the exit of existing
3.3 firms from the industry.
Production Function In general, Production function
may be classified into two
Production function refers to the „„Short-run Production Function as
relationship among units of the factors illustrated by the Law of Variable
of production (inputs) and the resultant Proportions.
quantity of a good produced (output).
„„Long-run Production Function as
According to George J. Stigler, explained by the Laws of Returns to Scale.
“Production function
is the relationship
between inputs of 3.4
productive services Law of Variable
per unit of time and Proportions
outputs of product per
unit of time.” The law states that if all other factors are fixed
Production and one input is varied in the short run, the
function may be total output will increase at an increasing
expressed as: Q = f (N, L, K, T) Where, rate at first instance, be constant at a point
Q = Quantity of output, N = Land; L = and then eventually decrease. Marginal
Labour; K = Capital; and T = Technology. product will become negative at last.
Depending on the efficiency of the According to G.Stigler, “As equal
producer, this production function varies. increments of one input are added, the
The function implies that the level inputs of other productive services being
of output (Q) depends on the quantities of held constant, beyond a certain point,
different inputs (N, L, K, T) available to the resulting increments of product will
the firm. decrease, i.e., the marginal product will
Short-run Production and Long diminish”.
run Production
Assumptions
In Micro economics, the distinction
between long run and short run is made on the The Law of Variable Proportions is based
basis of fixed inputs that inhibit the production. on the following assumptions.

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 „„Only one factor is variable while to the change in the units of the input. It is
others are held constant. expressed as
„„All units of the variable factor are
homogeneous. MP=ΔTP/ΔN

„„The product is measured in physical where,

units. MP = Marginal Product
„„There is no change in the state of
ΔTP = Change in total product
technology.
ΔN = Change in units of input
„„There is no change in the price of the
product. It is also expressed as

Total Product (TP) MP = TP (n) – TP (n-1)

It refers to the total amount of commodity
Where,
produced by the combination of all inputs
in a given period of time. MP = Marginal Product
„„Summation of marginal products, i.e.
TP(n) = Total product of employing nth
TP = ∑MP
unit of a factor
where, TP= Total Product, MP= Marginal
Product TP(n-1) = Total product of employing the
previous unit of a factor, that
Average Product (AP) is, (n-1)th unit of a factor.

It is the result of the total product divided The Law of Variable Proportions is
by the total units of the input employed. explained with the help of the following
In other words, it refers to the output per schedule and diagram:
unit of the input. In table 3.1, units of variable factor (labour)
Mathematically, AP = TP/N are employed along with other fixed factors
of production. The table illustrates that there
Where,
AP= Average Product Y
TP= Total Product 18
TPL 16 TPL
14 Stage I Stage III
N= Total units of inputs employed
Output

APL 12 A
10
MPL 8
Marginal Product (MP) 6
4
It is the addition or the increment made to 2 APL
0
the total product when one more unit of the -2 1 2 3 4 5 6 7 x
L

variable input is employed. In other words, it Units of Variable Factor

is the ratio of the change in the total product Diagram 3.1

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 Table 3.1 Stages of Production
Units of variable Total Product Marginal Product Average Product Stages
factor (L) (TPL) (MPL) (APL)

1 2 2 2
2 6 4 3 I
3 12 6 4
4 16 4 4
5 18 2 3.6 II
6 18 0 3
7 16 -2 2.28 III

are three stages of production. Though total tendency of total product to increase
product increases steadily at first instant, at an increasing rate stops at the point A
constant at the maximum point and then and it begins to increase at a decreasing
diminishes, it is always positive for ever. rate. This point is known as ‘Point of
While total product increases, marginal Inflexion’.
product increases up to a point and then
decreases. Total product increases up to Stage II
the point where the marginal product is
In the second stage, MPL decreases up
zero. When total product tends to diminish
to sixth unit of labour where MPL curve
marginal product becomes negative.
intersects the X-axis. At fourth unit of
In diagram 3.1, the number of labor MPL = APL. After this, MPL curve
workers is measured on X axis while is lower than the APL. TPL increases at a
TPL, APL and MPL are denoted on decreasing rate.
Y axis. The diagram explains the three
stages of production as given in the above
Stage III
table.
Third stage of production shows that the
Stage I sixth unit of labour is marked by negative
MPL, the APL continues to fall but remains
In the first stage MPL increases up to
positive. After the sixth unit, TPL declines
third labourer and it is higher than the
with the employment of more units of
average product, so that total product
variable factor, labour.
is increasing at an increasing rate. The

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 Relationship among Total, Average and Marginal Products

Stages Total Product Marginal Product Average Product

Stage I Initially it increases at an At the beginning At the first instant it
increasing rate and then it increases, then increases, then attains
increases at a decreasing reaches a maximum maximum
rate and starts to decrease
Stage II It continues to increase It continues to It is equal to MP
at a diminishing rate and diminish and and then begins to
reaches maximum. becomes equal to zero diminish
Stage III It diminishes It becomes negative It continues to
diminish but always
greater than zero
(positive)

3.5 Three Phases of Returns to

Scale
Laws of Returns to Scale
(1) Increasing Returns to Scale:

In the long- run, there is no fixed In this case if all inputs are increased
factor; all factors are variable. The by one percent, output increase by
laws of returns to scale explain the more than one percent.
relationship between output and the (2) Constant Returns to Scale:
scale of inputs in the long-run when In this case if all inputs are increased
all the inputs are increased in the same by one percent, output increases
proportion. exactly by one percent.
(3) Diminishing Returns to Scale:
Assumptions
In this case if all inputs are increased
Laws of Returns to Scale are based on the by one percent, output increases by
following assumptions. less than one percent.
„„All the factors of production (such as
land, labour and capital) are variable
but organization is fixed. Diagrammatic Illustration
„„There is no change in technology. The three laws of returns to scale can be
„„There is perfect competition in the explained with the help of the diagram
market. below.
„„Outputs or returns are measured in In the diagram 3.2, the movement
physical quantities. from point a to point b represents

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 d
K, Unit of capital
8
q=8

4 c
q=6
2 b q=3
1 a q=1
0 1 2 4 8
Labour
Diagram 3.2

Stages Input Output Returns to

Scale
a to b 100% ↑ 200% ↑ Increasing
b to c 100% ↑ 100% ↑ Constant by the internal and external factors of the
c to d 100% ↑ 33.33% ↑ Decreasing firm. Accordingly, Economies are broadly
divided into two types by Marshall.
increasing returns to scale. Because, 1. Internal Economies and
between these two points input has
2. External Economies
doubled, but output has tripled.
Economies of scale reduces the cost of
The law of constant returns to production: and, diseconomies of scale
scale is implied by the movement from increases the cost of production.
the point b to point c. Because, between
these two points inputs have doubled and
output also has doubled. 3.6.1 Internal Economies of
Decreasing returns to scale are Scale
denoted by the movement from the point c ‹The term Internal Economies of Scale›
to point d since doubling the factors from refers to the advantages enjoyed by
4 units to 8 units produce less than the the production unit which causes a
increase in inputs, that is, by only 33.33% reduction in the cost of production of the
commodity. For example, a firm enjoying
3.6 the advantage of an application of most
Economies of Scale modern machinery, generation of internal
capital, an improvement in managerial
‘Scale of Production’ refers to the ratio skill etc. are sure to reduce the cost of
of factors of production. This ratio can production. They are of various types:
change because of availability of factors. „„Technical Economies: When the size of
The Scale of Production is an important the firm is large, large amount of capital
factor affecting the cost of production. can be used. There is a possibility to
Every producer wishes to reduce the costs introduce up-to-date technologies;
of production. Hence he (he includes she this improves productivity of the
as well) uses an advantage of economy of firm. Here research and development
scale. This economy of scale is effected both strategies can be applied easily.
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 „„Financial Economies: Big firms can 4. Development of information and
float shares in the market for capital communication
expansion, while small firms cannot
easily float shares in the market. 3.7
„„Managerial Economies: Large scale Diseconomies of Scale
production facilitates specialisation
and delegation. The diseconomies of the scale are a
„„Labour Economies: Large scale disadvantage to a firm or an industry or
production implies greater and an organisation. This necessarily increases
minute division of labour. This leads the cost of production of a commodity or
to specialisation which enhances the service. Further it delays the speed of the
quality. This increases the productivity supply of the product to the market. These
of the firm. diseconomies are of two types:

„„Marketing Economies: In the a) Internal Diseconomies of Scale: and

context of large scale production, the b) External Diseconomies of Scale
producers can both buy raw-materials
in bulk at cheaper cost and can take 3.7.1 Internal Diseconomies
the products to distant markets. They of Scale
enjoy a huge bargaining power.
When the scale of production increases
„„Economies of Survival: Product
beyond optimum limit, its efficiency may
diversification is possible when there
come down.
is large scale production. This reduces
the risk in production. Even if the
market for one product collapses, 3.7.2 External Diseconomies
market for other commodities of Scale
offsets it. The term “External diseconomies of scale”
refers to the threat or disturbance to a firm
3.6.2 External Economies of or an industry from factor lying outside it.
Scale For example a bus strike prevents the easy
External Economies of Scale refer to and correct entry of the workers into a firm.
changes in any factor outside the firm Similarly the rent of a firm increases very
causing an improvement in the production much if new economic units are established
process. This can take place in the case of in the locality.
industry also. These are the advantages
enjoyed by all the firms in the industry 3.8
due to the structural growth. Important
Iso-quants
external economies of scale are listed below.
1. Increased transport facilities
Production function may involve, at a
2. Banking facilities
time, the use of more than one variable
3. Development of townships input. This is presented with the help of
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 iso-quant curves. The two words ‘Iso’ Iso-quants are based on the
and ‘quant’ are derived from the Greek following assumptions.
language, meaning ‘equal’ and ‘quantity’
1. It is assumed that only two factors
respectively. In our presentation only two
are used to produce a commodity.
factors, labour and capital are used.
2. Factors of production can be divided
In Economics, an iso-quant is a into small parts.
curve drawn by joining the combinations
3. Technique of production is constant.
of changing the quantities of two or more
inputs which give the same level of output. 4. The substitution between the two
Isoquants are similar to indifference factors is technically possible. That
curves. is, production function is of ‘variable
proportion’ type rather than fixed
An iso-quant curve can be defined
proportion.
as the locus of points representing various
combinations of two inputs capital and 5. Under the given technique, factors
labour yielding the same output. The iso- of production can be used with
quant is also called as the “Equal Product maximum efficiency.
Curve” or the “Product Indifference
Curve” Iso-quant Schedule
Let us suppose that there are two
3.8.1 Definition of Iso-quant factors namely., labour and capital. An
According to Ferguson, “An iso-quant is Iso-quant schedule shows the different
a curve showing all possible combinations combinations of these two inputs that
of inputs physically capable of producing a yield the same level of output. It is given
given level of output” below.

Table 3.2 Iso-quant

Combination Units of Labour Units of Capital Output of Cloth ( meters)
A 2 30 400
B 4 22 400
C 6 16 400
D 8 12 400
E 10 10 400

It is seen from the table 3.2 that

3.8.2 Iso-quant Curve
the five combinations of labour units and
units of capital yield the same level of An equal product curve represents all
output, i.e., 400 meters of cloth. those combinations of two inputs which

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 3.8.4 Properties of Iso-quant
Y
Iso-quant curve Curve

30 Y
Capital

22
A
16 K4
B

Capital
12 K3
10 IQ=400 C
K2
D
K1
6 8 10 IQ
0 2 4 X
Labour
0 L4 L3 L2 L1 X
Diagram 3.3 Labour
Diagram 3.5

are capable of producing the same level

of output. An iso-product curve can 1. The iso-quant curve has negative
be drawn with the help of isoquant slope. It slopes downwards from left
schedule. to right indicating that the factors
are substitutable. If more of one
3.8.3 Iso-quant Map factor is used, less of the other factor
is needed for producing the same
level of output.
Y
IQ4 In the diagram combination A refers
IQ3 to more of capital K5 and less of
IQ2
IQ1 labour L2. As the producer moves
to B, C, and D, more labour and less
Capital

capital are used.

400 Unit
300 Unit
200 Unit
2. Convex to the origin.
100 Unit
This explains the concept of diminishing
0 X Marginal Rate of Technical Substitution
Labour
Diagram 3.4 (MRTSLK). For example, the capital
substituted by 1 unit of labour goes on
decreasing when moved from top to
An iso-quant map has different iso- bottom. If so, it is called diminishing
quant curves representing the different MRTS. Constant MRTS (straight line)
combinations of factors of production, and increasing MRTS (concave) are
yielding the different levels of output. In also possible. It depends on the nature
simple term, an iso-quant map is a family of iso-quant curve.
of iso-quants. In other words, if more than This means that factors of
one iso-quant is drawn in a diagram, it is production are substitutable to each
called iso-quant map. other. The capital substituted per

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 MARGINAL RATE OF TECHNICAL SUBSTITUTION

Y Diminishing MRTS Y Constant MRTS Y Increasing MRTS

Y Y
Capital

Capital

Capital
Isoquant curve IQ4
IQ3
IQ2
30 IQ1

Capital
Capital

Capital
22 0 0 0
X X X
16 Labour Labour Labour 400 Unit
12 300 Unit
10 IQ=400 200 Unit
Diagram 3.6 100 Unit
0 2 4 6 8 10 Y X
Labour
Labour
Diagram 3.4
Diagram 3.3
unit of labour goes on decreasing when upper iso-quant curve implies the use
the iso-quant is convex to the origin. of more factors than the lower isoquant
3. Non inter-section of Iso-quant curve.
curves.

Y Y
IQ2 IQ1 IQ3
Y
IQ1
Capital

A
Capital

c
Capital

A
c 300 Units
300 Units 300 Unit
B
B 100 Units 100 Unit
100 Units
0 Labour X 0 X
Labour
Labour X
Diagram 3.7 Diagram 3.8
Diagram 3.7
For instance, point A lie on the iso-
quants IQ1 and IQ2. But the point C The arrow in the figure shows
shows a higher output and the point an increase in the output with a right
B shows a lower level of output IQ1. and upward shift of an iso-quant
If C=A, B=A, then C=B. But C>B curve.
which is illogical. 5. Iso-quant curve does not touch ES>1
Y Y
4. An upper iso-quant curve represents either X axis or
S Y axis.
C
a higher level of output. 5 No iso-quant curve
a touches the X axis or A
Higher IQ 2 show higher outputs Y axis because in IQ1, only capital is used,
Price

4 b
and lower IQ1 show lower outputs, for and in IQ2 only labour is used.
3 c
Price

o B D
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2 d
Y
1 e
E Chapter-03.indd 66 20-02-2020 11:48:12
C
R IQ(500 Units) S
 Y Suppose that a producer has a
C total budget of ₹120 and for producing a
certain level of output, he has to spend
this amount on two factors Labour (L)
Capital

and Capital (K). Prices of factors K is

IQ IQ2
₹30 and L is ₹10. Iso Cost Curve can be
drawn by using the following hypothetical
0 L X table.
Labour
As shown in Table, there are
Diagram 3.9 five combinations of capital and labour
such as combination A represents
4 units of capital and zero units of
3.9 labour and this combination costs ₹120.
Similarly other combinations (B,C,D
The Iso-cost Line and E) cost same amount of rupees
(₹120).
The iso-cost line is an important
component in analysing producer’s
behaviour. The iso-cost line illustrates all
Y
the possible combinations of two factors
that can be used at given costs and for a 4
A
given producer’s budget. Simply stated,
B
an iso-cost line represents different 3
Capital

C
combinations of inputs which shows the 2 Iso-cost line
same amount of cost. The iso-cost line gives D
1
information on factor prices and financial E
resources of the firm. It is otherwise called
0 2 4 6 8 10 12 X
as “iso-price line” or “iso-income line”
Labour
or “iso-expenditure line” or “total outlay
curve”. Diagram 3.10

Table 3.3 The Iso-cost

Combinations Units of Capital Units of Labour Total Expenditure
Price = ₹30 Price = ₹10 ( in Rupees)
A 4 0 120
B 3 3 120
C 2 6 120
D 1 9 120
E 0 12 120

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 Capital
A
c
300
B
100

0 Symbolically, 0
„„At point of tangency, the iso-quant
Labour
X X X
4KLabour
+ 0L= ₹.120 curve must be convex to the origin or
Diagram 3.7
3K + 3L= ₹.120 MRTSLk must be declining.
Diagram 3.6
2K + 6L= ₹.120
When the outlay and prices of two factors,
1K + 9L= ₹.120, and namely, labour and capital are given,
0K + 12L= ₹.120. producers attain equilibrium (or least cost
Thus, all the combinations combination of factors is attained by the
A, B, C, D and E cost the firm) where the iso-cost line is tangent to
an iso-product curve. It is illustrated in
same total expenditure.
the following Diagram 3.11.
From the figure 3.10, it is shown that the
costs to be incurred on capital and labour Y
are represented by the triangle OAE. The

Units of a capital
B P3
line AE is called as Iso-cost line. H
C P2
P1 K
Isocost line
3.10
D P
N E
E
Producer’s Equilibrium R S IQ(500 Units)
2 4 6 8 10 12 X
O M L L1 L2 L3 X
Labour
Producer equilibrium implies the situation Units of labour
Diagram 3.10
where producer maximizes his output. It Diagram 3.11
is also known as optimum combination
of the factors of production. In short, the
In the above figure, profit of the firm (or
producer manufactures a given amount
the producer) is maximised at the point of
of output with ‘least cost combination of
equilibrium E.
factors’, with his given budget.
At the point of equilibrium, the
Optimum Combination of slope of the iso cost line is equal to the
Factors implies either slope of iso product curve (or the MRTS
of labour for capital is equal to the price
„„there is output maximisation for given
ratio of the two factors)
inputs or
Hence, it can be stated as follows.
„„there is cost minimisation for the
given output. PL
MRTS L ,K = =10/30=1/3=0.333
PK
Conditions for Producer’s
Equilibrium At point E, the firm employs OM units of
labour and ON units of capital. In other
The two conditions that are to be fulfilled for
words, it obtains least cost combination or
the attainment of producer equilibrium are:
optimum combination of the two factors
„„The iso-cost line must be tangent to to produce the level of output denoted by
iso-quant curve. the iso-quant IQ.
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 The other points such as H, K, R and The Cobb-Douglas production
S lie on higher iso cost lines indicating that function can be expressed as follows.
a larger outlay is required, which exceeds
the financial resources of the firm. Q = AL α Kß
Where, Q = output; A = positive constant;
K = capital; L = Labor α and β are positive
3.11
fractions showing, the elasticity coefficients
Cobb-Douglas Production of outputs for the inputs labor and capital,
Function respectively.

ß = (1- α) since α + ß = 1. denoting

constant returns to scale.
Factor intensity can be measured by the
ratio ß / α.
The sum of α + ß shows the returns to scale.

i) (α + ß) =1, constant returns to scale.

W.Cobb and Paul H.Douglas ii) (α + ß) <1, diminishing returns to
scale.
iii) (α + ß) >1, increasing returns to scale.
Cobb-Douglas Production Function
is a specific standard equation „„The production function explains that
applied to describe how much output with the proportionate increase in the
can be made with capital and labour factors, the output also increases in
inputs. It is used in empirical studies the same proportion.
of manufacturing industries and in „„Cobb-Douglas production function
inter-industry comparisons. The implies constant returns to scale.
relative shares of labour and capital in „„Cobb-Douglas production function
total output can also be determined. considered only two factors like
It is still used in the analysis of
„„Cobb-Douglas Production Function
economies of modern, developed and
is a specific standard equation applied
stable nations in the world.
to describe how much output can be
made with capital and labour inputs.
The Cobb-Douglas Production Function It is used in empirical studies of
was developed by Charles W. Cobb and Paul manufacturing industries and in inter-
H. Douglas, based on their empirical study industry comparisons. The relative
of American manufacturing industry. It is shares of labour and capital in total
a linear homogeneous production function output can also be determined. It is
which implies that the factors of production still used in the analysis of economies
can be substituted for one another up to a of modern, developed and stable
certain extent only. nations in the world.

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 „„labour and capital. Production takes place expectations and so on. Mathematically
only when both factors are employed. the supply function is
„„Labour contributes three-fourth of
Qs = f (Px, Pr, Pf, T, O, E )
production and capital contributes
one-fourth of production. Where Qs = Quantity supplied of x
„„The elasticity of substitution between commodity
the factors is equal to one. Px = Price of x Commodity
Pr = Price of related goods
3.12
Pf = Price of factors of production
Law of Supply
T = Technology
Law of Supply is associated with O = Objective of the producer
production analysis. It explains the E = Expected Price of the commodity.
positive relationship between the price
of a commodity and the supply of that Assumptions
commodity. For example, if the price of
cloth increases, the supply of cloth will also Law of Supply is based on the following
increase. This is due to the fact that when assumptions.
price rises, it is profitable to increase the „„There is no change in the prices of
production and hence supply increases. factors of production
„„There is no change in price of capital
Law of Supply describes a direct goods
relation between price of a good and „„Natural resources and their availability
the supply of that good. remain the same
„„Prices of substitutes are constant
„„There is no change in technology
Definition
„„Climate remains unchanged
The Law of Supply can be stated as: „„Political situations remain unchanged
“Other things remaining the same, if the „„There is no change in tax policy
price of a commodity increases its quantity
supplied increases and if the price of a Explanation
commodity decreases, quantity supplied Suppose that the supply function is
also decreases”.
Qs = f(P) or Q = 20P
3.12.1 Supply Function P is an independent variable. When its value
changes, new values of Qs can be calculated.
The supply of a commodity depends on
the factors such as price of commodity,
Supply Schedule
price of labour, price of capital, the
state of technology, number of firms, A supply schedule shows the different
prices of related goods, and future price quantities of supply at different prices.
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 This information is given in the supply on the Y axis. The points such as a, b, c,
schedule given below. d and e on the supply curve SS’, represent
various quantities at different prices.
Table 3.4 Price and Supply
3.12.3 Factors determining
Price (P) Supply (Qs) supply
1 20
1. Price of the commodity
2 40
Qs = 20P Higher the price larger the supply.
3 60
Price is the incentive for the
4 80 producers and sellers to supply more.
5 100 2. Price of other commodities

The supply of a commodity
depends not only upon its price
3.12.2 Supply Curve but also price of other commodities.
For instance if the price of commercial
A supply curve represents the data given crops like cotton rise, this may
in the supply schedule. As the price of result in reduction in cultivation
the commodity increases, the quantum of food crops like paddy and so its
supplied of the commodity also increases. supply.
Thus the supply curve has a positive slope
3. Price of factors
from left to right. (see diagram 3.12.)
When the input prices go up, this
Y results in rise in cost and so supply
S will be affected.
5 e 4. Price expectations
4 d The expectation over future prices
determines present supply. If a rise in
3 c price is anticipated in future, sellers
Price

2
tend to retain their produce for
b
future sale and so supply in present
1 a market is reduced.
S 5. Technology
0 20 40 60 80 100 X With advancement in technology,
Commodity x production level improves, average cost
Diagram 3.12 declines and as a result supply level
increases.

The quantum supplied of 6. Natural factors

commodity x is represented on X axis. And In agriculture, natural factors like
the price of the commodity is represented monsoon, climate etc. play a vital

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 role in determining production
3.12.4 Elasticity of Supply
level.
7. Discovery of new raw materials Elasticity of supply may be defined as the
degree of responsiveness of change in supply
The discovery of new raw materials
to change in price on the part of sellers.
which are cheaper and of high
quality tends to increase supply of It is mathematically expressed as:
the product.
Elasticity = proportionate change in
8. Taxes and subsidies
of supply supply / proportionate
Subsidies for inputs, credit, power change in price
etc. encourage the producers to
produce more. Withdrawal of such es=(∆Qs/Qs) / (∆P/P); es = ∆Qs / ∆P × P/Qs
incentives will hamper production. Where Q s represents the supply, P
Taxes both direct and indirect kill represents price, ∆ denotes a change.
the ability and willingness to produce
more.
3.12.5 Types of Elasticity of
9. Objective of the firm Supply
When the goal of the firm is sales There are five types of elasticity of supply.
maximisation or improving market
share, the supply of the product is 1. Relatively elastic supply (see
likely to be higher. Diagram 3.13)

ES>1 s1 ES=1 s2 ES<1 s3

Y Y Y
C C C
A
A
Price

Price

Price

o B D x o B D x o B D x
Supply Supply Supply
ES=0 s4 ES=α
Y Y

C
A s5
A
Price

Price

o D x o B D x
Supply Supply
Diagram 3.13

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 The co-efficient of elastic supply is they get a high price. Once they get
greater than 1(Es > 1). One percent higher price, larger supply is possible.
change in the price of a commodity The elasticity of supply of durable
causes more than one per cent change in goods is high. But perishables are to
the quantity supplied of the commodity. be sold immediately. So perishables
2. Unitary elastic supply (see Diagram have low elasticity of supply.
3.13) 2. Cost of production
The coefficient of elastic supply is When production is subject to either
equal to 1 (Es = 1). One percent change constant or increasing returns,
in the price of a commodity causes an additional production and therefore
equal ( one per cent) change in the increased supply is possible. So
quantity supplied of the commodity. elasticity of supply is greater. Under
3. Relatively inelastic supply diminishing returns, increase in
(see Diagram 3.13) output leads to high cost. So elasticity
of supply is less.
The coefficient of elasticity is less
than one (Es < 1). One percent change 3. Technical condition
in the price of a commodity causes a In large scale production with huge
less than one per cent change in the capital investment, supply cannot be
quantity supplied of the commodity. adjusted easily. So elasticity of supply
4. Perfectly inelastic supply (see is lesser. Where capital equipment
Diagram 3.13) is less and technology simple, the
supply is more elastic.
The coefficient of elasticity is equal
to zero (Es = 0). One percent change 4. Time factor
in the price of a commodity causes During very short period when
no change in the quantity supplied of supply cannot be adjusted, elasticity
the commodity. of demand is very low. In short
5. Perfectly elastic supply (see Diagram period, variable factors can be added
3.13) and so supply can be adjusted to
some extent. So elasticity of supply
The coefficient of elasticity of supply
is more. In long period, even the
is infinity. (E s = α ). One percent
fixed factors can be added and hence
change in the price of a commodity
supply is highly elastic.
causes an infinite change in the
quantity supplied of the commodity.
3.13
Conclusion
3.12.6 Factors governing
elasticity of supply
Production takes place with the view to
1. Nature of the commodity fulfilling the demands of the consumers. Today
Durable goods can be stored for a long consumption expands in a variety of ways.
time. So, the producers can wait until Hence, production has to necessarily expand
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 in size and improve in quality. Production „„Supply: The quantity of output
should also help in the determination of the which producers are willing and
price of the factors so that the amount of the able to offer to the market at various
income generated be appropriately spent on prices.
the factors of production. „„Elasticity of Supply: Responsiveness
of the quantity supplied of a good to a
Glossary change in its price.
„„Production: An activity that „„Iso-quant: All the combination of two
transforms input into output. inputs which are capable of producing
„„Factors of Production: Four factors same level of output.
are Land, Labour, Capital and „„Iso-cost: All combination of two
Organisation. Factor services are used inputs shows that a firm can purchase
in the process of production. with the same amount of money.
„„Land: All gifts of Nature. „„Short-run Production Function:
„„Labour: Physical or mental effort Relationship between inputs and
of human being in the process of output, when there is at least one fixed
production. factor in the production process.

„„Capital: Man-made material source „„Long-run Production Function:

of production. Relationship between inputs and
output when all factors are variable.
„„Organisation: which takes decisions
and bears risk. „„Economies of Scale: A proportionate
saving in costs gained by an increased
„„Production function: Technological
level of production.
relationship between inputs and
output.

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 ICT CORNER
LAW OF VARIABLE PROPORTION

Analyse the changes in TPL and

APL with respect to the changes
in MPL.

Steps:
• Open the Browser type the URL given (or) Scan the QR Code.
• GeoGebra Work book called “XI STD ECONOMICS” will appear.
Open the worksheet named “Law of Variable Proportions”
• In the Right side of the work sheet Total Product, Marginal Product
and Average Product are given and in the left side Respective graph
is shown. Analyse the data and the graphs drawn and the points.
• vAnalyse the change in MPL and click the check boxes, STAGE-
I,STAGE-II and STAGE-III so that Each stage appears in different
colours. Now analyse TPL and APL in each stage and compare what
is given in the text book lesson.

Step1 Step2 Step3 Step4

Pictures are indicatives only*

URL:
https://ggbm.at/ddY3wkjp
(or) scan the QR Code

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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. The primary factors of production

are:
a. Labour and Organisation
6. The functional relationship between
b. Labour and Capital
“inputs” and “outputs” is called as
c. Land and Capital
a. Consumption Function
d. Land and Labour.
b. Production Function
2. The man-made physical goods used to c. Savings Function
produce other goods and services are
d. Investment Function
referred to as.
a. Land b. Labour 7. In a firm 5 units of factors produce
24units of the product. When the
c. Capital d. Organization.
number of factor increases by one,
3. Formula for calculating AP is the production increases to 30 units.
Calculate the Avarage Product.
a. ΔTP/N
a. 30
b. ΔTP/ΔN
b. 6
c. TP/MP
c. 5
d. TP/N
d. 24
4. Which factor is called the changing
agent of the Society 8. The short-run production is studied
through
a. Labourer
a. The Laws of Returns to Scale
b. Land
b. The Law of Variable Proportions
c. Organizer
c. Iso-quants
d. Capital
d. Law of Demand
5. Who said, that one of the key
of an entrepreneur is “uncertainty- 9. The long-run production function is
bearing”. explained by
a. J.B.Clark a. Law of Demand
b. Schumpeter b. Law of Supply
c. Knight c. Returns to Scale
d. Adam Smith d. Law of Variable Proportions

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 10. An Iso-quant curve is also known as 16. Modern economists have propounded
a. Inelastic Supply Curve the law of
b. Inelastic Demand Curve a. Increasing returns
c. Equi-marginal Utility b. decreasing returns
d. Equal Product Curve c. Constant returns
11. Mention the economies reaped from d. variable proportions.
inside the firm
a. financial 17. Producer’s equilibrium is achieved at
b. technical the point where:
c. managerial a. Marginal rate of technical
d. all of the above substitution(MRTS) is greater than
the price ratio
12. Cobb-Douglas production function
assumes b. MRTS is lesser than the price
ratio
a. Increasing returns to scale
b. Diminishing returns to scale c. MRTS and price ratio are equal to
each other
c. Constant returns to scale
d. All of the above d. The slopes of isoquant and isocost
lines are different.
13. Name the returns to scale when the
output increases by more than 5%, for
a 5% increase in the inputs, 18. The relationship between the price
of a commodity and the supply of
a. Increasing returns to scale
commodity is
b. decreasing returns to scale
a. Negative
c. Constant returns to scale
b. Positive
d. All of the above
c. Zero
14. Which of the following is not a
characteristic of land? d. Increase
a. Its limited supply. 19. If average product is decreasing, then
b. It is mobile marginal product
c. Heterogeneous a. must be greater than average
d. Gift of Nature product
15. Product obtained from additional b. must be less than average product
factors of production is termed as
c. must be increasing
a. Marginal product
d. both a and c
b. Total product
c. Average product
d. Annual product

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 20. A production function measures
the relation between
a. input prices and output prices c. the quantity of inputs and the
b. input prices and the quantity of output quantity of output.
d. the quantity of inputs and input
prices.

Part-A Answers

1 2 3 4 5 6 7 8 9 10
d C d c c b c b c d
11 12 13 14 15 16 17 18 19 20
d C a b a a c b b c

Part-B 
Answer the following questions in one or
two sentences.
21. Classify the factors of production.
22. Define Labour.
23. State the production function.
24. Define Marginal Product of a factor.
25. What is Iso-cost line?
26. What are the conditions for producer’s equilibrium?
27. What are the reasons for upward sloping supply curve?

Part-C Answer the following questions in one paragraph.

28. What are the characteristics of land?

29. What are the factors governing elasticity of supply?
30. What are the functions of Entrepreneur?
31. State and explain the elasticity of supply.
32. Bring out the Relationship among Total, Average and Marginal Products.
33. Illustrate the concept of Producer’s Equilibrium.
34. State the Cobb-Douglas Production Function.

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 Part-D Answer the following questions in about a page

35. Examine the Law of Variable Proportions with the help of a diagram.

36. List out the properties of iso-quants with the help of diagrams.

37. Elucidate the Laws of Returns to Scale. Illustrate.

38. Explain the internal and external economies of scale.

ACTIVITY
1. Visit a market and write a report on the factors that influence
the quantity of supply of a commodity of your locality.
2. Visit a factory and show how the four factors of production are
effectively employed to produce the product in your locality.

References

1. Irvin B. Tucker – Microeconomics for Today - 2004 Thomson/South-Western

2. A. Koutsoyiannis – Modern Microeconomics - (2008) Macmillan Press Ltd
3. Hal R. Varian – Microeconomic Analysis - (2010) W.W. Norton & Company
4. Shashi kumar – Micro Economics (2004) - Anmol Publication Pvt Ltd
5. Ben S.Bernake – Principles of Micro Economics (2001) - MC Graw Hill Education
6. M.L.Seth – Micro Economics (2012) - Lakshmi Narain Agarwal Publication
7. M.L. Jhingan – Modern Micro Economics (Fourth Edition) (2012) - Virnda
Publication Pvt Ltd
8. Ryan C. Amacher – Principles of Micro Economics (1980) - South-Western Pub.Co
http://careercart.blogspot.in/2012/11/managerial-economics-production.html

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 CH A P TER

4 Cost and Revenue

Analysis

“The big hurdle is going out and raising the revenue ”

–Tyler Cowen

Learning Objectives

1  o identify the cost involved in the production of any commodity or service

T
and to present the ways in which it is utilized, combining with revenue in the
calculation of profit of the firm; and

2 To point out how revenue is realized at the sale of the goods and services
produced at the various types of market.

4.1 its supply behaviour in the market, it is

necessary to understand the cost and
Introduction
revenue concepts .

Cost and revenue analysis refers to

4.2
examining the cost of production and
sales revenue of a production unit or firm Cost Analysis
under various conditions. The objective of
a firm is to earn profit, and not to make Cost refers to the total expenses incurred
loss. However, a firm’s profit or loss is in the production of a commodity. Cost
primarily determined by its costs and analysis refers to the study of behaviour of
revenue. In simple terms, profit / loss is cost in relation to one or more production
defined as the difference between the total criteria, namely size of output, scale of
revenue and the total cost i.e., Profit (or) production, prices of factors and other
Loss = Total Revenue - Total Cost. As costs economic variables. The functional
and revenue are very important to decide relationship between cost and output is
the production behaviour of a firm and expressed as ‘Cost Function’.

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 A Cost Function may be written as
4.3.3 Explicit Cost
C = f (Q) (Paid out cost)
Eg. TC = Q3–18Q2 + 91Q + 12 Payment made to
where, C=Cost and Q=Quantity of output. others for the purchase
Cost functions are derived functions because of factors of production
they are derived from Production Functions. is known as Explicit
We shall discuss the basic cost concepts and costs. It refers to the
their behaviour below. actual expenditures of
the firm to purchase
or hire the inputs the firm needs. Explicit
4.3
cost includes, i) wages, ii) payment for
Cost Concepts raw material, iii) rent for the building, iv)
interest for capital invested, v) expenditure
on transport and advertisement vi) other
4.3.1 Money Cost expenses like license fee, depreciation and
Production cost expressed in money terms insurance charges, etc. It is also called
is called as money cost. In other words, it Accounting Cost or Out of Pocket Cost or
is the total money expenses incurred by a Money Cost.
firm in producing a commodity. Money
cost includes the expenditures such as cost
4.3.4 Implicit Cost
of raw materials, payment of wages and
salaries, payment of rent, interest on capital, Payment made to the use of resources
expenses on fuel and power, expenses on that the firm already owns, is known as
transportation and other types of production Implicit Cost. In simple terms, Implicit
related costs. These costs are considered as Cost refers to the imputed cost of a firm’s
out of pocket expenses. Money costs are self-owned and self-employed resources.
also called as Prime Cost or Direct Cost A firm or producer may use his own land,
or Nominal Cost or Accounting Cost or building, machinery, car and other factors
Explicit Cost or Out of Pocket Cost, suiting in the process of production. These costs
to context. are not recorded under normal accounting
practices as no cash payment takes place.
However, the value of the own services are
4.3.2 Real Cost imputed and considered for preparing the
Real cost refers to the payment made to profit and loss accounts. Implicit Cost is
compensate the efforts and sacrifices of all also called as Imputed Cost or Book Cost.
factor owners for their services in production.
It includes the efforts and sacrifices of 4.3.5 Economic Cost
landlords in the use of land, capitalists to save
It refers to all payments made to the resources
and invest, and workers in foregoing leisure.
owned and purchased or hired by the firm
Adam Smith regarded pains and sacrifices of
in order to ensure their regular supply to the
labour as real cost of production.
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 process of production. It is the summation because, they are unalterable, unrecoverable,
of explicit and implicit costs. Economic Cost and if once invested it should be treated as
is relevant to calculate the normal profit and drowned or disappeared. For example, if
thereby the economic profit of a firm. a firm purchases a specialized equipment
designed for a special plant, the expenditure
Economic Cost = Implicit Cost + on this equipment is a sunk cost, because it
Explicit Cost has no alternative use and its opportunity
Cost is zero. Sunk cost is also called as
‘Retrospective Cost’.
4.3.6 Social Cost
4.3.9 Floating Cost
It refers to the total cost borne by the society
due to the production of a commodity. It refers to all expenses that are directly
Alfred Marshall defined the term social associated with business activities but not
cost to represent the efforts and sacrifices with asset creation. It does not include the
undergone by the various members of the purchase of raw material as it is part of
society in producing a commodity. Social current assets. It includes payments like
Cost is the cost that is not borne by the wages to workers, transportation charges,
firm, but incurred by others in the society. fee for power and administration. Floating
For example, large business firms cause cost is necessary to run the day-to-day
air pollution, water pollution and other business of a firm.
damages in a particular area which involve
cost to the society. These costs are treated as 4.3.10 Prime Cost
social cost. It is also called as External Cost.
All costs that vary with output, together
with the cost of administration are known
4.3.7 Opportunity Cost as Prime Cost. In short, Prime cost =
It refers to the cost of next best alternative Variable costs + Costs of Administration.
use. In other words, it is the value of the
next best alternative foregone. For example, 4.3.11 Fixed Cost
a farmer can cultivate both paddy and
Fixed Cost does not change with the change
sugarcane in a farm land. If he cultivates
in the quantity of output. In other words,
paddy, the opportunity cost of paddy
expenses on fixed factors remain unchanged
output is the amount of sugarcane output
irrespective of the level of output, whether
given up. Opportunity Cost is also called
the output is increased or decreased or
as ‘Alternative Cost’ or ‘Transfer Cost’.
even it becomes zero. For example, rent of
the factory, watchman’s wages, permanent
4.3.8 Sunk Cost
worker’s salary, payments for minimum
A cost incurred in the past and cannot be equipments and machines insurance
recovered in future is called as Sunk Cost. premium, deposit for power, license fee, etc
This is historical but irrelevant for future fixed cost is also called as ‘Supplementary
business decisions. It is called as sunk Cost’ or ‘Overhead Cost’.

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 Y

Y 900

600

Cost
Cost
400
1000 TFC 300
200

0
0 Output X

Diagram 4.1
4.3.12 Variable Cost
These costs vary with the level of output. For instance if TC = Q3 –18Q2 + 91Q +12,
Examples of variable costs are: wages of the fixed cost here is 12. That means, if
temporary workers, cost of raw materials, Q isY zero, the Total cost will be 12, hence Y
fuel cost, electricity charges, etc. Variable fixed
10 cost.
cost is also called as Prime Cost, Special 8
It could be observed that TFC does not

Price
Cost, or Direct Cost. 6
change with output. Even when the output
Price

4
is zero, the fixed cost is ₹.1000. TFC is
2
4.4 a horizontal straight line, ARparallel to
0 0
X axis. 1 2 3 4 5 6 7 8 9 10 X Y
Short run Cost Curves -2

Revenue (TR)
-4
MR

-6
4.4.2 Total Variable Cost (TVC)
-8

Total
4.4.1 Total Fixed Cost (TFC) All payments Diagram
to the variable
4.13 factors of
production is called as Total Variable Cost.
Table 4.1 Total Fixed Cost Hypothetical TVC is shown in table-4.2 0
Output Total Fixed and Diagram 4.2
(in unit) Cost (in ₹)
0 1000
1 1000 Table 4.2 Total Variable Cost
2 1000 Output Total Variable Cost
3 1000 (in unit) (in ₹)
4 1000 0 0
5 1000 1 200
2 300
All payments for the fixed factors of 3 400
production are known as Total Fixed Cost. 4 600
A hypothetical TFC is shown in table 4.1 5 900
and diagram 4.1

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 Y
TC

TVC
Table
19004.3 Total Cost Curves
Y
Y
Output1600 Total Total Total Cost
900 (in unit)1400Fixed Variable (TC)

Cost
1300 Cost Cost TFC+TVC 10

Average fixed cost

1200 TVC
600
(TFC) (TVC) (in ₹)
1000 TFC
Cost

900 (in ₹) (in ₹)

400 0 600 1000 0 1000
TFC 50
300 1 400 1000 200 1200
200 33
2 300200
1000 300 1300 25
20
3 1000 400 1400
0 1 2 3 4 5 X 0 1 2 3 4 5 X
4 1000 600 1600
X Output
5 1000 Output
900 1900
Diagram 4.2 Diagram 4.3

Y
TC
In the diagram the TVC is zero when 1900
TVC Y
nothing
Y is produced. As output increases
1600
TVC
900 Yalso increases. TVC curve Y
C/R TC
Cost

1400
slopes upwarde>|1|from left to right. For 1300 1000

Average fixed cost

1200 J
instance in TC =e=1Q 3 – 18Q 2 + 91Q TVC
Total Revenue & Total Cost

75
TR
Price

600 1000 TFC

+12, variable cost, TVC = Q3 – 18Q2
Cost

900 45
e<|1| H
+40091Q B
TFC AR=D 600 500
R 300 0 M Q
0 MR 400 1 5 333
Profit

200 9 X
9 10 X X 300 N 250
Y 30
200 28 Total Production 200
4.4.3 Total Cost Curves 22
Revenue (TR)

0 1 2 X of all 3 4 5 012 1 2 3 4 5 0
X
Total Cost means the sum total 0 M X
payments madeOutput
in the production.
TR It is also -2 1 Output
5 9 X
Total

TP
called as Total Cost 4.2
Diagram of Production. Total Diagram 4.3
cost is the summation of Total Fixed Cost Diagram 4.15
0 X
Quantity(Q)
(TFC) and Total Variable Cost (TVC). It is It is to be noted that
written symbolically as 4.14
Diagram
a) The TC curve is obtained by adding
TC = TFC + TVC. For example, TFCC/Rand TVC curves vertically.
Y the total fixed cost is ₹ 1000 and
when Y TC

e>|1| b) TFC curve remains parallel to x axis,

the total variable cost is ₹ 200 then the J
Total Revenue & Total Cost

indicating
75
a straight line. TR
Total cost is = ₹e=1
1200 (₹ 1000 + ₹ 200).
Price

c) TVC
45 starts fromHthe origin and moves
If TFC = 12 ande<|1|
upwards,B as no variable cost is incurred
TVC = Q – 18Q 3 2 AR=D
+ 91Q
0
at0zero
1
M
output. 5 Q
MR
Profit

9 X
0 X X
Y TC = 12 + Q3 – 18Q2 + 91Q d) When TFC and TVC
Totalare added, TC
30
28
Production
N
22
Revenue (TR)

starts
12
from TFC and moves upwards.
0 M
TR -2 1 5 9 X
Total

Cost and Revenue Analysis 84 TP

Diagram 4.15
0 X
Quantity(Q)
Chapter-04.indd 84 06-02-2020 16:17:01
 e) TC curve lies above the TFC curve It is to be noted that
f) TVC and TC curves are the same a. AFC declines as output increases, as
shapes but beginning point is different. fixed cost remains constant
b. AFC curve is a downward sloping

4.4.4 Average Fixed Cost throughout its length, never touching

(AFC) X and Y axis. It is asymptotic to both
the axes.
It refers to the fixed cost per unit of output. It
c. The shape of the AFC curve is a
is obtained by dividing the total fixed cost by
rectangular hyperbola.
the quantity of output. AFC = TFC / Q where,
AFC denotes average fixed cost, TFC denotes
total fixed cost and Q denotes quantity of 4.4.5 Average Variable Cost
output. For example, if TFC is 1000 and the (AVC)
quantity of output is 10, the AFC is ₹ 100, Table 4.5 Average Variable Cost
obtained by dividing ₹ 1000 by 10. AFC is Q TVC AVC
shown in table 4.4 and diagram 4.4.

Table 4.4 Average Fixed Cost

(in
unit) UNIT-4(in ₹) TVC/Q
(in ₹)
0 0 0/0 = 0
Q TFC AFC 1 200 200/1 = 200
2 300 300/2 = 150
(in unit) (in ₹) TFC/Q
3 400 400/3 = 133
(in ₹) 4 600 600/4 = 150

UNIT-4
0 1000 1000/0 = ∞ 5 900 900/5 = 180
TC
1 1000 1000/1 = 1000
Y2 1000 1000/2 = 500
Y Y
3 1000 1000/3 = 333
4 1000 1000/4 = 250 1200
Average Variable Cost

1000
Average fixed cost

TVC 5 1000 1000/5 = 200 AVC

Average Cost
TFC TC 200
650
150
500 Y
Y Y
466
400
100 380
333
1200
Average Variable Cost

250
200 1000 AFC 50
Average fixed cost

TVC
AVC
Average Cost

TFC 0 1 2 3 4 5 X 200 0 1
X 0 A
Quantity produced 150
1 2 3 4 5 X
650
500 Quantity 466
400
380
333 Diagram 4.4 100 Diagram 4.5
250
200 AFC 50
0 1 2 3 4 5 0 1 2 3 4
3 4 5 X
X
It refers
0 to the total variable cost per unit
Quantity produced 1 2 3 4 5 X Outpu
ut of output. It Quantity
is obtained by dividing total
m 4.3 Diagram 4.4 variable cost (TVC) by the quantity of
Diagram 4.5 Diagram

Cost and Revenue Analysis 85

TC
Chapter-04.indd 85 06-02-2020 16:17:01
 output (Q). AVC = TVC / Q where, AVC
denotes
Y Average Variable cost, TVC Y Y
denotes total variable cost and Q denotes 1200
ATC
Average Variable Cost

quantity of output. For example, When the

TVC is ₹ 300 and the quantity AVCproduced is

Average Cost

Marginal Cost
200
2, the AVC is ₹ 150, (AVC = 300/2 = 150) A C
650
AVC150is shown in table 4.5 and Diagram 4.5. 466
300
400 B
If TVC
100
= Q3 – 18Q2 + 91Q 380 200
AFC AVC 50
= Q –18Q + 91 2
100
X It is to be noted that 0 1 2 3 4 5 X
0 0
1 2 3 4 5 X Output
a) AVC declines initially and then
Quantity
increases with the increase
Diagram 4.5 of output. Diagram 4.6
b) AVC declines up to a point and moves
upwards steeply, due to the law of 1600/4 = 400) If ATC is Q3 – 18Q2
returns. + 91Q +12, then AC = Q2 – 18Q +91
c) AVC curve is a U-shaped curve.
+ 12/Q
2. ByATC is derived by adding together
Average Fixed Cost (AFC) and
4.4.6 Average Total Cost (ATC)
Average Variable Cost (AVC) at
or Average Cost (AC)
each level of output. ATC = AFC
It refers to the total cost per unit of output. + AVC. For example, when Q= 2,
It can be obtained in two ways. TFC = 1000, TVC=300; AFC=500;
1. By dividing the firm’s total cost (TC) AVC=150;ATC=650. ATC or AC
by the quantity of output (Q). ATC = is shown in table 4.6 and Diagram
TC / Q. For example, if TC is ₹ 1600 4.6
and quantity of output is Q=4, the It should be noted that
Average Total Cost is ₹ 400. (ATC =

Table 4.6 Average Total Cost or Average Cost

Q TFC TVC TC ATC AFC AVC ATC
(in (in ₹) (in ₹) (in ₹) (TC/Q) (in ₹) (in ₹) (AFC
unit) TFC (in ₹) +AVC)
+TVC (in ₹)
0 1000 0 1000 1000 /0= ∞ 0 0 0+0=0
1 1000 200 1200 1200 /1= 1200 1000 200 1000+200 =1200
2 1000 300 1300 1300 /2= 650 500 150 500 + 150= 650
3 1000 400 1400 1400 /3= 466 333 133 333 + 133= 466
4 1000 600 1600 1600 /4= 400 250 150 250 + 150= 400
5 1000 900 1900 1900 /5= 380 200 180 200 + 180= 380

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 FINAL
a) ATC curve is also a ‘U’ shaped curve. by producing one extra unit of output.
b) Initially the ATC declines, reaches a Marginal cost is important for deciding
minimum when the plant is operated whether any additional output can be
optimally, and rises beyond the produced or not. MC = ∆TC / ∆Q where
optimum output. MC denotes Marginal Cost, ∆TC denotes
change in total cost and ∆Q denotes change
c) The ‘U’ shape of the AC reflects the
in total quantity. For example, a firm
law of the variable proportions.
produces 4 units of output and the Total
cost is ₹ 1600. When the firm produces
4.4.7 Marginal Cost (MC)
one more unit (4 +1 = 5 units) of output
at the total cost of ₹ 1900, the marginal
Table 4.7 Marginal Cost cost is ₹ 300.
Q TC MC MC = ₹ 1900 – ₹ 1600 = ₹ 300.
(in unit) (in ₹) (in ₹)
0 1000 -- The other method of estimating MC is :
1 1200 1200 - 1000 = 200 MCn=TCn –TCn-1
2 1300 1300 - 1200 = 100
where, ‘MC’ denotes Marginal Cost,
3 1400 1400 - 1300 = 100
‘TC n’ denotes Total cost of ‘n’th item,
4 1600 1600 - 1400 = 200
TCn-1 denotes Total Cost of ‘n-1’ th item.
5 1900 1900- 1600 = 300
For example,
when TC4 = ₹.1600, TC(4-1)=₹1400
It is the cost of the last single unit
and then MC= ₹200, (MC=1600-1400)
produced. It is defined as the change in
total costs resulting from producing one MC schedule is shown in Table 4.7
extra unit of output. In other words, it and MC Curve is shown in diagram 4.7.
is the addition made to the total cost It is to be noted that
a) MC falls at first due to more efficient
use of variable
Y factors.
Y Y
b) MC curve increases after the lowest
ATC 1200
point and it slopes upward.
MC
c) MC cure AC
900 is a U-shaped curve.
Average cost
Marginal Cost

C d) The slope of TC is MC. MC

Cost

300 If TC = Q650
3
–18Q2 + 91Q +12
450
200 MC = 3Q300
2
– 36Q +91
200
100
X
0 0 1 2 3 4 5 X
1 2 3 4 5 X
Quantity Output
Diagram 4.7 Diagram 4.8

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 LAC is given in diagram 4.9.
4.4.8 The relationship
Y
Y
Y
between Average Cost SAC1 SAC2
SAC3
1200
MC and Marginal cost
LAC
AC Cost
900
There is a unique relationship between

Average cost
Marginal Cost

MC Econom
the AC and MC curves as shown in
Cost
300 650
450
200 300
200
100
Min
Y 0 1 2 3 4 5 K x effic
0
1 2 3 4 5
X Y MES
Quantity
X Output Output SAC3
SAC1
Diagram 4.7 1200 Diagram 4.8 Diagram 4.9 SAC2
LAC
MC
AC C
900 Long run average cost (LAC) is equal

Average cost
MC to long run total costs divided by the level
Cost

650 of output.
450
300 LAC = LTC/Q
NAL 200 where, LAC denotes Long-Run Average Cost,
0 1 2 3 4 5 X
K
LTC denotes Long-run Total Cost andx
X Output Output
Q denotes the quantity of output.
Diagram 4.8 Diagram 4.9
The LAC curve is derived from short-
run average cost curves. It is the locus of points
diagram 4.8.
denoting the least cost curve of producing
1. When AC is falling, MC lies the corresponding output. The LAC curve is
below AC. called as ‘Plant Curve’ or ‘Boat shape Curve’ or
2. When AC becomes constant, MC ‘Planning Curve’ or ‘Envelop Curve’.
also becomes equal to it.
3. When AC starts increasing, MC lies A significant recent development in
above the AC. cost theory is that the long-run average
4. MC curve always cuts AC at its cost curve is L- shaped rather than
minimum point from below. U-shaped. The L-shape of the long-run
average cost curve implies that in the
4.5 beginning when output is expanded
through increase in plant size and
Y Long Run Cost Curve:
Y
SAC3
associated variable factors, cost per unit
SAC1
falls rapidly due to economies of scale.
SAC2
1200
LAC
MC
AC Cost Y
In the long run all factors of production
900
Average cost

MC
become variable. The existing size of the
Economies of scale
Cost

Total Revenue

650
450 30
firm can be increased in the case of long
300 Economies of scale
exhausted
25
20
200 15
run. There are neither fixed inputsK nor
AC (Q)
Minimum 10
x efficiency of scale 5
0 1 2 3 4 5 X
X fixed costs
Output in the long run. Output MES Q 0 1 2 3 4
Quantity
5 6

Diagram 4.8 Diagram 4.9

Diagram 4.10
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 4.6 Table 4.8
Total Revenue - Constant Price
Revenue Analysis
Quantity Price Total Revenue
sold (Q) (P) (TR)
The amount of money that a producer
1 5 5
receives in exchange for the sale of
2 5 10
goods is known as revenue. In short,
revenue means sales revenue. It is the 3 5 15
amount received by a firm from the sale 4 5 20
of a given quantity of a commodity at
5 5 25
the prevailing price in the market. For
example, if a firm sells 10 books at the 6 5 30
price of ₹100 each, the total revenue will
be ₹1000.
TR=P × Q
4.6.1 Revenue Concepts

The three basic revenue concepts are: Total where,

Revenue, Average Revenue and Marginal TR denotes Total Revenue,
Revenue. P denotes Price and
a) Total Revenue: Q denotes Quantity sold.
Total revenue is the amount of income For example, a cell-phone company sold 100
received by the firm from the sale of its cell-phones at the price of ₹ 500 each. TR is
products. It is obtained by multiplying the ₹ 50,000. (TR= 500 × 100 = 50,000).
price of the commodity by the number of
When price is constant, the behaviour of
units sold.
TR is shown in table 4.8 and diagram 4.10,
assuming P=5. When P = 5; TR = PQ

When price is declining with increase

Y
in quantity sold. (Eg. Imperfect
TR Competition on the goods market) the
Total Revenue

30 behaviour
30 of TR is shown in table 4.9 and
Total Revenue

28
le 25 24
20 diagram
18 4.11. TR can be obtained from
AC (Q) 15 10
10 Demand fuction: If Q = 11–P, TR
5 0 1 2 3 4 5 6 7 8 9 10 X
Q 0 1 2 3 4 5 6 x Output
Quantity
Diagram 4.10 When P = 1, Q = 10Diagram 4.11

Cost and Revenue Analysis 89

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 Table 4.9 Revenue is ₹6. (AR= 30/5 =6) It is to be
Total Revenue - Price declining noted that AR is equal to Price.
Quantity Price Total Revenue AR=TR/Q = PQ/Q=P
sold (Q) (P) (TR)
1 10 10 c) Marginal Revenue
2 9 18 Marginal revenue (MR) is the addition to
3 8 24 the total revenue by the sale of an additional
4 7 28 unit of a commodity. MR can be found out
5 6 30 by dividing change in total revenue by the
6 5 30 change in quantity sold out. MR = ∆TR /
∆Q where MR denotes Marginal Revenue,
7 4 28
∆TR denotes change in Total Revenue and
8 3 24
∆Q denotes change in total quantity.
9 2 18
10 1 10 The other method of estimating
MR is:
TR Y MR=TRn –TRn-1 (or) TRn+1 – TRn
30 where, MR Y denotes Marginal Revenue,
Total Revenue

28
24
18
TRn denotes total revenue of nth item, TRn-1
AR /MR
denotes Total Revenue of n-1th item and
Price

10 5
TR
TRn+1 denotes Total Revenue of n+1thitem.
0 1 2 3 4 5 6 7 8 9 10 X

x Output
If TR0= PQ
1 2MR3 = ∆TR/∆Q
4 5 6 = P,
X
Output
Diagram 4.11 which is equal to AR.
Diagram 4.12

TR = PQ = 1 × 10 = 10 4.6.2 Relationship between
When P = 3, Q = 8, TR = 24 AR and MR Curves

When P = 10, Q = 1, TR = 10 If a firm is able to sell additional units at the

same price then AR and MR will be constant
b) Average Revenue
and equal. If the firm is able to sell additional
Average revenue is the revenue per unit units only by reducing the price, then both
of the commodity sold. It is calculated by AR and MR will fall and be different .
dividing the Total Revenue(TR) by the
number of units sold (Q) Constant AR and MR
AR = TR /Q; if TR = PQ, AR = PQ/Q = P (at Fixed Price)
AR denotes Average Revenue, TR denotes When price remains constant or
Total Revenue and Q denotes Quantity of fixed, the MR will be also constant and will
unit sold. coincide with AR. Under perfect competition
For example, if the Total Revenue as the price is uniform and fixed, AR is equal
from the sale of 5 units is ₹30, the Average to MR and their shape will be a straight

Cost and Revenue Analysis 90

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 Diagram 4.1

line horizontal to X axis. The AR and MR Y Y

Schedule under constant price is given in 10
Table 4.10 and in the diagram 4.12 8

Price
6
Table 4.10

Price
4
TR, AR, MR - Constant price
2
Quantity Price Total Average Marginal AR
0
Sold (P) Revenue Revenue Revenue 1 2 3 4 5 6 7 8 9 10 X Y
-2
(Q) (TR) (AR) (MR)

Revenue (TR)
-4

MR
₹ ₹ ₹ ₹
-6
1 5 5 5 5 -8

Total
2 5 10 5 5 Diagram 4.13
3 5 15 5 5
4 5 20 5 5
5 5 25 5 5 Table 4.11
6 5 30 5 5 AR, TR, MR at declining price
Price (P)/
Quantity Total Marginal
Y Average
Sold Revenue Revenue
Revenue
AR /MR (TR) (MR)
(Q) (AR)
Price

5 ₹ ₹
TR ₹
9 10 X
1 10 10 -
0 1 2 3 4 5 6 X
Output 2 9 18 8
Diagram 4.12 3 8 24 6
4 7 28 4
Declining AR and MR (at 5 6 30 2
Declining Price) 6 5 30 0
When a firm sells large quantities at lower 7 4 28 -2
prices both AR and MR will fall but the 8 3 24 -4
fall in MR will be more steeper than the 9 2 18 -6
fall in the AR. 10 1 10 -8

It is to be noted that MR will be

lower than AR. Both AR and MR will be
4.6.3 Relationship among TR,
sloping downwards straight from left to
AR and MR Curves:
right. The MR curve divides the distance
between AR Curve and Y axis into two When marginal revenue is positive,
equal parts. The decline in AR need not total revenue rises, when MR is zero the
be a straight line or linear. If the prices total revenue becomes maximum. When
are declining with the increase in quantity marginal revenue becomes negative total
sold, the AR can be non-linear, taking a revenue starts falling. When AR and MR
shape of concave or convex to the origin both are falling, then MR falls at a faster
rate than AR.

Cost and Revenue Analysis 91

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 Diagram 4.1 Diagram 4.2

Y
4.6.4 
TR, AR, MR and Y Y
10 Elasticity of Demand e>|1|

Total Revenue & Total Cost

8 75

Price
The6 relationship among AR, MR and e=1
45
elasticity of demand (e) is stated as follows. e<|1|
Price

4
2 e = AR/AR – MRAR AR=D 0
0 0 MR

Profit
The relationship
1 2 3 4 between
5 6 7 the
8 9 AR10 curve
X Y
X 30
-2 28
and MR curve depends upon the elasticity 22

Revenue (TR)
-4
MR

of AR
-6
curve (AR = DD = Price). 12
0
When price elasticity of demand is
a. -8 TR -2

Total
Diagram
greater than one, MR4.13 is positive and
TR is increasing.
0 X
b. When price elasticity of demand is less Quantity(Q)
than one, MR is negative and TR is Diagram 4.14
decreasing.
c. When price elasticity of demand is
equal to one, MR is equal to zero and At the output range of
TR is maximum and constant. 5 to 6 units, the price
It is to be noted that, the output range of 1 elasticity of demand is
to 5 units, the price elasticity of demand is equal to one. Hence, TR
greater than one according to total outlay is maximum and MR
method. Hence, TR is increasing and MR equals to zero.
is positive. At the output range of 6 units to 10
units, the price elasticity of demand is less
Table 4.12 TR, AR, MR & Elasticity than unity. Hence, TR is decreasing and
MR is negative.
Quan- Price TR AR MR Elasticity
tity (Q) (P)
1 10 10 10 10 4.7
2 9 18 9 8 Conclusion
3 8 24 8 6 e>1
4 7 28 7 4 This Chapter has analysed the behaviour of
5 6 30 6 2 Cost Curves and revenue curves under two
6 5 30 5 0 e=1 situations and the relationship among price
7 4 28 4 -2 elasticity of demand , TR, AR and MR.
8 3 24 3 -4
9 2 18 2 -6 e<1
10 1 10 1 -8
11 0 0 0 -10

Cost and Revenue Analysis 92

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 GLOSSARY Marginal The additional cost
Cost incurred for producing
Cost It refers to expenses one more unit of
incurred on production output.

Revenue It refers to sales revenue Average Cost per unit of output

Cost produced. It is obtained
Explicit Cost It refers to out of pocket by dividing total cost by
expenses or money cost output.
or accounting costs. They
are the payments made to Average Variable Cost per unit
others. Variable of output, obtained by
Cost dividing total variable
Implicit The cost imputed for the cost by output.
Cost resources provided by the Average Fixed cost per unit of
owner. Fixed Cost output, obtained by
dividing total fixed cost
Fixed Costs The costs that remain by output.
constant at all levels of
Average Average revenue refers
output. They do not vary
Revenue to revenue per unit of
with output.
output sold. It is obtained
Variable The cost that varies with by dividing the total
Cost the level of output. revenue by quantity sold.
Marginal The additional revenue
Total Cost The sum of total fixed Revenue obtained by selling one
cost and total variable more unit of output.
costs.

Cost and Revenue Analysis 93

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 ICT CORNER
Cost and Revenue Analysis ANALYSIS: REVENUE ANALYSIS

This activity for Revenue

Analysis helps in analysis of
Total Revenue Under different
conditions.

Steps:
• Open the Browser type the URL given (or) Scan the QR Code.
• GeoGebra Work book called “XI STD ECONOMICS” will appear.
Open the worksheet named “Revenue Analysis”
• In the Right side of the work sheet two data are given. 1.Total Revenue
for the quantity when Price is constant and 2. Total Revenue for
the quantity when Price is reduced when the quantity is increased.
Analyse the graph drawn on the Left side for constant price. It is a
straight-line graph.
• Now click on the check box , “Show Total Revenue when price is
declining with increase in quantity”. You can see a curve graph.
Now analyse the data values and Graph in each Data and compare
what is given in the text book lesson. You can get similar data from
internet and type in the columns and see the change in graph.

Step1 Step2 Step3 Step4

Pictures are indicatives only*

URL:
https://ggbm.at/ddY3wkjp
(or) scan the QR Code

Cost and Revenue Analysis 94

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 MODEL QUESTIONS

Part-A Multiple Choice 6. The costs of self–owned resources are

Questions termed as ________ cost.

1. Cost refers to ________ a. real

a. price b. explicit
b. value c. money
c. fixed cost d. implicit
d. cost of production 7. The cost that remains constant at all
2. Cost functions are also known as levels of output is _______ cost.
_______________ function. a. fixed
a. production
b. variable
b. investment
c. real
c. demand
d. social
d. consumption
8. Identify the formula of estimating
3. Money cost is also known as average variable cost.
____________ cost.
a. TC/Q
a. explicit
b. TVC/Q
b. implicit
c. TFC/Q
c. social
d. real d. TAC/Q
9. The cost incurred by producing one
4. Explicit cost plus implicit cost denote
more unit of output is______cost.
___________ cost.
a. variable
a. social
b. economic b. fixed

c. money c. marginal
d. fixed d. total

5. Explicit costs are termed as 10. The cost that varies with the level of
output is termed as _______ cost.
a. out of pocket expenses
a. money
b. real cost
b. variable cost
c. social cost
c. total cost
d. sunk cost
d. fixed cost
Cost and Revenue Analysis 95

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 11. Wage is an example for ________ 16. Revenue received from the sale of
cost of the production. products is known as _______ revenue.
a. fixed a. profit
b. variable b. total revenue
c. marginal c. average
d. opportunity d. marginal

12. The cost per unit of output is denoted 17. Revenue received from the sale of
by _________ cost. additional unit is termed as ________
a. average revenue.

b. marginal a. profit

c. variable b. average

d. total c. marginal
d. total
13. Identify the formula of estimating
average cost. 18. Marginal revenue is the addition made
a. AVC/Q to the

b. TC/Q a. total sales

c. TVC/Q b. total revenue

d. AFC/Q c. total production

d. total cost
14. Find total cost where TFC=I00 and
TVC = 125. 19. When price remains constant, AR will
a. 125 be ________ MR.

b. 175 a. equal to

c. 225 b. greater than

d. 325 c. less than

d. not related to
15. Long-run average cost curve is also
called as __________ curve. 20. A book seller sold 40 books with the
a. demand price of ₹10 each. The total revenue of
the seller is ₹___________.
b. planning
a. 100
c. production
b. 200
d. sales
c. 300
d. 400

Cost and Revenue Analysis 96

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 Part- A Answers

1 2 3 4 5 6 7 8 9 10
d a a b a d a b c b
11 12 13 14 15 16 17 18 19 20
b a b c b b c b a d

Part-B 
Answer the following questions in one or
two sentences.

21. Define cost. 25. Explicit Cost - Define.

22. Define cost function. 26. Give the definition for ‘Real Cost’.

23. What do you mean by fixed cost? 27. What is meant by Sunk cost?

24. Define Revenue.

Part C Answer the following questions in one paragraph.

28. Distinguish between fixed cost and 32. State the relationship between AC and
variable cost. MC.

29. State the differences between money 33. Write a short note on Marginal
cost and real cost. Revenue.

30. Distinguish between explicit cost and 34. Discuss the Long run cost curves with
implicit cost. suitable diagram.

31. Define opportunity cost and provide

an example.

Part-D Answer the following questions in about a page

35. If total cost = 10+Q3, find out AC, 37. Bring out the relationship between AR
AVC, TFC, AFC when Q=5. and MR curves under various price
conditions.
36. Discuss the short run cost curves with
suitable diagram.

Cost and Revenue Analysis 97

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 ACTIVITY
Visit a small business firm and identify the various items of
expenditure incurred by the firm. Classify the items under fixed
cost and variable cost. Estimate Total Fixed Cost, Total Variable
Cost, Total Cost and Average Fixed Cost, Average Variable Cost
and Average Total Cost.

References

1. Principles of Microeconomics, 7th Edition (Mankiw’s Principles of Economics)

by N. Gregory Mankiw
2. Microeconomics: Principles, Problems, & Policies (McGraw-Hill Series in
Economics) by Campbell McConell, Stanley Brue, and Sean Flynn
3. M.L.Seth – Micro Economics (2012) - Lakshmi Narain Agarwal Publication
4. M.L. Jhingan – Modern Micro Economics (Fourth Edition) (2012) - Virnda
Publication Pvt Ltd
5. Ryan C. Amacher – Principles of Micro Economics (1980) - South-Western Pub.Co
http://wikieducator.org/Introduction_to_Cost_Concepts

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 CH A P TER

5 MARKET STRUCTURE
AND PRICING

“Marketing is not the art of finding clever ways to dispose of

what you make. It is the art of creating genuine customer value”.
Oligopoly Mark
– Philip Kotler

Learning Objectives

1 To understand the characteristics of markets and how the price and output are
determined under the several types of markets; and,

2 To study the nature of the profit obtained by a firm under different types of
markets

5.1
Introduction

Every commodity or service that is

exchanged has two sides: the supply side
and the demand side. The supply side
contains information on the number Market
of sellers, the nature and the quantum
of the product produced and brought
to the market for sale. The demand
side contains information on the 5.2
number of buyers entering the market Meaning of Market
for buying the product. Hence the Perfect Competition Oligopoly Mar
-Independent suppliers
study of market and market structure -On line ticket auctions control supply and
In thefarming
-Truck ordinary sense, the word ‘market’demand for the products
forms an important feature of micro -Examples include airlines,
refers to a physical place, where commodities
-Salt automotive and banking
economics. -Gravel
companies
and services are bought and sold.
-Garage Sales
-On line sales in general
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 In Economics, the term ‘market’ iv. International market arises when
refers to a system of exchange between products and services are sold and
the buyers and the sellers of a commodity. bought at the world level. For example,
Besides direct exchanges, there are petrol, gold etc.
exchanges that are carried out through
correspondence, telephones, online, 5.3.2 On the basis of Time:
email etc. A market has the following Alfred Marshall classifies market on the
characteristic features: basis of time. The ‘time’ here refers to the
1. Buyers and sellers of a commodity or nature of the factors, such as fixed factors
a service and variable factors, used in the production
2. A commodity to be bought and sold process, and how the supply of the products
meets with varying demand situations in
3. Price agreeable to buyer and seller
the determination of price of the products.
4. Direct or indirect exchange.
i. Very short period market or Market
Period
5.3
It occurs when with the available time,
Classification of Markets the quantum supplied of a product
cannot be increased (or decreased).
Market is of various kinds. They are Here, the supply curve is vertical; it is
classified: inelastic. In this market, the demand
force is more active than the supply
5.3.1 On the basis of Area: force in the determination of the price.
For example, given an inelastic supply
The market is classified not only on its
for food, an increase in its demand, as
geographical spread, but also on the nature
for example, during a flood situation,
of the goods exchanged.
raises the price of food.
i. Local market arises when products or
ii. Short period market
services are sold and bought in the place
of their production. In such markets, the It occurs when the quantum supplied of a
products exchanged are mostly perishable product can be increased (or decreased)
and semi-durable in nature: For example, to some extent. Here, the supply curve is
Vegetable, fruits etc. a little more elastic. In this period, some
factors continue to be fixed and they
ii. Provincial market arises when
work a little more intensively to meet an
products or services are sold and
increased demand.
bought in a restricted circle. For
example, provincial newspaper. iii. Long period market

iii. National market arises when products and It occurs when the quantum supplied
services are sold and bought throughout of a product can be increased (or
a country. For example, Nation-wide decreased) to a larger extent. Here
market for tea, coffee, cement, electrical the supply curve is very much elastic.
goods, some printed books etc. Thus, to meet an increase in demand,

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 the quantum of all the factors Firm and Industry
becomes variable. There are no
Firm: A firm refers to a single production
fixed factors here. Therefore, there
unit in an industry, producing a large or a
is a possibility for larger changes
small quantum of a commodity or service,
in supply. The price of the product
and selling it at a price in the market. Its
cannot be as high as in the case of
main objective is to earn a profit. There
short run.
may be other objectives as described by
iv. Very long period market (or a managerial and behavioral theories of the
Secular Period Market) firm.
It occurs when the entire economy Industry: An industry refers to a group
undergoes a drastic change. Newer of firms producing the same product or
technologies are introduced and service in an economy. For example, a
most modern products are produced. group of firms producing cement is called
Several newer methods of production a cement industry.
are adopted in the production
process, with improvements taking
place in technology. For example, 5.4
the entry of pen-drive has driven Equilibrium Conditions for
out compact disc (CD); as CD a Firm
has replaced floppies which once
replaced tape cassettes. Equilibrium of the firm means that the
firm reaches the maximum profit. Now,
5.3.3 
On the Basis of Quantity there are two approaches (TC = TR) for
of the Commodity calculating the maximum profits
i. Whole-sale market is for bulk selling i. Total curve approach; and, ii.
and buying of goods (Clothing, Marginal curve approach (MC = MR)
Grocery etc.). The price is likely to
be low compared to retail market. Y
5.4.1 Total curve approach
ii. Retail market is for selling or buying
of commodities in small quantities A
(Clothing, Vegetable etc). Y TC
10
9
TC/ TR & Profit

8
AR, MR & MC

E Q
5.3.4 On the Basis of 75
TR 7
Competition 45
N
i. Perfect competition market P
ii. Imperfect competition market which
0 1 2 3 4 5 6 7 8 9
comprises monopoly market, X
Output o 1
monopolistic competition market,
duopoly market, oligopoly market etc. Diagram 5.1

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 In the TC-TR Approach, profit is obtained
by a firm, through the difference between
the TC and the TR. Equilibrium is obtained
advantageous for the producer to
continue his production.
F
Again, he will not be in equilibrium
at the point where maximum difference beyond 5 units of Q, when his MC >
between the TC and TR occurs. This TC- MR, implying that the seller incurs loss.
TR method is not generally adopted in the
Therefore, he is said to be in equilibrium,
calculation of maximum profit. Hence to
i.e., at the point of maximum profit
calculate profit / loss, economists resort to
when his MC is equal to MR. Hence,
the MC=MR approach. Shaded area denotes
MC = MR is the first condition for the
profit. Profit is maximum when Q = 5
equilibrium. (Note: This is a necessary
condition but not a sufficient condition).
5.4.2 Marginal curve 2. MC cuts MR curve from below
Approach (Sufficient conditions)
In this approach, the following two A firm under perfect competition faces
conditions are to be verified to obtain a horizontal price line. (It is also the AR
equilibrium of a firm. curve and the MR curve). A firm under
imperfect competition focuses declining
price line. The MC is U-shaped and it
Y
cuts MR at two points, both from above
MC
(i.e., at point A) and also from below (i.e.,
A B at point B), as shown in the diagram.
TC
10 Industry Firm 1
9 AR = MR Only at point B, the equilibrium
Price/ Revenue/cost

Price/ Revenue/cost
Price/Revenue/cost
8 is S fulfilled. Y Thus for
AR, MR & MC

Q condition
D MC Y
7 AC
TR equilibrium E under all market
E 1 12
10 L 10 Profit L 10 Loss
situations the two conditions 8 viz., MC
B
= MR; and
S MCDcuts MR from below.
o 50 o 50 o
8 9 X Output
Market Structure Output
o 1 2 3 4 5 Normal profit Abnormal=2 x 50=100 Los
Q X
Output
Diagram 5.2 Market Diagram 5.3

Perfect competion Imperfect competion

1. MC = MR
Look at the following hypothetical Monopoly
situation. A rational seller will not Monopolistic
be in equilibrium at output level Competionion
1, though MC=MR at that point, Oligopoly
since continuing production, his Bilateral
profit increases. When he produces Monopoly
Duopoly
an output beyond 1 unit till he
reaches 5 units, his MC < MR. It is
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 Market
5.5 The term, ‘large number of sellers’ implies
Perfect Competition: that share of each individual seller is a very,
very small quantum of a product. This
means that he has no power to fix the price
Perfect Competition Oligopoly
of the product. Market
Like the buyer,System
the seller also
-Independent suppliers
-On line ticket auctions only a price-taker
control supply and and not a price-maker.
demand for the products
-Truck farming
b. Homogeneous Product and Uniform Price
-Examples include airlines,
-Salt automotive and banking
companies
-Gravel The product sold and bought is
-Garage Sales homogeneous in nature, in the sense
-On line sales in general that the units of the product are perfectly
substitutable. All the units of the product
are identical (ie) of the same size, shape,
colour, quality etc. Therefore, a uniform
price prevails in the market.
It is an ideal but imaginary market. 100%
perfect competition cannot be seen. Perfect c. Free Entry and Exit
Monopolistic Competition- Examples
Competition market is that type of market In the short run, it is possible for the
in which the number of buyers and sellers very efficient producer, producing the
Toothpaste

Toothpaste

Toothpaste

is very large, all are engaged in buying and product at a very low cost, to earn super
selling a homogenous product at uniform normal profits. Attracted by such a
price without any artificial restrictions profit, new firms enter into the industry.
and possessing perfect knowledge of the When large number of firms enter, the
market at a time. supply (in comparison to demand)
According to Joan Robinson, would increase, resulting in lower price.
“Perfect competition prevails when the An inefficient producer, who is unable
demand for the output of each producer is to bring down the cost incurs loss.
perfectly elastic”. Disturbed by the loss, the existing
loss-incurring firms quit the market. If
5.5.1 Features of the Perfect it happens, supply will then decrease,
Competition: price will go up. Existing firms could
earn more profit.
a. Large Number of Buyers and Sellers
d. Absence of Transport Cost
‘A large number of buyers’ implies
that each individual buyer buys a very, The prevalence of the uniform price is also
very small quantum of a product as due to the absence of the transport cost.
compared to that found in the market. e. Perfect Mobility of Factors of Production
This means that he (he includes she
The prevalence of the uniform price is also
also) has no power to fix the price of
due to the perfect mobility of the factors of
the product. He is only a price-taker
production. As they enjoy perfect freedom
and not a price-maker.
to move from one place to another and

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 FINAL
from one occupation to another, the price 100 = 10P; 100/10 = P Qd = demand
gets adjusted. P = 10 P = Price
f. Perfect Knowledge of the Market Qd = 100-5(10) Qs = Supply
All buyers and sellers have a thorough 100-50 = 50
knowledge of the quality of the
Qs = 5(10)=50
product, prevailing price etc.
Therefore 50 = 50
g. No Government Intervention
There is no government regulation
on supply of raw materials, and in the This diagram consists of three panels. The
determination of price etc. equilibrium of an industry is explained
in the first panel. The demand and sup-
5.5.2 Perfect Competition: ply forces of all the firms interact and the
Firm’s Equilibrium in price is fixed as ₹10. The equilibrium of an

unit 5
the Short Run industry is obtained at 50 units of output.

In the short run, at least a few factors In the second part of the diagram,
of production are fixed. The firms under AC curve is lower than the price line. The
Perfect Competition take the price equilibrium condition is achieved where
(10) from the industry and start MC=MR. Its equilibrium quantity sold
adjusting their quantities produced. For is 50. With the prevailing price, ₹10 it
example Qd= 100 – 5P and Qs=5P. experiences super normal profit. AC = ₹8,
At equilibrium Qd=Qs. Therefore 100-5P=5P AR = ₹10.

Price & Output Determination-Perfect Competition during

MC
Short Run Y

Price/ AR/ MR/AC/MC

Industry Firm 1 Firm 2
AR = MR
Price/ Revenue/cost

Y
Price/ Revenue/cost
Price/Revenue/cost

D S Y Y MC
MC
AC AC
E E1 12 R
10 L 10 Profit L 10 Loss
L (AR=MR) 8
8
B E2
S D
o 50 o 50 o 50 x
Output Output Output o
Normal profit Abnormal=2 x 50=100 Loss=2 x 50=100
Q X Qu
Diagram 5.3 Dia

SS – m
 arket supply DD – market demand
AR – A verage Revenue AC – A
 verage Cost
MR – M  arginal Revenue MC – M arginal Cost

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 Y
Its total revenue is 50X10=500. Its Y LMC
total cost is 50X8=400. Therefore, its total

Price/ AR/ MR/AC/MC

profit 23
Firm 1 is 500-400=100. Firm 2 LAC

Price/ Revenue/cost
Price/Revenue/cost

MCIn the third

Y part of the
S Y MC diagram,
AC AC 14
E

Price
firm’s
E1 cost curve 12is aboveR the price line. 12.6
10 Profit L Loss
10condition 8 L (AR=MR)
8 The equilibrium Lis(AR=MR)
achieved
B E 2
D
at point where MR=MC. Its quantity
o sold
50 is 50. With the o prevailing
50 price, it
x
experiences
Output loss. (AC>AR) Output o 500 x 0
ofit Abnormal=2Its
x 50=100 Loss=2 x 50=100
total revenue is 50X10=500. Its Quantity
total 5.3
Diagram cost is 50X12=600. Therefore, its Diagram 5.4
total loss is 600-500=100.
As profit prevails in the market, also known as planning curve. First, the
new firms will enter the industry, thus firms will earn only normal profit.
increasing the supply of the product. This
Secondly, all the firms in the market
means a decline in the price of the product
are in equilibrium. This means that there
and increase the cost of production. Thus,
should neither be a tendency for the new
the abnormal profit will be wiped out;
firms to enter into the industry nor for any of
loss will be incurred.
the existing firms to exit from the industry.
When loss prevails in the market,
the existing loss making firms will exit the
industry, thus decreasing the supply of the
product. This means a rise in the price of
the product and reduction in the cost of
production. So the loss will vanish; Profit
will emerge. Consequent upon the entry
and exit of new firms into the industry,
firms always earn ‘normal profit’ in the
long run as shown in diagram.

5.5.3 Perfect Competition:
Firm’s Equilibrium in
the Long Run (Normal Long run supply curve is explained
Profit) to determine the long run price after an
increase in demand. The effect of the
In the long run, all the factors are increase in demand in the short run is
variable. explained by the movement from point ‘a’
The LAC curve is an envelope to point ‘b’. The price increases from ₹8 to
curve as it contains a few average cost ₹13, and the quantity increases from 600
curves. It is a flatter U shaped one. It is to 800 units. Economic profit of a firm is

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 positive. Therefore, new firms enter the 5.6
market. In the long run new firms entry
Imperfect Competition
will continue until the price drops to ₹11
and the quantity is 1,200 units. The new
long run equilibrium is shown by point ‘c’,
where the new demand curve intersects
supply curve. At this price level (₹11) and
quantity (1,200 units). Due to diminishing
returns, it is very difficult to increase Joan Robinson
output in the short tun, as a result the price 1903-1983
will increase to cover these higher cost of
production. New firms will enter into the
market. The price gradually drops to the
etition point (₹11) at whichMarket
Oligopoly each firm
Systemmakes zero
-Independent suppliers
tions economic profit.
control supply and
demand for the products
-Examples include airlines,
A firm under perfect competition
automotive and banking
companies Edward Chamberlin
even in the long run is a price – taker, 1899 -1967
eneral not a price – maker. It takes the price of
the product from the industry. And it
superimposes its cost curves on the revenue
curves.

ompetition- Examples Long run equilibrium of the firm is The concept of imperfect competition
illustrated in the diagram. Under perfect was propounded in 1933 in England by
Toothpaste

Toothpaste

Toothpaste

competition, long run equilibrium is only Joan Robinson and in America by E.H.
at minimum point of LAC. At point E, Chamberlin.
LMC = MR = AR = LAC.
It is an important market category
In the above diagram (5.4), average where the individual firms exercise their
cost is equal to average revenue. The control over the price.
Indian Railways
equilibrium of the firm finally rests at
Definition: Imperfect competition is a
point E where price is 8 and output is 500.
competitive market situation where there
(Numbers are hypothetical) At this point,
are many sellers, but they are selling
the profit of the firm is only normal. Thus
heterogeneous (dissimilar) goods as
condition for long run equilibrium of the
opposed to the perfect competitive market
firm is:
scenario. As the name suggests, competitive
Price = AR=MR = Minimum AC markets are imperfect in nature.
At the equilibrium point, the SAC>LAC. Description: Imperfect competition is the
Hence, long run equilibrium price is lower real world competition. Today some of
than short run equilibrium price; long run the industries and sellers follow it to earn
equilibrium quantity is larger than short surplus profits. In this market scenario,
run equilibrium quantity.

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 the seller enjoys the luxury of influencing form of market where there is a single seller
Joan Robinson
the price in order to earn more profits.
1903-1983
selling a particular commodity for which
there are no close substitutes.
If a seller is selling a non-identical good in the
market, then he can raise the prices and earn
profits. High profits attract other sellers to
Oligopoly Market System
5.7.1 Features of Monopoly
pendent suppliers
enter the market and sellers, who are incurring
1. There is a single producer / seller of
ol supply and
nd for the products
mples include airlines,
losses, can very easily exit the market.
Edward Chamberlin
motive and banking
anies a product;
1899 -1967
2. The product of a monopolist is
5.7 unique and has no close substitute;
Monopoly 3. There is strict barrier for entry of
any new firm;
4. The monopolist is a price-maker;
5. The monopolist earns maximum
profit/ abnormal profit.

Indian Railways 5.7.2 Sources of Monopoly

Power
1. Natural Monopoly:
Ownership of the natural raw
materials [Eg.Gold mines (Africa),
Meaning: Coal mines, Nickel (Canada) etc.]

The word monopoly has been derived 2. State Monopoly:

from the combination of two Greek words Single supplier of some special
i.e., ‘Mono’ and ‘Poly’. Mono refers to a services (Eg.Railways in India)
single and “poly” to seller. 3. Legal Monopoly:
In this way, monopoly refers to A monopoly firm can get its monopoly
a market situation in which there is power by getting patent rights, trade
only one seller of a commodity. Hence, mark from the government.
there is no scope for competition. (Still
some economists observe that there 5.7.3 Price & Output
will always be potential threat to the Determination Under
monopolists). Monopoly
A monopoly is a one firm-industry.
Definition
Therefore, a firm under monopoly faces a
Monopoly is a market structure downward sloping demand curve (or AR
characterized by a single seller, selling the curve). Since, under monopoly AR falls,
unique product with the restriction for a
new firm to enter the market. Monopoly is a
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 5.7.4 Price
Y
Discrimination
Y SMC
under monopoly Y
MC
AC A discriminating monopoly is a single
Q SAC

AR, AC, MR & MC

Q P
23 entity that charges different prices for

AR, AC, MR & MC

C PROFIT R
differentS consumers. Higher price will be
14 charged for price inelasticE consumers and
Price

12.6 D/AR
R=MR) T vice versa D/AR

MR Types of Price Discrimination

MR

x
There are three types of price discrimination.
0 3 x 0 M
Quantity (i) Personal – Quantity
Different prices xare
Diagram 5.6 charged for different individuals (for
Diagram 5.7
example, the railways give tickets
at concessional rate to the ‘senior
as more units of output are sold, the MR citizens’ for the same journey).
lies below the AR curve (MR<AR).
(ii) Geographical - Different prices are
The monopolist will continue to charged at different places for the
sell his product as long as his MR>MC. same product (for example, a book
He attains equilibrium at the sold within India at a price is sold in
level of output when its MC is equal to a foreign country at lower price). On
MR. Beyond this point, the producer their basis, China drops its goods in
will experience loss and hence will stop selling. Indian market. As a result, watch and
toys industries closed down their
From this diagram, till he sells
business.
3 units output, MR is equal to MC. The
(iii) On the basis of Use - Different prices
monopoly firm will be in equilibrium at
the level of output where MR is equal to are charged according to the use
MC. The price is 23. of a product (for example, lower
rates are charged by Tamil Nadu
To checkup how much profit the Electricity Board for domestic
monopolist is making at the equilibrium uses of electricity and higher rates
output, the average revenue curves and the are charged for commercial and
average cost curves are used. At equilibrium industrial uses).
level of output, (3) is the average revenue is
23 and the average cost is 12.67, therefore
(23-12.67 = 10.33) is the profit per unit. 5.7.5 Degrees of Price
Total profit = (Average Revenue – Average Discrimination
Cost) X Total output Price discrimination has become
= (23 – 12.67) × 3 widespread in almost all monopoly
markets. According to A.C.Pigou, there
= 10.33 × 3 = 30.99 are three degrees of price discrimination.

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 (i) First degree price discrimination
5.7.6 Dumping
A monopolist charges the maximum
price that a buyer is willing to Dumping refers to practice of the
pay. This is called as perfect price monopolist charging higher price for his
discrimination. This price wipes out product in the local market and lower
the entire consumer’s surplus. This is price in the foreign market. Through
maximum exploitation of consumers. dumping, a country expands its command
Joan Robinson named it as “Perfect over other countries for its product.
Discriminating Monopoly” This is also called as ‘International Price
Discrimination”.
(ii) Second degree price discrimination
For example, India’s electronic market
Under this degree, buyers are charged
is flooded with the China’s products.
prices in such a way that a part of
their consumer’s surplus is taken
away by the sellers. This is called as 5.8
imperfect price discrimination. Joan Monopolistic Competition
Robinson named it as “Imperfect
Discriminating Monopoly”. Under Monopolistic competition refers to a
this degree, buyers are divided into market situation where there are many
different groups and a different firms selling a differentiated product.
price is charged for each group. For There is competition which is keen,
example, in cinema theatres, prices though not perfect, among many firms
are charged for same film show making very similar products. No firm
from viewers of different classes. In can have any perceptible influence on the
a theatre the difference between the price-output policies of the other sellers
first row of first class and the last nor can it be influenced much by their
row in the second class is smaller actions. Thus monopolistic competition
as compared to the differences in refers to competition among a large
charges. number of sellers producing close but not
perfect substitutes for each other.
(iii) Third degree price discrimination
The monopolist splits the entire market
into a few sub-market and charges 5.8.1 Features of monopolistic
different price in each sub-market. competition
The groups are divided on the basis
of age, sex and location. For example, The important features of monopolistic
railways charge lower fares from competition are :
senior citizens. Students get discounts 1. There are large number of buyers
in museums, and exhibitions. and many sellers.

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 (3) The demand curve (the average
Monopolistic Competition- Examples
revenue curve) is fairly elastic.

Toothpaste

Toothpaste

Toothpaste
Under monopolistic competition, different
firms produce different varieties of the
product and sell them at different prices.
Each firm under monopolistic competition
seeks to achieve equilibrium as regards
1. Price and output, 2. Product adjustment
2. Firms under monopolistic and 3. selling cost adjustment.
competition are price makers. They
Short-run equilibrium:
set their own prices.
How does a monopolistically competitive
3. Firms produce differentiated
firm achieve price-output level
products. It is the key element of
equilibrium? The profit maximisation is
monopolistic competition.
achieved when MC=MR.
4. There is a free entry and exit of firms.
‘OM’ is the equilibrium output. ‘OP’
5. Firms compete with each other by is the equilibrium price. The total revenue
incurring selling cost or expenditure is ‘OMQP’. And the total cost is ‘OMRS’.
on sales promotion of their products. Therefore, total profit is ‘PQRS’. This is super
6. Non – price competition is an essential normal profit under short-run.
part of monopolistic competition. But under differing revenue and
7. A firm can follow an independent cost conditions, the monopolistically
price policy. competitive firms may incur loss.
As shown in the diagram, the AR and MR
5.8.2 Price and Output curves are fairly elastic. The equilibrium
Determination under
Monopolistic Competition
Y Y SMC
Y
The firm under monopolistic
MC competition
AC
achieves its equilibrium when it’s MC = Q SAC K
Q P AR, AC, MR & MC
MR,23and when its MC curve cuts its MR
AR, AC, MR & MC

C PROFIT R P
curve from below. If MC is less than MR, S

the 14
sellers will find it profitable to expand E
Price

12.6 D/AR D/AR

R=MR) their output. T

Under monopolistic competition

MR
MR
(1) The demand curve is downwards
x 0
sloping.
0 3 x 0 M x
Quantity Quantity
(2) There are close substitutes.
Diagram 5.6 Diagram 5.7

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 situation occurs at point ‘E’, where MC =
MR and MC cuts MR from below. Y MC
AC

The equilibrium output is OM and

L

AR, AC, MR & MC

the equilibrium price is OP. K
Profit
P Q
The total revenue of the firm is
E
‘OMQP’ and the total cost of the firm is D/AR
‘OMLK’ and thus the total loss is ‘PQLK’.
This firm incurs loss in the short run.
MR

0 M F x
Y Y AC
MC AC Quantity MC
Diagram 5.9
K L
SAC substitutesK are available. Hence,
L the firms
AR, AC, MR & MC

AR, AC, MR & MC

P will earn only normal profit.
PROFIT
P
Q
In the diagram equilibrium is achieved
E E D/AR
D/AR D/AR at point ‘E’. The equilibrium output is ‘OM’
and the equilibrium price is ‘OP’. The average
revenue at the equilibrium output is ‘MQ’ and
MR the average cost is also ‘MQ’. Thus, in the
MR long

0 run under monopolistic competition, there is

M x
equilibrium0 when AR=ACMand MC=MR.F It
x
x Quantity
means that a firm earnsQuantity
normal profit. AR is
Diagram 5.8 Diagram
tangent to the Long Run Average 5.9Cost (LAC)
curve at point ‘Q’.

Long-Run Equilibrium of the

Firm and the Group Equilibrium
The only one condition : MC = MR.
In the short run a firm under for equilibrium in the
monopolistic competition may earn super short run
normal profit or incur loss. But in the The two conditions : MC = MR
long run, the entry of the new firms in the for equilibrium in the and
industry will wipe out the super normal long run AC = AR.
profit earned by the existing firms. The
entry of new firms and exit of loss making
firms will result in normal profit for the
5.8.3 Wastes of Monopolistic
firms in the industry.
Competition
In the long run AR curve is Generally there are five kinds of wastages
more elastic or flatter, because plenty of under monopolistic competition.

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 1. Idle Capacity: Unutilized capacity is 5. Inefficient Firms: Under monopolistic
the difference between the optimum competition, inefficient firms charge
output that can be produced and the prices higher than their marginal cost.
actual output produced by the firm. Such type of inefficient firms should be
In the long run, a monopolistic firm kept out of the industry. But, the buyers’
produces delibrately output which preference for such products mostly
is less than the optimum output due to emotions, enables the inefficient
that is the output corresponding to firms to continue to exist. Efficient
the minimum average cost. This is firms cannot drive out the inefficient
done so mainly to create artificial firms because sometimes the Efficient
scarcity and raise price. This leads firms may not be able to spend money
to excess capacity which is actually on attractive advertisement to lure
a waste in monopolistic competition. the buyers. In reality, the consumers
In diagram 5.9, MF quantity of are mostly emotional rather than
output refers to unused capacity. If rational, as stated by Richard Theiler,
OF is produced, the society will get the Nobel prize winner for the year
2017.Rational decisions are made by
larger quantity with lower price.
mind; emotional decisions are made
2. Unemployment: Under monopolistic by heart.
competition, the firms produce less
than optimum output. As a result,
5.9
the productive capacity is not used
to the fullest extent. This will lead to Duopoly
unemployment of human resources also.
Duopoly is a special case of the theory of
3. Advertisement: There is a lot of wastes
oligopoly in which there are only two sellers.
in competitive advertisements under
Both the sellers are completely independent
monopolistic competition. The wasteful
and no agreement exists between them. Even
and competitive advertisements lead
though they are independent, a change in the
to high cost to consumers. It is also
price and output of one will affect the other,
claimed that advertisements cheat the
and may set a chain of reactions. A seller may,
consumers by giving false, information
about the product. Monopsony
4. Too Many Varieties of Goods: Monopsony is a market structure in
Introducing too many varieties of a which there is only one buyer of a good
good is another waste of monopolistic or service. If there is only one customer
competition. The goods differ in size, for a certain good, that customer has
shape, style and colour. A reasonable monopsony power in the market for
number of varieties would be sufficient. that good. Monopsony is analogous to
Cost per unit can also be reduced, monopoly, but monopsony has market
if only a few varieties are produced power on the demand side rather than
in larger quantity instead of larger on the supply side.
varieties with small quantity.
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 Perfect Competition Oligopoly Market System
Bilateral Monopoly: -Independent suppliers
-On line ticket auctions control supply and
Bilateral
-Truckmonopoly
farming refers to a market demand for the products
-Examples include airlines,
-Salt in which a single producer
situation automotive and banking
companies
-Gravel
(monopolist) of a product faces a single
-Garage Sales
buyer
-On(monopsonist) of that product.
line sales in general

5.10.1 Features of
however, assume that his rival is unaffected Oligopoly
by what he does, in that case he takes only his
own direct influence Competition-
on the price. Examples 1. Few large firms
Monopolistic
Very few big firms own the major control
of the whole market by producing major
Toothpaste

Toothpaste

Toothpaste

5.9.1 Characteristics of
portion of the market demand.
Duopoly
2. Interdependence among firms
1. Each seller is fully aware of his rival’s
The price and quality decisions of a
motive and actions.
particular firm are dependent on the
2. Both sellers may collude (they agree price and quality decisions of the rival
on all matters regarding the sale of firms.
the commodity).
3. Group behaviuor
3. They may enter into cut-throat
The firms under oligopoly realise the
competition.
importance of mutual co-operation.
4. There is no product differentiation.
4. Advertisement cost
5. They fix the price for their product with
The oligopolist could raise sales
a view to maximising their profit.
either by advertising or improving
5.10 the quality of the product.
5. Nature of product
Oligopoly
Perfect oligopoly means homogeneous
products and imperfect oligopoly
Oligopoly is a market situation in which
deals with heterogeneous products.
there are a few firms selling homogeneous or
differentiated products. Examples are oil and 6. Price rigidity
gas. It is difficult to pinpoint the number of It implies that prices are difficult to
firms in ‘competition among the few.’ With be changed. The oligopolistic firms
only a few firms in the market, the action of do not change their prices due to the
one firm is likely to affect the others. fear of rivals’ reaction.

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 5.11
Comparison among the Features of Various Markets

S Features Perfect Monopoly Monopolistic

No Competition Competition

Number of
1 Innumerable Only One Large
Producers/Sellers

Unique
Nature of the Homogeneous Differentiated Product
2 (No close
Product Perfect Substitute (close substitutes)
substitute)
Some control
3 Control over Price Price-Taker Price-Maker depending on branded
loyalty

Barriers to
4 Entry / Exit Free Free
entry

Abnormal profit /
Abnormal profit in
loss in short-run, Monopoly
5 Profit short-run, Normal
Normal profit in Profit
profit in long run
long-run

6 Market Knowledge Complete Complete Partial

Parallel to X axis Fairly Flat

7 AR Curves Steep (highly inelastic)
Perfectly elastic More elastic

Less
compared
8 Quantity Very large Substantial
to perfect
competition

9 Price Uniform and low High Moderate and varied

10 Market power Nil Absolute Limited

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 5.12
Conclusion

Different forms and characteristics of different Marginal cost Addition made to total
markets have been studied in this chapter costs already incurred by producing one
Market, in general is divided into perfect more unit of the commodity.
market and imperfect market. Imperfect
market consists of Monopoly, Monopolistic Marginal revenue Addition made to total
Competition, Duopoly, Monopsony etc. In revenue already incurred by selling one
the long-run, firms earn normal profit. Under more unit of the commodity.
imperfect market, the sellers would manage
to reap larger profits depending upon the
Monopolist A single-seller who controls
degree of monopoly power.
entire or major part of output, which has
no close substitutes.
Glossary
Equilibrium A situation or a state at
Price-maker The power in the firm to set
which a firm seeks to rest.
the price for goods in the market.

Equilibrium Price The price at which

Price-taker The feature of a firm to accept
the quantity demanded of a good equals
the price fixed in the industry.
quantity supplied.

Firm A single organization which employs

factors of production to produce goods
and sells.

Long run The period of time during which

all factors of production are variable.

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 ICT CORNER
MARKET EQUILIBRIUM

Lets study of Equilibrium

for Quantity on Demand and
Quantity Supplied.

Steps:
• Open the Browser type the URL given (or) Scan the QR Code.
• GeoGebra Work book called “XI STD ECONOMICS” will appear.
In this several work sheets for Economics are given, Open the
worksheet named “Market Equilibrium”
• There are two equations 1. Quantity on Demand (QD) and 2.
Quantity Supplied (QS). Both the equations are drawn in the graph
as straight line. Observe both the lines intersect at a point E.
• That intersection point is called ‘Market Equilibrium’. At that point
both QD and QS are Equal. Thus, Market equilibrium is obtained
when Demand and Supply are equal. Now you change the Supply
function by moving the slider “b”. Observe the Equilibrium changes
as the supply changes. Now Analyse the Market structure required.

Step1 Step2 Step3 Step4

Pictures are indicatives only*

URL:
https://ggbm.at/ddY3wkjp
(or) scan the QR Code

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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. In which of the following is not a type 6. Profit of a firm is obtained when

of market structure Price will be very ……………..
high? a. TR < TC
a. Perfect competition b. TR - MC
b. Monopoly c. TR > TC
c. Duopoly d. TR = TC
d. Oligopoly
7. Another name of price is……………..
2. Equilibrium condition of a firm is...... a. Average Revenue
a. MC = MR b. MC > MR b. Marginal Revenue
c. MC < MR d. MR = Price c. Total Revenue
3. Which of the following is a feature of d. Average Cost
monopolistic competition?
8. In which type of market, AR and MR
a. One seller are equal …..
b. Few sellers a. Duopoly
c. Product differentiation b. Perfect competition
d. No entry c. Monopolistic competition
4. A firm under monopoly can earn d. Oligopoly
…………. in the short run.
9. In monopoly, MR curve lies below
a. Normal profit
………….
b. Loss
a. TR
c. Super normal profit
d. More loss b. MC
c. AR
5. There is no excess capacity under
………………… d. AC
a. Monopoly 10. Perfect competition assumes …………
b. Monopolistic competition a. Luxury goods
c. Oligopoly b. Producer goods
d. Perfect competition c. Differentiated goods
d. Homogeneous goods

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 11. Group equilibrium is analysed in 16. The average revenue curve under
……. monopolistic competition will be……
a. Monopolistic competition a. Perfectly inelastic
b. Monopoly b. Perfectly elastic
c. Duopoly c. Relatively elastic
d. Pure competition d. Unitary elastic

12. In monopolistic competition, the 17. Under perfect competition, the shape
essential feature is ..… of demand curve of a firm is...............
a. Same product a. Vertical
b. selling cost b. Horizontal
c. Single seller c. Negatively sloped
d. Single buyer d. Positively sloped

13. Monopolistic competition is a form of 18. In which market form, does absence
.……. of competition prevail?
a. Oligopoly a. Perfect competition
b. Duopoly b. Monopoly
c. Imperfect competition c. Duopoly
d. Monopoly d. Oligopoly

14. Price leadership is the attribute of 19. Which of the following involves
………… maximum exploitation of consumers?
a. Perfect competition a. Perfect competition
b. Monopoly b. Monopoly
c. Oligopoly c. Monopolistic competition
d. Monopolistic competition d. Oligopoly

15. Price discrimination will always lead 20. An example of selling cost is …
to…………. a. Raw material cost
a. Increase in output b. Transport cost
b. Increase in profit c. Advertisement cost
c. Different prices d. Purchasing cost
d. b and c

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 Part-A Answers

1 2 3 4 5 6 7 8 9 10
a a c c d c a b c d
11 12 13 14 15 16 17 18 19 20
a b c c d c b b b c

Part-B 
Answer the following questions in one or
two sentences.

21. Define Market.

22. Who is price-taker?
23. Point out the essential features of pure competition.
24. What is selling cost?
25. Draw demand curve of a firm for the following:
a) Perfect Competition b) Monopoly
26. Mention any two types of price discrimination
27. Define “Excess capacity”.

Part-C Answer the following questions in one paragraph.

28. What are the features of a market?

29. Specify the nature of entry of competitors in perfect competition and monopoly.

30. Describe the degrees of price discrimination.

31. State the meaning of selling cost with an example.
32. Mention the similarities between perfect competition and monopolistic competition.
33. Differentiate between ‘firm’ and ‘industry’.
34. State the features of duopoly.
Part-D Answer the following questions in about a page

35. Bring out the features of perfect competition.

36. How price and output are determined under the perfect competition?

37. Describe the features oligopoly.

38. Illustrate price and output determination under Monopoly.

39. Explain price and output determined under monopolistic competition with help of
diagram.
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 ACTIVITY-1
Divide the class into five groups. Assign each group a market structure;
for first group perfect competition, second group monopoly,
third group oligopoly, forth group duopoly and for fifth group
monopolistic competition. Now each student is to identify a business
or organization or seller that operate in that market structure. Ask
each student to prepare a brief description of the following.
1. Name of the market structure
2. Business name
3. Industry
4. Identify the conditions of market structure
5. What are prices of a particular product, whether same price or
different price?.
6. Is there non-price competition?

ACTIVITY-2
Find out the number of firms in Tamil Nadu or India which are
producing/selling TV and Mobile phones.

References

1. Roger Leroy Miller “ Economics today The Micro view “ , Addition Wesley , 15th
edition, 2010 .
2. Irvin B. Tucker, “ Economics for Today “, South Western Cengage learning, 6th
edition, 2010.
3. K.K. Dewett, M.H. Navalur, “ Modern Economic Theory “ , S. Chand, 23rd edition, 2010.
4. H.L. Ahuja, “ Principles of Micro Economics “, Publisher S. Chand , 22nd edition, 2016.
5. Sankaran, “ Micro Economics “,
6. Micro Economics (Principles, Applications and tools) by-Arthur O’ Sullivan,
Steven Sheffrin, Stephen Perez, Pearson

Websites

1. www.economicsconcepts.com
2. www.microeconomicsnotes.com
3. www.economicsdiscussion.net

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 CH A P TER

6 Distribution
Analysis

“Distribution accounts for the sharing of wealth produced by a

community among the agents or owners of the factors which have been
active in its production”
–Chapman

Learning Objectives

1 To acquire knowledge about distribution of income among the factors of

production.

2 To enable the students to understand the theories of rent, wages, interest and
profit.

6.1 6.2
Introduction Meaning of Distribution

The factors of production viz., Land, Distribution means division of income

Labour, Capital and Entrepreneur or among the four factors of production in
Organization are involved in production. terms of rent to landlords, wage to labourer,
The theory of functional distribution interest to capital and profit to entrepreneurs.
deals with how the relative prices of these
factors of production are determined. The
theory of factor prices is popularly known
as the theory of distribution. Interesting
aspect here is in the fact that large number
of ideas has emerged and various factors
have been identified the economists,
contributing to the development of
Economics Science.

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 6.3 also known as “General
Theory of Distribution”
Kinds of Distribution of or “National Dividend
Income Theory of Distribution”.

Assumptions
Personal Distribution
This theory is based on the following
Personal Distribution is the distribution assumptions:
of national income among the individuals.
1. All the factors of production are
homogenous.
2. Factors of production can be
substituted for each other.
3. There is perfect competition both in
the factor market and product market.
4. There is perfect mobility of factors
of production.
5. There is full employment of factors.
6. This theory is applicable only in the
long-run.
7. The entrepreneurs aim at profit
Functional Distribution
maximization.
Functional Distribution means the 8. There is no government intervention
distribution of income among the four in fixing the price of a factor.
factors of production namely land, labour,
9. There is no technological change.
capital and organisation for their services
in production process. Explanation of the Theory
According to the Marginal Productivity
6.4 Theory of Distribution, the price or the
reward for any factor of production is
Marginal Productivity
equal to the marginal productivity of that
Theory of Distribution
factor. In short, each factor is rewarded
according to its marginal productivity.
Introduction
Marginal Productivity Theory of Marginal Product
distribution was developed by Clark, The Marginal product of a factor of
Wickseed and Walras. This theory production means the addition made
explains how the prices of various factors to the total product by employment of
of production are determined. This an additional unit of that factor. The
theory explains how rent, wages, interest Marginal Product may be expressed as
and profit are determined. This theory is MPP, VMP and MRP.
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 1. Marginal Physical Product (MPP) the point, the marginal revenue product
The Marginal Physical Product of a is less than the price of the factor. Hence,
factor is the increment in the total employer will suffer loss when he uses more
product obtained by the employment of the factor. Therefore, the conclusion is
of an additional unit of that factor. that the employer will adjust the price of
the factor of production so as to equalize
2. Value of Marginal Product (VMP)
the marginal revenue product of that factor.
The Value of Marginal Product is
obtained by multiplying the Marginal In short, the Marginal Productivity
Physical Product of the factor by the Theory of Distribution states that
price of product. a) The price of a factor of production
Symbolically depends upon its productivity.
b) The price of a factor is determined by
VMP = MPP x Price and will be equal to marginal revenue
product of that factor.
3. Marginal Revenue Product (MRP)
c) Under certain conditions, the price of a
The Marginal Revenue Product of a
factor will be equal to both the average
factor is the increment in the total
and marginal products of that factor.
revenue which is obtained by the
employment of an additional unit of
The Marginal Productivity Theory
that factor.
of Distribution can be represented
MRP = MPP x MR diagrammatically as follows:

Statement of the Theory Marginal Productivity under

An employer employs a factor of Perfect Competition
production because it is productive. So, Y
the price he wants to pay for the factor Y
Factor Price and Revenue

Q
depends upon its productivity. The greater P
MFC = AFC

Factor Price and Revenue

the productivity of a factor, the higher P

Product
will be its reward. If the price of a factor
Product

ARP
of production is less than its marginal
revenue product, the employer will use MRP S
more of this factor, because his profit will
be increased.
O N X
O
When more of a factor is employed, Factor Units
its marginal revenue product diminishes. Diagram 6.1
But the employer will gain by using
additional units of the factor until the
marginal revenue product of the factor The diagram 6.1 refers to the factor pricing
is equal to its price. The employer’s profit under perfect competition in the factor
will be maximum at this point. Beyond market. X axis represents factor units
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 and Y axis represents the factor price and In diagram 6.2 the factor pricing under
revenue product. MRP is the Marginal imperfect competition is represented. AFC
Revenue Product Curve and ARP is the is Average Factor Cost curve. It represents
Average Revenue Product curve. AFC is the price paid to the factors. It increases
the Average Factor Cost curve and MFC as the number of factors demanded by the
is the Marginal Factor Cost curve. AFC is employer increases. As AFC rises, MFC
horizontal under perfect competition and lies above AFC. It represents the marginal
MFC coincides with it. cost paid to the factors. At the point Q,
When there is perfect competition in MFC = MRP, where the employer attains
the factor market, the firm is in equilibrium his maximum profit and so he stops
(i.e., earning maximum profits) only when employment of the factors at the point.
But the average cost paid is NRSO and the

final
MFC = MRP. Hence, in the diagram, the firm
reaches equilibrium at point Q by employing average revenue obtained is NQ or OP.
ON units of factors and paying OP price (NQ) Total revenue obtained is NQPO. Therefore,
where MFC = MRP. At the point Q, MRP = exploitation per unit of factor is RQ. But the
ARP. The price paid to the factor (NQ) is also total number of factors is ON. Thus, the total
equal to marginal revenue product (NQ) exploitation of factor by the employer is RQ
and average revenue product (NQ). This X SR = “PQRS” (shaded area). Thus, under
means that there is no exploitation of factors imperfect competition, factor is exploited at
under perfect competition. Beyond the point the equilibrium position.

UNIT 6
Q, no employer will employ factors, because
Criticism
after that point, the price paid to the factor
is more than marginal revenue product and This theory is subject to a few criticisms
average revenue product. 1. In reality, the factors of production
are not homogenous.
Marginal Productivity Theory 2. In practice, factors cannot be
under Imperfect Competition substituted for each other.
3. This theory is applicable only in the
long–run. It cannot be applied in the Y
Y MFC short-run.
Y
40 Economic Rent
Yield Per Acre (in Bags)

C = AFC
Rate of Interest
Q
6.5
Factor Price and Revenue

AFC
P 30
Rent R’
Product

No Rent
ARP 20
Land
S 10 Meaning R
MRP R ARP 6.5.1
MRP Rent is the price or reward given for the
0 A B C X
X
O N
use of landVarious
or house or a
Grades of Landmachine to 0
X
Factor Units the owner. But, in Economics, “Rent” or De
Diagram 6.2 “Economic Rent” refers
Diagram 6.3 to that part of

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 payment made by a tenant to his landlords 1. Land differs in fertility.
for the use of land only. 2. The law of diminishing returns
operates in agriculture.
3. Rent depends upon fertility and
location of land.
4. Theory assumes perfect competition.
5. It is based on the assumption of long
period.
6. There is existence of marginal land
or no-rent land.
6.5.2 Ricardian Theory of 7. Land has certain “original and
Rent indestructible powers”.
8. Land is used for cultivation only.
9. Most fertile lands are cultivated first.

Statement of the Theory with

Illustration
Assume that some people go to a newly
discovered island and settle down there.
There are three grades of land, namely
A, B and C in that island. ‘A’ being most
fertile, ‘B’ less fertile and ‘C’ the least
David Ricardo
fertile. They will first cultivate all the most
fertile land (A grade) available. Since the
The Classical Theory of Rent is called
land is abundant and idle, there is no need
“Ricardian Theory of Rent”. David Ricardo
to pay rent as long as such best lands are
explained the theory of rent thus:
freely available. Given a certain amount of
labour and capital, the yield per acre on ‘A’
Assumptions grade land is 40 bags of paddy.
Ricardian theory of rent assumes the Suppose another group of people
following: goes and settles down in the same island
after some time. Hence the demand for
“Rent is that portion of the produce agricultural produce will increase. The
of the earth which is paid to the most fertile lands [A grade] alone cannot
landlord for the use of the original produce all the food grains that are needed
and indestructible powers of the on account of the operation of the law of
soil”. diminishing returns. So the less fertile
lands [B grade] will have to be brought
David Ricardo
under cultivation in order to meet the

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 Y
growing
Y
population. For the same amount
MFC
labour and capital employed in ‘A’ grade Y
land, the yield perQ acre on ‘B’ grade land 40 Economic Rent

Yield Per Acre (in Bags)

C = AFC

Rate of Interest
Factor Price and Revenue

AFC
is 30 bags
P of paddy. The surplus of 10 30
R’
Product

bags [40-30] per acre appears on ‘A’ grade No Rent

ARP 20
land. This is “Economic Rent” of ‘A’ grade Land
R
RP land. S R ARP
10

Suppose yet another MRP group of

0 A B C X
X people goes and settles down in the same 0
O N X Various Grades of Land
island. So the least fertile land (C grade) Dem
Factor Units
will have to be brought under cultivation.
Diagram 6.2 Diagram 6.3
For the same amount of labour and capital,
the yield per acre on ‘C’ grade land is 20
bags of paddy. This surplus of ‘A’ grade
land is now raised to 20 bags [40-20], and
Diagrammatic Explanation
it is the “Economic Rent” of ‘A’ grade land.
The surplus of ‘B’ grade land is 10 bags In diagram 6.3, X axis represents various
[30-20]. This is the economic rent of ‘B’ grades of land and Y axis represents
grade land. yield per acre (in bags). OA, AB and BC
are the ‘A’ grade, ‘B’ grade and ‘C’ grade
In the above illustration in ‘C’
lands respectively. The application of
grade land, cost of production is just equal
equal amount of labour and capital on
to the price of its produce and therefore
each of them gives a yield represented
does not yield any rent (20 - 20). Hence,
by the rectangles standing just above the
‘C’ grade land is called “no-rent land or
respective bases. The ‘C’ grade land is the
marginal land”. Therefore, No-Rent Land
“no–rent land” ‘A’ and ‘B’ grade lands are
or Marginal Land is the land in which cost
“intra –marginal lands”. The economic
of production is just equal to the price of
rent yielded by ‘A’ and ‘B’ grade lands is
its produce. The land which yields rent is
equal to the shaded area of their respective
called “intra –marginal land”. Therefore, rent
rectangles.
indicates the differential advantage of the
superior land over the marginal land.
Criticisms

Table 6.1 Ricardian Theory Following are the limitations of Ricardian

of Rent theory of rent.
1. The order of cultivation from
Grades Production Surplus (i.e.,
most fertile to least fertile lands is
of Lands (in bags) Rent in bags)
historically wrong.
A 40 40-20=20
2. This theory assumes that, rent does
B 30 30-20= 10
not enter into price. But in reality,
C 20 20-20= 0 rent enters into price.

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 6.5.3 Quasi-Rent “Quasi-Rent is the income derived
from machines and other appliances
made by man”.

-Alfred Marshall

6.5.4 The Modern Theory

of Rent / Demand &
Supply Theory of Rent
Marshall introduced the concept of Quasi The classical economists’ thought that
rent. Factors other than land say plant land as a factor of production was different
and machinery are fixed in supply during from other factors of production. But
short period. They earn surplus income modern economists thought that all
when demand rises. It is purely temporary the factors of production are alike and
as it disappears in long run due to increase there is no basic difference between
in supply. The quasi-rent is a surplus that them. Hence, a special theory was rent,
a producer receives in the short period developed by Ricardo is not necessary.
over variable costs from the sale of output. Therefore, economists like Joan
Robinson and Boulding have contributed
Distinction between “Rent” their ideas for the determination of rent,
and “Quasi-Rent” which is known as the “Modern Theory
of Rent”.
Sl. No. Rent Quasi-Rent
1. Rent accrues Quasi-Rent
to land accrues to “The essence of the conception of
manmade rent is the conception of surplus
appliances. earned by a particular part of a factor
2. The supply of The supply of production over and above the
land is fixed of manmade minimum earnings that is necessary
forever. appliances is to induce it to do work”
fixed for a short - Joan Robinson
period only.
3. It enters into It does not Rent is the difference between the actual
price enter into price. earnings of a factor of production and its
transfer earning.

QR= Total Revenue – Total Rent = Actual earning –

Variable Cost Transfer earning.

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 The minimum payment that has to be 2. Real Wages
made to a particular factor of production Real wages are the wages paid in
to retain it in its present use is known as terms of goods and services. Hence,
transfer earnings. real wages are the purchasing power
of money wages.
6.6 3. Piece Wages
Wages Wages that are paid on the basis of
quantum of work done.
4. Time Wages
Wages that are paid on the basis of
the amount of time that the worker
works.

6.7
Theories of Wages

Wages are a payment for the services of 6.7.1 

Subsistence Theory of
labour, whether intellectual or physical. Wages
Wage may be paid daily, weekly, fortnightly, Subsistence theory is one of the oldest
monthly or yearly and partly at the end of theories of wages. It was first explained by
the year in the form of bonus. Physiocrats, a group of French economists
and restated by Ricardo.

6.6.1. Meaning According to this theory, wage

must be equal to the subsistence level of
Wage is the price paid to the labourer for the labourer and his family. Subsistence
the services rendered . means the minimum amount of food,
clothing and shelter which workers and
“A sum of money paid under contract their family require for existence.
by an employer to a worker for the If workers are paid higher wages
services rendered”. than the subsistence level, the workers
-Benham would be better off and they will have large
families. Hence, the population would
increase. When the population increases,
6.6.2 Kinds of Wages the supply of labourer would increase and
therefore, wages will come down.
Wages are divided into four types:
On the other hand, if wages are lower
1. Nominal Wages or Money Wages. than the subsistence level, there would be
Nominal wages are referred to the a reduction in population and thereby the
wages paid in terms of money. supply of labour falls and wages increase
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 to the subsistence level. So this theory is
6.7.3 Wage Fund Theory of
closely associated with Malthusian Theory of
Wages
Population. This theory holds that the wages
of workers would not be above or below the This theory was first
subsistence level of the labourer and his family. propounded by Adam
Smith. But the credit
Criticism goes to J.S.Mill who
1. Role of trade unions in collective perfected this theory
bargainings was not found. According to Mill
2. It does not explain the differences in “every employer will keep
wages in different occupations. a given amount of capital
for payment to the workers”. It is a known as
3. The assumption that population would
“Wage Fund”. It is fixed and constant. Wages
increase with a rise in wage rate is not
depend directly upon the fund and inversely
correct. Poor families (and countries)
with number of labourers employed. The
have more Children than rich
average wage of a worker can be calculated
families (countries).Actually, as wage
by using the formula.
rate increases, people can afford to
downsize their family size for adopting
costly family planning procedures; Total Wage
while poor people cannot do so. Fund
Average wage per worker =
Number of
6.7.2 Standard of Living Workers
Theory of Wages
The Standard of Living Theory of Wages If the number of workers increases, the
developed by Torrance is an improved wage per worker would fall and vice
and refined version of the Subsistence versa.
Theory of Wage. According to this theory,
wage is equal to the standard of living of Criticism
the workers. If standard of living is high,
1. It does not explain the difference in
wages will be high and vice versa.
wages in different occupations.
Standard of living wage means the
2. It ignores the role of trade unions.
amount necessary to maintain the labourer in
the standard of life to which he is accustomed. 3. Actually the capitalists will take away
a large sum before making payment of
Criticism wages.

1. According to this theory, the standard

of living determines wages. But in actual 6.7.4 Residual Claimant
practice, wages determine the standard Theory of Wage
of living. This theory was propounded by the
American economist F.A.Walkar in 1875,
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 in his book Political Economy. According
Capital
to this theory, wage is the residual portion All man - made things that help
after paying the remuneration of all the produce goods.
other three factors, namely, land, capital
and organization. Money is invested to buy things
such as building, machiney...

Criticisms
The reward for capital investment
1. This theory does not explain the role is interest.
of trade unions can secure higher
wage for workers.
2. Demand side of labour in the
determination of wages needs to be 6.8.1 Meaning
considered.
Interest is the reward paid by the borrower
to the lender for the use of capital.
6.7.5 Marginal Productivity
Theory of Wage
“Interest is the price paid for the use
The application of general theory of of capital in any market”
distribution to wage fixation is the -ALFRED MARSHALL
marginal productivity theory of wages.
According to this theory, wages are
determined by the marginal productivity
of labour and equal to it at the point of 6.8.2 Kinds of Interest
equilibrium. Gross Interest
Under perfect competition wage is Gross interest is the total interest amount
paid equal to marginal product of labour received by creditors from debtors.
(wage = MPL) But in real world where
Gross Interest = (Net Interest) + (reward
there is imperfect competition, there is
for inconvenience) + (insurance against
exploitation of labour and wage is less
risk of non-repayment) + (payment for
than MPL.
service of debt management)

6.8 Net Interest

Interest Net Interest is only a part of the gross
interest. It is the payment for use of capital
Generally speaking, interest is a payment only. A good example for net interest
made by a borrower to the lender for the is the interest payable for Government
money borrowed. Securities.

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 Criticism
6.9 Theories of Interest 1. According to this theory, saving involves
suffering. But savings may not always
involve suffering to some rich people.
Rich people have money for which they
do not get interest. Hoarding of money
is to quench the thirst for liquidity.

6.9.2 Agio Theory of Interest/

The Psychological
Theory of Interest/Time
Preference Theory
This theory was propounded by John Rae
6.9.1 Abstinence Theory or in 1834. But credit goes to Bohm Bawerk an
Waiting Theory Austrian School economist who has given
final shape to the theory. The American
This theory was propounded by N.W.Senior.
economist Irving Fisher modified and gave
To him, interest is the reward for abstaining
a new theory viz Time Preference theory.
from the immediate consumption of wealth.
According to Senior, capital is the result of According to this theory, people
saving. But saving involves “abstinence” prefer present goods rather than future
or “sacrifice”. It is possible to save only if goods. Because the present goods are more
one abstains from present consumption. certain than future goods, just “as a bird in
Such abstinence from present consumption the hand is worth two in the bush”. There
involves some suffering. Hence, it is are many countries where no one knows
necessary to reward the saver (capitalist) what will happen next day.ASEAN crisis of
to compensate for the sacrifice he has 1996 and American crisis of 2007-08 were
to undergo by abstaining from present not predicted even for economists, including
consumption. Therefore, interest is the Nobel Laureats. So, when people save they
reward or compensation paid to the saver have to postpone their present enjoyment or
(capitalist) for his “abstinence” or “sacrifice”. satisfaction. If one postpones one’s present
satisfaction, one has to be paid an “Agio”
Marshall accepted the Abstinence
or “Premium”. This premium is “interest”.
Theory of interest. But he used the word
People prefer present consumption than
‘waiting’ instead of “abstinence”. Saving
future consumption due to the risk increasing
implies waiting. According to him, interest
and uncertainties of the present world.
is the reward for waiting. Saving involves
waiting. But people do not like to wait. So,
in order to make them wait and in turn to 6.9.3 Loanable Funds Theory/
save, we have to pay them some reward. The Neo Classical Theory
Therefore, interest is the reward paid to the The Loanable Funds Theory, also known
saver (capitalist) for his “waiting”. as the “Neo–Classical Theory”, was
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 developed by Swedish economists like 1. Savings planned by individuals
Wicksell, Bertil Ohlin, Viner, Gunnar are called “ex-ante savings”. E.g.
Myrdal and others. LIC premium, EMI payment etc.
According to this theory, interest is 2. The unplanned savings are called,
the price paid for the use of loanable funds. “ex-post savings”. Savings is left
The rate of interest is determined by the out after spending are ex post
equilibrium between demand for and supply saving.
of loanable funds in the credit market. 2. Bank Credit (BC)
The bank credit is another source of
Demand for Loanable Funds
loanable funds. Commercial banks
The demand for loanable funds depends create credit and supply loanable
upon the following: funds to the investors.
1. Demand for Investment (I) 3. Dishoarding (DH)
The most important factor responsible Dishoarding means bringing out
for the loanable funds is the demand the hoarded money into use and
for investment. Bulk of the demand thus it constitutes a source of supply
for loanable funds comes from of loanable funds. In India,after
business firms which borrow money 1991,Public sector undertakings
for purchasing capital goods. are being sold to private people to
2. Demand for Consumption (C) mobilize more funds.This is also
called disinvestment.
The demand for loanable funds comes
from individuals who borrow money 4. Disinvestment(DI)
for consumption purposes also. Disinvestment is the opposite of
3. Demand for Hoarding (H) investment. In other words disinvestment
means not providing sufficient funds for
The next demand for loanable funds
depreciation of equipment. It gives rise
comes from hoarders. Demand for
to the supply of loanable funds.
hoarding money arises because of
people’s preference for liquidity, idle All the four sources of supply of
cash balances and so on. The demand loanable funds vary directly with the
for C, I and H varies inversely with interest rate.
interest rate.

Supply of Loanable Funds Classical theory of Interest

The supply of loanable funds depends The equilibrium interest rate,

upon the following four sources: according to classical theory, is
determined by the intersection of
1. Savings (S)
demand and supply curves, Demand
Loanable funds come from savings. for money refers to investment. Supply
According to this theory, savings of money refers to savings S=I.
may be of two types, namely,
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 Equilibrium funds; this is obtained by the summation of
the demand for investment curve I, demand
The rate of interest is determined by the
curve for consumption demand or dissaving
equilibrium between the total demand for
curve and curve for demand for hoarding
and the total supply of loanable funds.
curve H. The LD and LS curves, intersect
each other at the point “E” the equilibrium
Supply of and Demand for point. At this point, OR rate of interest and
Loanable Funds OM is the amount of loanable funds.
Supply of = Savings + Criticism
loanable funds Bank Credit +
Dishoarding + 1. Many factors have been included
Disinvestment in this theory.Still ther are many
= S + BC + DH + DI more factors.Two such factors are
1)Asymmetric Information and 2)
Demand for = Investment + Moral Hazard.In practice larger
loanable funds Consumption + firms, due to their political powers,
Hoarding
are able to get huge bank credit
=I+C+H at lower interest rates.But due to
NPAs, (Non-Performing Assets)
M2
Y smallYfirms and depositors lose their
L1
interest income. The loanable funds
DH DI S BC L
theory is “indeterminate”’ unless
Rate of Interest

Rate of Interest

LS the income level is already known.

E’
R’ (This Ican
1
be studiedE1in 12th standard
No Rent
Land E
Economics Book) E
I P
R
2. It is very difficult to combine real
1

I P
H C factors like savings and investment
LD
X with monetary factors like bank
d 0 M’ M X 0
credit and liquidityM2
preference. X
Demand for Loanable Funds and Demand for Money and
Supply of Loanable Funds Supply of Money
Diagram 6.4 6.9.4 Keynes’ Diagram
Liquidity6.5
Preference Theory of
In Diagram 6.4, X axis represents the Interest or The Monetary
demand for and supply of loanable funds Theory of Interest
and Y axis represents the rate of interest. The Keynes propounded the
LS curve represents the total supply curve Liquidity Preference
of loanable funds. This is obtained by the Theory of Interest in
summation of the Saving Curve (S), Bank his famous book, “The
credit curve (BC), Dishoarding curve (DH) General Theory of
and Disinvestment curve (DI). The LD curve Employment, Interest
represents the total demand for loanable and Money” in 1936. J.M. Keynes

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 According to Keynes, interest is purely a The amount saved under this motive
monetary phenomenon because the rate depends on the level of income. Mt
of interest is calculated in terms of money. and Y are positively associated. (Say
To him, “interest is the reward for parting Mt = 0.125Y; that means if income
with liquidity for a specified period of is ₹ 1000, demand for transaction
time”. motive is ₹ 125)

Meaning of Liquidity Mt = f (y)

Preference
2. The Precautionary Motive
Liquidity preference means the preference
The precautionary motive relates to
of the people to hold wealth in the form
the desire of the people to hold cash
of liquid cash rather than in other non-
to meet unexpected or unforeseen
liquid assets like bonds, securities, bills of
expenditures such as sickness,
exchange, land, building, gold etc.
accidents, fire and theft. The amount
saved for this motive also depends
“Liquidity Preference is the preference on the level of income. (Say Mp =
to have an amount of cash rather than 0.125Y; it means if income is ₹ 1000,
of claims against others”. demand for Mp is ₹ 125)
- Meyer
Mp = f (y)

Motives of Demand for Money 3. The Speculative Motive

According to Keynes, there are three The speculative motive relates to the
desire of the people to hold cash in
order to take advantage of market
movements regarding the future
changes in the price of bonds and
securities in the capital market.
The amount saved for this motive
depends on the rate of interest. Ms
= f (i). There is inverse relation
between liquidity preference and
rate of interest (Say Ms = 450-100i).

motives for liquidity preference. They are: Determination of Rate of

1. The Transaction Motive Interest
The transaction motive relates to the According to Keynes, the rate of interest
desire of the people to hold cash for is determined by the demand for money
the current transactions (or day–to- and the supply of money. The demand
day expenses). for money is liquidity preference. In fact,
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 liquidity preference for speculative motive Y
M2 M3 M2 M4
Y
determines rate of interest. The supply of
L1 L
money is L
determined by the policies of
I3 E3
the Government and the Central Bank
Rate of Interest

Rate of Interest
of a country. The total supply of money
E1
I1 of coins, currency
consists notes and bank
deposits
I
(Say M = E200). I2 E2
P1
E4
P I4
P
Equilibrium between Demand
and 0Supply of Money
M2 X 0 M3 M2 M4 X
The equilibrium
Demandbetween liquidity
for Money and preference Demand for Money and
Supply of Money
and demand for money determine the Supply of Money
Diagram
rate of interest. 6.5
In short-run, the supply of Diagram 6.6
money is assumed to be constant (₹ 200).
LP is the liquidity preference Curve =0.125Y+0.125Y+(450-100i). Total
(demand curve). M2 M2 shows the supply supply of money=₹ -200. Mt and Mp are
curve of money to satisfy speculative influenced by Y. Hence for the sake of
motive. Both curves intersect at the easy understanding, Ms alone can be
point E, which is the equilibrium point. considered Demand for money=supply
Hence, the rate of interest is T. If liquidity of money at equilibrium point:450-
preference increases from LP to L1P1 the 100i=200;450-200=100i;250=100i;
supply of money remains constant, the i=250/100=2.5.This is equilibrium interest
rate of interest would increase from OI In reality, interest rate is also influenced
to OI1. Numerical examples given above by national income and commodity sector
can also be used for better understanding. equilibrium.However, they are not included
Total demand for money=Mt+Mp+Ms here for making the understanding easier.
Suppose LP remains constant. If the supply
Y
M2 of money Yis OM2, the M3 interest
M2 isMOI2 and if the
4
L1 supply of moneyLis reduced from OM2 to OM3,
L the interestI would increase
E3
from OI2 to OI3. If the
3
supply of money is increased from OM2 to OM4,
Rate of Interest

Rate of Interest

LS
E1 the interest would decrease from OI2 to OI4.
I1

I E2
E
I P1 Criticism
2

E4
P
1. ThisI4 theory does not explain the P
LD existence of different interest rates
X 0 M2 X prevailing
0 inM3the market
M2 M4at the sameX
nd Demand for Money and time. Demand for Money and
Supply of Money Supply of Money
2. It explains interest rate only in the
Diagram 6.5 Diagram 6.6
short-run.
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 6.10 Here cost implies explicit costs only
(Normally economic cost, social cost and
Profit
environmental cost are not considered
by the Accountants in India).
The entrepreneur coordinates all the other
b. Net Profit or Pure Profit or Economic
three factors (land, labour and capital) of
profit or True profit
production. Entrepreneur is rewarded for
his services in the form of profit. Net or pure or economic or true profit
is the residual left with entrepreneur
after deducting from Gross profit the
6.10.1 Meaning of Profit
remuneration for the self-owned factors of
Profit is a return to the entrepreneur for the production, which are called implicit cost.
use of his entrepreneurial ability. It is the
net income of the organizer. In other words, Net Profit = Gross Profit-
profit is the amount left with the entrepreneur Implicit costs
after he has payments made for all the other c. Normal Profit
factors (land, labour and capital) used by
It refers to the minimum expected
him in the production process. However,
return to stay in business.
there are other versions also.
d. Super Normal Profit
Super normal profits are over and
6.10.2 Kinds of Profit
above the normal profit.
I. Monopoly Profit: Profit earned by
the firm because of its monopoly Super Normal = Actual profit-
control. Profit Normal profit
II. Windfall Profit: Some times, profit
arises due to changes in price level. 6.11
Profit is due to unforeseen factors.
Theories of Profit
III. Profit as functional reward: Just
like rent, wage and interest, profit is
earned by the entrepreneur for his
entrepreneurial function.

6.10.3. Concepts of Profit

a. Gross Profit
Gross Profit is the surplus which accrues
to a firm when it subtracts its Total
Expenditure from its Total Revenue.

Gross Profit = Total Revenue-

Total cost

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 Schumpeter, an entrepreneur is not only
6.11.1 Dynamic Theory of
an undertaker of a business, but also an
Profit
innovator in the process of production. To
This theory was him, profit is the reward for “innovation”.
propounded by the Innovation means invention put into
American economist commercial practice.
J.B.Clark in 1900. To him,
According to Schumpeter, an
profit is the difference
innovation may consist of the following:
between price and cost
of production of the 1. Introduction of a new product.
commodity. Hence, profit 2. Introduction of a new method of
is the reward for dynamic production.
changes in society. Further he points out 3. Opening up of a new market.
that, profit cannot arise in a static society.
4. Discovery of new raw materials
Static society is one where everything is
stationary or stagnant and there is no change 5. Reorganization of an industry / firm.
at all. Therefore, there is no role for an
entrepreneur in a static society. The price of When any one of these innovations is
the commodities in a static society would be introduced by an entrepreneur, it leads to
equal to their cost of production. So, there reduction in the cost of production and thereby
would be no profit for the entrepreneur. brings profit to an entrepreneur. To obtain
The entrepreneur only gets wages for profit continuously, the innovator needs to
management and interest on his capital. innovate continuously. The real innovators do
so. Imitative entrepreneurs cannot innovate.
At present several changes are
taking place in a dynamic society. Changes
are permanent. According to Clark, the 6.11.3 Risk Bearing Theory of
following five main changes are taking Profit
place in a dynamic society.
Risk bearing theory of profit was
1. Population is increasing propounded by the American economist
2. Volume of Capital is increasing. F.B.Hawley in 1907. According to him,
3. Methods of production are improving. profit is the reward for “risk taking”
in business. Risk taking is an essential
4. Forms of industrial organization are
function of the entrepreneur and is the
changing.
basis of profit. It is a well known fact that
5. The wants of consumer are multiplying. every business involves some risks.
Since the entrepreneur undertakes
the risks, he receives profits. If the
6.11.2 Innovation Theory of entrepreneur does not receive the reward,
Profit he will not be prepared to undertake the
Innovation theory of profit was risks. Thus, higher the risks, the greater
propounded by Joesph. A.Schumpeter. To are the profit.
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 Every entrepreneur produces incalculatable or not measurable or non-
goods in anticipation of demand. If his insurable).
anticipation of demand is correct, then According to Knight, profit does
there will be profit and if it is incorrect, not arise on account of risk taking,
there will be loss. It is the profit that because the entrepreneur can guard
induces the entrepreneurs to undertake himself against a risk by taking a suitable
such risks. insurance policy. But uncertain events
cannot be guarded against in that way.
When an entrepreneur takes himself the
6.11.4 Uncertainty Bearing
burden of facing an uncertain event, he
Theory of Profit
secures remuneration. That remuneration
Uncertainty theory was propounded is “profit”.
by the American economist Frank
H.Knight. To him, profit is the reward for
“uncertainty bearing”. He distinguishes
between “insurable” and “non-insurable” 6.12
risks. Conclusion

Insurable Risks In this chapter, the determination of

Certain risks are measurable or how the prices of various factors of
calculatable. Some of the examples of these production (namely land, labour, capital,
risks are the risk of fire, theft and natural and organization) has been discussed.
disasters. Hence, they are insurable. Such In short, all the theories are related to
risks are compensated by the Insurance factor pricing of factors of production.
Companies. However,it needs to be understood that
no theory can completely comprehend
every thing.The reality will always be
Non-Insurable Risks
more complicated than what the theories
There are some risks which are could predict or perceive.Theories are
immeasurable or incalculatable. The only guide lines,they cannot predict with
probability of their occurrence cannot 100% perfection.However,the scientific
be anticipated because of the presence studies attempt to enhance the degree of
of uncertainty in them. Some of the perfection.
examples of these risks are competition,
market condition, technology change and
GLOSSARY
public policy. No Insurance Company can
undertake these risks. Hence, they are non- 1. Distribution – Distribution of
insurable. The term “risks” covers the first wealth among agents or the owners
type of events (measurables - insurable) of the factors of production.
and the term “uncertainty” covers the 2. Rent – Rent is reward for the use of
second type of events (unforeseeable or land.

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 3. Wages – Wages are the reward for labour. 8. Money wage – Money wage is the
4. Interest – Interest is the price paid remuneration received by a labourer
for the use of capital. in terms of money.
5. Profit – Profit is the reward for 9. Real wage – Real wage is the
organisation or entrepreneurship. purchasing power of the money
wages in terms of goods and
6. Quasi-Rent – Quasi-Rent is the
services.
surplus earned by man-made
appliances and instruments of 10. Loanable fund – Loanable fund is
production in the short-period. that part of capital meant for loan.
7. Transfer earnings – Transfer earnings 11. Innovation – Invention put into
refer to minimum payment payable to commercial practice.
a factor to retain it in its present use.

MODEL QUESTIONS

PART – A

1. In Economics, distribution of income 3. Rent is the reward for the use of

is among the a. capital
a. factors of production b. labour
b. individual c. land
c. firms d. organization
d. traders
4. The concept of ‘Quasi-Rent’ is
2. Theory of distribution is popularly associated with
known as, a. Ricardo
a. Theory of product-pricing b. Keynes
b. Theory of factor-pricing c. Walker
c. Theory of wages d. Marshall
d. Theory of Interest

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 5. The Classical Theory of Rent was c. interest
propounded by d. profit
a. Ricardo
11. Keynesian Theory of interest is
b. Keynes popularly known as
c. Marshall a. Abstinence Theory
d. Walker b. Liquidity Preference Theory
6. ‘Original and indestructible powers of c. Loanable Funds Theory
the soil’ is the term used by
d. Agio Theory
a. J.S.Mill
12. According to the Loanable Funds
b. Walker Theory, supply of loanable funds is
c. Clark equal to
d. Ricardo a. S + BC + DH + DI
b. I + DS + DH + BM
7. The reward for labour is
c. S + DS + BM + DI
a. rent
d. S + BM + DH + DS
b. wage
c. profit 13. The concept of meeting unexpected
expenditure according to Keynes is
d. interest
a. Transaction motive
8. Money wages are also known as
b. Precautionary motive
a. real wages
c. Speculative motive
b. nominal wages
d. Personal motive
c. original wages
14. The distribution of income or wealth
d. transfer wages
of a country among the individuals are
9. Residual Claimant Theory is a. functional distribution
propounded by b. personal distribution
a. Keynes c. goods distribution
b. Walker d. services distribution
c. Hawley
15. Profit is the reward for
d. Knight
a. land
10. The reward given for the use of capital b. organization
a. rent c. capital
b. wage d. labour

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 16. Innovation Theory of profit was given by c. Walker
a. Hawley d. J.S.Mill
b. Schumpeter 19. Abstinence Theory of Interest was
c. Keynes propounded by
d. Knight a. Alfred Marshall
17. Quasi-rent arises in b. N.W Senior

a. Man-made appliances c. Bohm-Bawerk

b. Homemade items d. Knut Wicksell

c. Imported items 20. Loanable Funds Theory of Interest is

d. None of these called as
a. Classical Theory
18. “Wages as a sum of money are paid under
contract by an employer to a worker for b. Modern Theory
services rendered” –Who said this? c. Traditional Theory
a. Benham d. Neo-Classical Theory
b. Marshall

Part- A Answers

1 2 3 4 5 6 7 8 9 10
a b c d a d b b b c
11 12 13 14 15 16 17 18 19 20
b a b b b b a a b d

PART – B Answer the following questions in one or two

sentences.

21. What is meant by distribution? 25. What do you mean by interest?

22. Mention the types of distribution. 26. What is profit?
23. Define ‘Rent’. 27. State the meaning of liquidity
preference.
24. Distinguish between real and money
wages.

Part C Answer the Following Questions in a Paragraph

28. What are the motives of demand for 29. List out the kinds of wages.
money?
30. Distinguish between rent and quasi-rent.

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 31. Briefly explain the Subsistence Theory 33. Describe briefly the Innovation
of Wages. Theory of Profit.

32. State the Dynamic Theory of Profit. 34. Write a note on Risk-bearing Theory
of Profit.

PART – D Answer the Following Questions in One Page

35. Explain the Marginal Productivity 37. Elucidate the Loanable Funds Theory
Theory of Distribution. of Interest.

36. Illustrate the Ricardian Theory of 38. Explain the Keynesian Theory of
Rent. Interest.

ACTIVITY
Visit any manufacturing unit (factory) and collect information
about factors of production (land, labour, capital and organisation)
and compare their remunerations.
Students may be asked to meet the stakeholders in the
factory.
„„ Entrepreneur.
„„ Manager or Managing Director.
„„ Employees.

References

1. Dewett, K.M. and Navalur, M.H. (2016), “Modern Economic Theory”, S. Chand
and Company Pvt. Ltd., New Delhi.
2. Jhingan, M.L. ( ), Micro Economic Theory,
3. Ahuja, H.L. (2016), “Principle of Microeconomics”, S.Chand and Company Pvt.
Ltd., New Delhi.
4. Karl, E. Case, Raw C. Fair and Sharon Oster (2014), “Principle of Economics”,
Pearson, Darling Kindersley (India), Pvt. Ltd., New Delhi, Douglas C.
5. Alfred W. Stonier and Hague (2008), “A Text Book of Economic Theory”,
Pearson, Dorling Kindersley (India), Pvt Ltd., New Delhi.

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 CH A P TER

7 Indian Economy

“India will be a global player in the digital economy”

–Sunder Pichai, CEO Google

Learning Objectives

1 To understand the current status of the Indian Economy in terms of features,

Natural resources, infrastructure facilities and so on.

2  o understand the contributions of major Indian Economic

T
Thinkers.

7.1 Quality of Life Index (PQLI) and Gross

National Happiness Index (GNHI).
Meaning of Growth and
Development
Gross National Happiness Index
(GNHI)
A country’s economic growth is usually
measured by National Income, indicated The term “Gross National Happiness”
by Gross Domestic Product (GDP). was coined by the fourth king of
The GDP is the total monetary value of Bhutan, Jigme Singye Wangchuck, in
the goods and services produced by that 1972. It is an indicator of progress,
country over a specific period of time, which measures sustainable develop­
usually one year. ment, environmental conservation
promotion of culture and good
The level economic development
governance.
is indicated not just by GDP, but by an
increase in citizens’ quality of life or
well-being. The quality of life is being On the basis of the level of economic
assessed by several indices such as Human development, nations are classified as
Development Index (HDI), Physical developed and developing economies.

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 Developed economies are those countries
which are industrialised, utilise their Features of a Developed Economy
resources efficiently and have high per capita 1) High National Income
income. The USA, Canada, U.K, France, and 2) High Per Capita Income
Japan are some of the developed economies.
3) High Standard of Living
Developed economies are also termed as
Advanced Countries. On the other hand, 4) Full Employment of Resources
countries which have not fully utilized their 5) Dominance of Industrial Sector
resources like land, mines, workers, etc., 6) High Level of Technology
and have low per capita income are termed
7) High Industrialisation
as under developed economies. Examples of
underdeveloped countries are Sub Saharan 8) High ConsumptionLevel
Africa, BanglaDesh, Myanmar, Pakistan, 9) High Level of Urbanisation
Indonesia etc.They are also termed as Under 10) Smooth Economic Growth
developed Countries or Backward Nations
11) Social Equity, Gender Equality
or Third World Nations.
and Low Levels of Poverty
12) Political Stability and Good
7.2 Governance
Indian Economy
The diametrically opposite features
GDP Growth Rate
of Indian Economy are discussed below in
Top 10 countries by GDP (normal) 2016
Source : IMF (Outlook October 2016 )
detail.
20000
18000
16000
14000
7.3
12000
Features of Indian
Billion dollar

10000
8000 Economy
6000
4000
2000
7.3.1 Strengths of Indian
Economy
m

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an
te

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na

a
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il
pa

na
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az
di
an

Ita
i
Ch

ng
Ja

Ca
Br
Fr
Ge
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Ki
ite

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Un

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Diagram 7.1
1. India has a mixed economy
Indian economy is the Seventh largest
economy of the world. Being one of Indian economy is a typical example
the top listed countries. In terms of of mixed economy. This means both
industrialization and economic growth, private and public sectors co-exist and
India holds a robust position with an function smoothly. On one side, some
average growth rate of 7% (approximately). of the fundamental and heavy industrial
Even though the rate of growth has units are being operated under the public
been sustainable and comparatively stable, sector,while, due to the liberalization of
there are still signs of backwardness. the economy, the private sector has gained

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 importance. This makes it a perfect model Emerging as a top economic giant
for public – private partnership. among the world economy, India bags
2. A
 griculture plays the seventh position in terms of nominal
the key role Gross Domestic Product (GDP) and third
in terms of Purchasing Power Parity (PPP).
Agriculture being the maximum pursued As a result of rapid economic growth
occupation in India, it plays an important Indian economy has a place among the
role in its economy as well. Around G20 countries.
60% of the people in India depend
upon agriculture for their livelihood.
5. Fast Growing Economy
In fact, about 17% of our GDP today is
contributed by the agricultural sector. India’s economy is well known for high
Green revolution, ever green revolution and sustained growth. It has emerged as
and inventions in bio technology have the world’s fastest growing economy in
made agriculture self sufficient and the year 2016-17 with the growth rate of
also surplus production. The export 7.1% in GDP next to People’s Republic of
of agricultural products such as fruits, China.
vegetables, spices, vegetable oils, tobacco,
animal skin, etc. also add to forex earning 6. Fast growing Service Sector
through international trading.

3. An emerging market
China 738.5
India has emerged as vibrant economy India 462.1

sustaining stable GDP growth rate even United States 286.9

in the midst of global downtrend. This Brazil 139.1

Indonesia
has attracted significant foreign capital
132.7

Japan 118.4
through FDI and FII.India has a high
potential for prospective growth. This also
Diagram 7.2
makes it an emerging market for the world.
The service sector, contributes a lion’s share
4. Emerging Economy of the GDP in India. There has been a high
rise growth in the technical sectors like
WORLD NATION IN G-20 Information Technology, BPO etc. These
1. Argentina 11. Italy sectors have contributed to the growth
2. Australia 12. Japan
of the economy. These emerging service
3. Brazil 13. Mexico
sectors have helped the country go global
4. Canada 14. Russia
and helped in spreading its branches around
5. China 15. Saudi Arabia
6. European Union
the world.
16. South Africa
7. France 17. South Korea
8. Germany 18. Turkey 7. Large Domestic consumption
9. India 19. United Kingdom
With the faster growth rate in the economy
10. Indonesia 20. United States
the standard of living has improved a lot.
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 This in turn has resulted in rapid increase The human capital of India is young. This
in domestic consumption in the country. means that India is a pride owner of the
The standard of living has considerably maximum percentage of youth. The young
improved and life style has changed. population is not only motivated but
skilled and trained enough to maximize
the growth. Thus human capital plays
8. Rapid growth of Urban areas
a key role in maximizing the growth
Urbanization is a key ingredient of the prospects in the country. Also, this has
growth of any economy. There has been a invited foreign investments to the country
rapid growth of urban areas in India after and outsourcing opportunities too.
independence. Improved connectivity in
transport and communication, education
and health have speeded up the pace of 7.3.2 Weakness of Indian
urbanization. Economy
1. Large Population
9. Stable macro economy
India stands second in terms of size of
The Indian economy has been projected population next to China and our country
and considered as one of the most stable is likely to overtake china in near future.
economies of the world. The current Population growth rate of India is very
year’s Economic survey represents the high and this is always a hurdle to growth
Indian economy to be a “heaven of rate. The population growth rate in India
macroeconomic stability, resilience and is as high as 1.7 per 1000.The annual
optimism. According to the Economic addition of population equals the total
Survey for the year 2014­15, 8%­plus population of Australia.
GDP growth rate has been predicted, with
actual growth turning out to be a little 2. Inequality and poverty
less (7.6%). This is a clear indication of a
There exists a huge economic disparity in
stable macroeconomic growth.
the Indian economy. The proportion of
income and assets owned by top 10% of
10. Demographic dividend Indians goes on increasing. This has led to
an increase in the poverty level in the society
232 million Armenia and still a higher percentage of individuals
Youth population of India is nearly equal the total
population of 18 West Asian countries in 2011
Azerbaijan
Bahrain are living Below Poverty Line (BPL). As a
Cyprus
Georgia result of unequal distribution of the rich
Iraq
Israel becomes richer and poor becomes poorer.
Jordan
Kuwait
Youth Lebanon
3. Increasing Prices of
West Asian
Population countries Oman
Qatar
= Saudi Arabia Essential Goods
State of Palestine
Syrian Arab Republic
Turkey Even though there has been a constant
United Arab Emirates
Yemen growth in the GDP and growth

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 opportunities in the Indian economy, „„Sex-ratio
there have been steady increase in the „„Life-expectancy at birth
prices of essential goods. The continuous
„„Literacy ratio
rise in prices erades the purchasing power
and adversely affects the poor people, a. Size of Population
whose income is not protected.
Table 7.1 Population Growth
4. Weak Infrastructure Census Population Average annual
Even though there has been a gradual Year (in crores) growth rate
improvement in the infrastructural 1901 23.84 -
development in the past few decades, there 1911 25.21 0.56
is still a scarcity of the basic infrastructure
1921 25.13 -0.03
like power, transport, storage etc.
1931 27.90 1.04
5. I
 nadequate Employment 1941 31.87 1.33
generation 1951 36.11 1.25
With growing youth population, there 1961 43.92 1.96
is a huge need of the employment 1971 54.81 2.20
opportunities. The growth in production 1981 68.33 2.22
is not accompanied by creation of job.
1991 84.33 2.16
The Indian economy is characterized by
‘jobless growth’. 2001 102.70 1.97
2011 121.02 1.66
6. Outdated technology (Source: Registrar General of India)

The level of technology in agriculture and

Over a period of 100 years, India has
small scale industries is still outdated and
quadrupled its population size. In terms
obsolete.
of, size of population, India ranks 2nd
in the world after China. India has only
about 2.4% of the world’s geographical
7.3.3 Demographic trends in
area and contributes less than 1.2% of the
India
world’s income, but accommodates about
Scientific study of the characteristics of 17.5% of the world’s population. In other
population is known as Demography. The words, every 6th person in the world is an
various aspects of demographic trends in Indian. Infact, the combined population of
India are: just two states namely, Uttar Pradesh and
„„Size of population Maharashtra is more than the population
of United States of America, the third most
„„Rate of growth
populous country of the world. Some of
„„Birth and death rates the states in India have larger population
„„Density of population than many countries in the world.
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 The negative growth during has declined from 27.4 in 1951 to 7.1 in 2011.
1911-21 was due to rapid and frequent However, from the data it is clear that the fall
occurrence of epidemics like cholera, in birth rates is less than that of death rates.
plague and influenza and also famines. Kerala has the lowest birth rate (14.7)
The year 1921 is known as the ‘Year of and Uttar Pradesh has the highest birth rate
Great Divide’ for India’s population as (29.5). West Bengal has the lowest death
population starts increasing. rate (6.3) and Orissa (9.2) has the highest.
During 1951, population growth Among States, Bihar has the highest decadal
rate has come down from 1.33% to 1.25%. (2001-11) growth rate of population, while
Hence it is known as ‘Year of Small divide’. Kerala has the lowest growth rate. The four
In 1961, population of India states Bihar, Madhya Pradesh, Rajasthan
started increasing at the rate of 1.96% and Uttar Pradesh called BIMARU states
i.e, 2%. Hence 1961 is known as ‘Year of have very high population.
Population Explosion’. In the year 2001,
the Population of India crossed one billion c. Density of population
(100 crore) mark. It refers to the average number of persons
The 2011 census reveals growth of residing per square kilometre. It represents
youth population which is described as the man- land ratio. As the total land area
‘demographic transition’. remains the same, an increase in population
causes density of population to rise.
b. Birth rate and death rate
Density of population
Crude Birth rate: It refers to the number
Total population
of births per thousand of population. =
Land area of the region
Crude Death rate: It refers to the number
of deaths per thousand of population. Table 7.3 Density of population
Crude birth and death rates of India Year Density of population
during various years. (No. of persons per sq. km)
Table 7.2 1951 117
Birth rate and death rate 2001 325
Year C.B.R C.D.R. 2011 382
1951 39.9 27.4 (Source: Registrar General of India)

2001 25.4 8.4 Just before Independence, the density of

2011 21.8 7.11 population was less than 100. But after
(Source: Registrar General of India) independence, it has increased rapidly
from 117 in 1951 to 325 in 2001. According
Birth rate was 39.9 in 1951; it fell to 21.8 in to 2011 census, the present Density of
2011. Although the birth rate has declined, the population is 382. Thus, the pressure of
decline is not so remarkable. The death rate population on land has been rising. Kerala,
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 West Bengal, Bihar and Uttar Pradesh have expectancy is high when death rate is low
density higher than the India’s average and / or instances of early death are low.
density. Bihar is the most densely populated
state in the country with 1,102 persons Table 7.5 Life Expectancy
living per sq.km followed by West Bengal Year Male Female Overall
with 880. Arunachal Pradesh has low
density of population of only 17 persons. 1951 32.5 31.7 32.1
1991 58.6 59.0 58.7
d. Sex ratio 2001 61.6 63.3 62.5
It refers to the number of females per 2011 62.6 64.2 63.5
1,000 males. It is an important indicator (Source: Registrar General of India)
to measure the extent of prevailing equity
between males and females at a given During 1901 – 11, life expectancy was
point of time. just 23 years. It increased to 63.5 years
in 2011. A considerable fall in death rate
Table 7.4 Sex Ratio is responsible for improvement in the
Census year Sex ratio life expectancy at birth. However the life
(Number of females per expectancy in India is very low compared
1000 males) to that of developed countries.
1951 946
f. Literacy ratio
2001 933
It refers to the number of literates as a
2011 940 percentage of the total population. In
(Source: Registrar General of India) 1951, only one-fourth of the males and
one-twelfth of the females were literates.
In India, the sex ratio is more favourable to Thus, on an average, only one-sixth of the
males than to females. In Kerala, the adult people of the country were literates. In
sex ratio is 1084 as in 2011. The recent 2011, 82% of males and 65.5% of females
census (2011) shows that there has been a were literates giving an overall literacy
marginal increase in sex ratio. Haryana has rate of 74.04% (2011). When compared
the lowest sex ratio of 877 (2011) among to other developed countries and even Sri
other states, while Kerala provides better Lanka this rate is very low.
status to women as compared to other
States with 1084 females per 1000 males Table 7.6 Literacy ratio
Census Literate Males Females
e. Life expectancy at birth
year persons
It refers to the mean expectation of life at 1951 18.3 27.2 8.9
birth. Life expectancy has improved over
2001 64.8 75.3 53.7
the years. Life expectancy is low when
death rate is high and / or instances of early 2011 74.04 82.1 65.5
death are high. On the other hand, life (Source: Registrar General of India)

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 Kerala has the highest literacy ratio (94%), According to Agricultural Census,
Mizoram (91.3%),followed by Goa (88.7%), the area operated by large holdings (10
Himachal Pradesh (82.8%), Maharastra hectares and above) has declined and area
(82.3%),Sikkim (81.4%), and Tamil Nadu operated under marginal holdings (less
(80.1%). Bihar has the lowest literacy ratio than one hectare) has increased. This
(61.8%) in 2011. indicates that land is being fragmented
and become ineconomic.
7.4
Natural Resources
7.4.2 Forest Resources

Any stock or reserve that can be drawn India’s forest cover in 2007 is 69.09 million
from nature is a Natural Resource. The hectare which constitutes 21.02 per cent of the
major natural resources are - land, forest, total geographical area. Of this, 8.35 million
water, mineral and energy. India is rich hectare is very dense forest, 31.90 million
in natural resources, but majority of the hectare is moderately dense forest and the rest
Indians are poor. Nature has provided 28.84 million hectare is open forest.
with diverse climate, several rivers for
irrigation and power generation, rich 7.4.3 Important Mineral
minerals, rich forest and diverse soil. Resources
a. Iron-Ore
Types of Natural resources India possesses high quality iron-ore in
(a) Renewable Resources: Resources
abundance. The total reserves of iron-ore
that can be regenerated in a in the country are about 14.630 million
given span of time. E.g. forests, tonnes of haematite and 10,619 million
wildlife, wind, biomass, tidal, tonnes of magnetite. Hematite iron is
hydro energies etc. mainly found in Chattisgarh, Jharkhand,
Odisha, Goa and Karnataka.The major
(b) Non-Renewable Resources:
deposit of magnetite iron is available at
Resources that cannot be
western coast of Karnataka. Some deposits
regenerated. E.g. Fossil fuels-
of iron ore are also found in Kerala, Tamil
coal, petroleum, minerals, etc.
Nadu and Andhra Pradesh.

b. Coal and Lignite

7.4.1 Land Resources
Coal is the largest available mineral
In terms of area India ranks seventh in resource. India ranks third in the world
the world with a total area of 32.8 lakh after China and USA in coal production.
sq. km. It accounts for 2.42% of total area The main centres of coal in India are the
of the world. In absolute terms India is West Bengal, Bihar, Madhya Pradesh,
really a big country. However, land- man Maharashtra,Odisha and Andhra Pradesh.
ratio is not favourable because of the huge Bulk of the coal production comes from
population size. Bengal-Jharkhand coalfields.
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 c. Bauxite Kimberlile fields have been discovered in
Raipur and Pastar districts of Chattisgarh,
Bauxite is a main source of metal
Nuapada and Bargarh districts of Odisha,
like aluminium. Major reserves are
Narayanpet – Maddur Krishna areas of
concentrated in the East Coast bauxite
Andhra Pradesh and Raichur-Gulbarga
deposits of Odisha and Andhra Pradesh.
districts of Karnataka.
d. Mica
Mica is a heat resisting mineral which 7.5
is also a bad conductor of electricity. It
Infrastructure
is used in electrical equipments as an
insulator. India stands first in sheet mica
production and contributes 60% of mica Infrastructural development means the
trade in the world. The important mica development of many support facilities.
bearing pegmatite is found in Andhra These facilities may be divided into (a)
Pradesh, Jharkhand, Bihar and Rajasthan. economic infrastructure and (b) social
infrastructure. Economic infrastructure
includes - transport, communication,
e. Crude Oil
energy, irrigation, monetary and financial
Oil is being explored in India at many places institutions. Social infrastructure includes
of Assam and Gujarat. Digboi, Badarpur, - education, training and research, health,
Naharkatia, Kasimpur, Palliaria, Rudrapur, housing and civic amenities.
Shivsagar, Mourn (All in Assam) and Hay
of Khambhat, Ankaleshwar and Kalol (All
in Gujarat) are the important places of oil 7.6
exploration in India.
Economic
f. Gold Infrastructure
India possesses only a limited gold reserve.
There are only three main gold mine Economic infrastructure is the support
regions—Kolar Goldfield, Kolar district system which helps in facilitating
and Hutti Goldfield in Raichur district production and distribution. For instance,
(both in Karnataka) and Ramgiri Goldfield railways, trucks, posts and telegraph
in Anantpur district (Andhra Pradesh). offices, ports, canals, power plants, banks,
insurance companies etc. are all economic
g. Diamond infrastructure of an economy. They help
As per UNECE (United Nations Economic in the production of goods and services.
Commission for Europe)the total reserves
of diamond is estimated at around 4582,
thousand carats which are mostly available 7.6.1 Transport
in Panna(Madhya Pradesh),Rammallakota For the sustained economic growth of a
of Kurnur district of Andhra Pradesh and country, a well-connected and efficient
also in the Basin of Krishna River.The new
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 transport system is needed. India has
7.6.2 Energy
a good network of rail, road, coastal
shipping, and air transport. The total Electrical energy is one of the necessary
length of roads in India being over 30 components of our life. Nowadays, without
lakh km, India has one of the largest electricity, we cannot survive in this
road networks in the world. In terms of world of technology. The energy sources
railroads, India has a broad network of are classified under two heads based on
railroad lines, the largest in Asia and the the availability of the raw materials used,
fourth largest in the world. The total rail while generating energy.
route length is about 63,000 km and of
this 13,000 km is electrified. The major 1. Non-renewable energy sources
Indian ports including Calcutta, Mumbai, 2. Renewable energy sources
Chennai, Vishakhapatnam and Goa
handle about 90% of sea- borne trade and 1. Non-renewable energy sources
are visited by cargo carriers and passenger As the name suggests, the sources
liners from all parts of the world. A of energy which cannot be renewed
comprehensive network of air routes or re-used are called non-renewable
connects the major cities and towns of energy sources. Basically these are
the country. The domestic air services are the energy sources which will get
being looked after by Indian Airlines and exhausted over a period of time.
private airlines. The international airport Some of the examples of this kind of
service is looked after by Air India. resources are coal, oil, gas etc.
2. Renewable energy sources

Indian Railways Provide Wi-Fi These are the kind of energy source
Facility First in India is Bangalore which can be renewed or reused again
Railway Station and again. These kinds of materials
do not exhaust or literally speaking
these are available in abundant or
infinite quantity. Example for this
Air India and Indian Airlines were kind include
merged on August 27, 2007 to from 1. Solar energy
National Aviation Company of India
2. Wind energy
Ltd. (NACIL)
3. Tidal energy
4. Geothermal energy

The National Harbour board was 5. Biomass energy

set up in1950 to advise the Central Sometimes renewable sources are also
and State Governments on the called non-conventional sources of energy
management and development of since, these kinds of materials or these
ports, particularly minor ports ways of energy production were not used
earlier or conventionally.
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 7.7 The education system in India
consists of primarily six levels:
Social Infrastructure
„„Nursery Class
Social infrastructure refers to those „„Primary Class
structures which are improving the quality „„Secondary Level
of manpower and contribute indirectly „„Higher Secondary Level
towards the growth of an economy.
„„Graduation
These structures are outside the system
of production and distribution. The „„Post-Graduation
development of these social structures
help in increasing the efficiency and c. Education Institutions in India:
productivity of manpower. For example, Education in India follows the 10+2
schools, colleges, hospitals and other pattern. For higher education, there
civic amenities. It is a fact that one of are various State run as well as private
the reasons for the low productivity of institutions and universities providing
Indian workers is the lack of development a variety of courses and subjects. The
of social infrastructure. The status and accreditation of the universities is decided
developments in the social infrastructure under the University Grants Commission
in India are discussed below. Act. The Education Department consists of
various schools, colleges and universities
7.7.1 Education imparting education on fair means for all
sections of the society. The budget share of
a. Education in India the education sector is around 3% of GDP,
Imparting education on an organized of this largest proportion goes for school
basis dates back to the days of ‘Gurukul’ education. However, per pupil expenditure
in India. Since then the Indian education is the lowest for school students.
system has flourished and developed with
the growing needs of the economy. The 7.7.2 Health
Ministry of Human Resource Development
a. Health in India
(MHRD) in India formulates education
policy in India and also undertakes Health in India is a state government
education programs. responsibility. The Central Council Of
Health and Welfare formulates the various
b. Education system in India health care projects and health department
Education in India until 1976 was the reform policies. The administration of
responsibility of the State governments. health industry in India as well as the
It was then brought under concurrent technical needs of the health sector are the
list (both Centre and State). The Centre responsibility of the Ministry Of Health
is represented by the Ministry of Human And Welfare.
Resource Development decides the India’s Health care in India has many
education budget. forms. These are the ayurvedic medicine
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 practice, unani or galenic herbal care, support of life. Since rain provides food,
homeopathy, allopathy, yoga, and many it forms the basis for stable economic life.
more. Each different healthcare form has Agriculture which is the most fundamental
its own treatment system and practice economic activity depends on rain,”It is rain
patterns. The medical practicing in India that both ruins and aids the ruined to rise”.
needs a proper licensing from the Ministry
of Health. All medical systems are now a. Factors of Production
under one ministry viz AYUSH.
Thiruvalluvar has made many passing
references about the factors of production
b. Health Care Services in India: viz., Land, Labour, Capital, Organisation,
The health care services in India are mainly Time, Technology etc. He says, “Unfailing
the responsibility of the Ministry of Health. harvest, competent body of men, group of
State wise, health status is better in Kerala men, whose wealth knows no diminution, are
as compared to other States. Compared to the components of an economy”.(Kural 61)
other developed countries, India’s health
status is not satisfactory. India’s health b. Agriculture
status is poor compared to Sri Lanka.
According to Thiruvalluvar, agriculture is the
most fundamental economic activity. They
7.8 are the axle-pin of the world, for on their
prosperity revolves prosperity of other sectors
Contributions of Indian of the economy, “The ploughmen alone”, he
Economic Thinkers says “live as the freemen of the soil; the rest
are mere slaves that follow on their toil”(Kural
7.8.1 Thiruvalluvar 1032). Valluvar believes that agriculture is
superior to all other occupation.
The economic ideas of
Thiruvalluvar are found
c. Public Finance
in his immortal work,
Thirukkural, a book Thiruvalluvar has elaborately explained
of ethics. Even though Public Finance under the headings Public
scholars differ widely Revenue, Financial Administration and
over the estimation of the Public expenditure. He has stated these
period of Thiruvalluvar, it is generally believed as 1) Creation of revenue, 2) Collection
that, he belongs to the Sangam age in Tamil of revenue, 3) Management of revenue
Nadu around third century A.D. Thiruvalluvar’s 4) Public expenditure
work is marked by pragmatic idealism.
A large part of Valluvar’s economic d. Public Expenditure
ideas are found in the second part of Valluvar has recommended a balanced budget.
Thirukkural, the porutpal. It deals with “ It is not a great misfortune for a state if its
wealth. Thiruvalluvar is a fundamental revenues are limited, provided the expenditure
thinker. He believes that rains are the basic is kept within bounds.” He has given certain

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 guidelines for a budgetary policy. “Budget for a 3) good crop 4) prosperity and happiness
surplus, if possible, balances the budget at other and 5) full security for the people.
times, but never budget for a deficit.” Valluvar
advocates the following main items of public 7.8.2 Mahatma Gandhi
expenditure: 1) Defence 2) Public Works and
3) Social Services. Gandhian Economics is
based on ethical foundations.
e. External Assistance In 1921, Gandhi wrote,
“Economics that hurts the
Valluvar was against seeking external
moral well-being of an
assistance. According to Kural No. 739,
individual or a nation is immoral, and
countries taking external assistance are not
therefore, sinful.” Again in 1924, he repeated
to be considered as countries at all. In other
the same belief: “that economy is untrue
words, he advocated a self-sufficient economy.
which ignores or disregards moral values”.

f. Poverty and Begging Salient Features of Gandhian

Valluvar consideres freedom from hunger Economic Thought
as one of the fundamental freedoms 1. Village Republics: To Gandhi, India
that should be enjoyed by every citizen. lives in villages. He was interested
According to him ‘poverty’ is the root in developing the villages as self-
cause of all other evils which would lead to sufficient units. He opposed extensive
ever-lasting sufferings. It is to be noted that use of machinery, urbanization and
the number of people living below poverty industrialization.
line, begging, sleeping on the roadsides and 2. On Machinery: Gandhi described
rag picking in India has been increasing. machinery as ‘Great sin’. He said that
“Books could be written to demonstrate
g. Wealth its evils… it is necessary to realize that
Valluvar has regarded wealth as only a machinery is bad. Instead of welcoming
means and not an end. He said, “Acquire machinery as a boon, we should look upon
a great fortune by noble and honorable it as an evil. It would ultimately cease.
means.” He condemned hoarding and 3. Industrialism: Gandhi considered
described hoarded wealth as profitless industrialism as a curse on mankind. He
richness. To him industry is real wealth thought industrialism depended entirely
and labour is the greatest resource. on a country’s capacity to exploit.
4. Decentralization: He advocated
h. Welfare State a decentralized economy, i.e.,
Thiruvalluvar is for a welfare state. In a welfare production at a large number of
state there will be no poverty illiteracy, places on a small scale or production
disease and industry. The important elements in the people’s homes.
of a welfare state are 1) perfect health of the 5. Village Sarvodaya: According to
people without disease 2) abundant wealth, Gandhi, “Real India was to be found in
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 villages and not in towns or cities.” So
7.8.3 Jawaharlal Nehru
he suggested the development of self-
sufficient, self-dependent villages. Jawaharlal Nehru,
6. Bread Labour: Gandhi realized one of the chief
the dignity of human labour. He builders of Modern
believed that God created man to eat India, was the first
his bread by the sweat of his brow. Prime Minister of
Bread labour or body labour was the Independent India and he was there in
expression that Gandhi used to mean that post till his death in 1964. He was a
manual labour. great patriot, thinker and statesman. His
7. The Doctrine of Trusteeship: views on economics and social problems
Trusteeship provides a means of are found in the innumerable speeches he
transforming the present capitalist made and in the books he wrote.
order of society into an egalitarian
a. Democracy and Secularism
one. It gives no quarter to capitalism.
However, now India experiences both Jawaharlal Nehru was a firm believer in
casino capitalism and crony capitalism democracy. He believed in free speech
8. On the Food Problem: Gandhi was civil liberty,adult franchise and the Rule
against any sort of food controls. He of Law and Parliamentary democracy.
thought such controls only created Secularism, is another signal contribution
artificial scarcity. Once India was of Nehru to India. In our country,
begging for food grain, but India tops there are many religions - Hinduism,
the world with very large production Islam, Christianity, Buddhism, Jainism,
of foodgrains, fruits, vegetables, Zoroastrianism, Sikhism and so on.
milk, egg,meat etc., But there is no domination by religious
majority. Secularism means equal respect
9. On Population: Gandhi opposed for all religions.
the method of population control
through contraceptives. He was, b. Planning
however, in favour of birth control
Jawaharlal Nehru was responsible for the
through Brahmacharya or self-
introduction of planning in our country. To
control. He considered self-control
Jawaharlal Nehru, the Plan was essentially
as a sovereign remedy to the problem
an integrated approach for development.
of over-population.
Initiating the debate on the Second Plan
10. On Prohibition: Gandhi advocated in the Lok Sabha in May 1956, Nehru
cent per cent prohibition. He regarded spoke on the theme of planning. He said,
the use of liquor as a disease rather “the essence of planning is to find the best
than a vice. He felt that it was better for way to utilize all resources of manpower, of
India to be poor than to have thousands money and so on.” Planning for Nehru was
of drunkards. But now many states essentially linked up with industrialization
depend on revenue from liquor sales. and eventual self-reliance for the country’s

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 economic growth on a self- accelerating M.Sc degree in 1921. And his thesis“
growth. Nehru carried through this basic The Problem of the Rupee” was accepted
strategy of planned development. Nehru’s for the award of the D.Sc degree by the
contribution to the advancement of science, London School of Economics in 1923. It is
research, technology and industrial a miracle that RBI was conceptualized as
development cannot be forgotten. It was per the guidelines presented by Ambedkar
during his period, many IITs and Research in his book, “The Problem of the Rupee;Its
Institutions were established. He always origin and its solution”. The main economic
insited on “scientific temper”. ideas of Ambedkar may be studied under
four broad headings:
c. Democratic Socialism 1. Financial Economics
Socialism is another contribution of Nehru Much of the work done by Ambedkar
to India. He put the country on the road during his stay abroad mostly
towards a socialistic pattern of society. But during the period 1913-1923, was
Nehru’s socialism is democratic socialism. in the field of Finance Economics.
Ambedkar divided the evolution of
7.8.4 B. R. Ambedkar provisional finance into three stages:
(i). Budget by Assignment (1871-72
B. R. Ambedkar (1891- to 1876-77); (ii) Budget by Assigned
1956) was a versatile Revenue (1877-78 to 1881-82); and
personality. He was (iii) Budget by Shared Revenues
the architect of the (1882-83 to 1920-1921).
Indian Constitution, 2. Agricultural Economics
a custodian of social In 1918, Ambedkar published a paper
justice and a champion “Small Holding in India and their
of socialism and state Remedies”. Citing Adam Smith’s ‘Wealth
planning. Ambedkar’s of Nations”, he made a fine distinction
writings included between “Consolidation of Holdings”
“Ancient Indian Commerce” (a thesis and “Enlargement of Holdings”.
submitted to the Columbia University for the
3. Economics of Caste
award of the Master of Arts Degree in 1915),
‘National Dividend of India: A Historical Ambedkar believed that caste was an
and Analytical Study (a thesis for which he obstacle to social mobility. It resulted
was awarded Ph.D). His thesis was published in social stratification. He was of
as ‘The Evolution of Provincial Finance the firm view that individuals must
in British India: A Study of the Provincial be free to change their occupations.
Decentralization of Imperial Finance”. Moreover, the caste system caused
social tensions. The caste system
Ambedkar’s thesis on “Provincial
has resulted in the absence of social
Decentralization of Imperial Finance
democracy in India as distinct from
in British India” was accepted for the
political democracy.

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 4. Economics of Socialism development, competition and efficiency
Ambedkar was a socialist. He was in free-market economies. Gandhi and
a champion of state socialism. He Kumarappa envisioned an economy focused
advocated the nationalization of all on satisfying human needs and challenges
key industries and suggested state while rooting out socio-economic conflict,
ownership of land and collective unemployment, poverty and deprivation.
farming. He was for state monopoly Kumarappa worked as a Professor
of insurance business. Not only that, of economics at the Gujarat Vidyapith in
he advocated compulsory insurance Ahmedabad, while serving as the editor of
for every citizen. Young India during the Salt Satyagraha. He
There is no doubt that Ambedkar was founded the All India Village Industries
a great economist. But his academic Association in 1935; and was imprisoned
work as an economist was eclipsed for more than a year during the Quit India
by his greater contributions in the movement. He wrote during his imprisonment,
field of law and politics. Above all he Economy of Permanence: The Practice and
was a great social reformer. Precepts of Jesus (1945) and Christianity: Its
Economy and Way of Life (1945).
7.8.5 J. C. Kumarappa Several of Gandhi’s followers
developed a theory of environmentalism.
Joseph Chelladurai
Kumarappa took the lead in a number of
Kumarappa was born
relevant books in the 1930s and 1940s.
on 4 January 1892
Historian Ramachandra Guha calls
in Tanjavur, Tamil
Kumarappa, “The Green Gandhian,”
Nadu. A pioneer of
portraying him as the founder of modern
rural economic development theories,
environmentalism in India.
Kumarappa is credited for developing
economic theories based on Gandhism – Kumarappa worked for the Planning
a school of economic thought he coined Commission of India and the Indian National
“Gandhian Economics”. Congress to develop national policies for
agriculture and rural development. He also
Gandhian Economics travelled to China, Eastern Europe and
J.C.Kumarappa strongly supported Japan on diplomatic assignments and to
Gandhi’s notion of village industries and study their rural economic systems.
promoted Village Industries Associations.
Kumarappa worked to combine Christian
7.8.6 V.K.R.V. Rao
and Gandhian values of “trusteeship”, non-
violence and a focus on human dignity According to P.R. Brahmananda, “ the great
and development in place of materialism trinity of pre- independent and post independent
as the basis of his economic theories. Indian economists consisted of D.R.Gadgill,
While rejecting socialism’s emphasis on C.N.Vakil and V.K.RV. Rao. These scholars
class war and force in implementation, were imbibed with a missionary zeal and
he also rejected the emphasis on material analyzed the Indian economic problems with
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 a view to designing and international attack on world poverty,
propagating economic not only through his contributions to
policies/programmes the question of international aid and
and plans to India’s improved flows of external resources,
national advantage.” but also through his activities in the
V.K.R.V: Rao was a field of food aid.
prolific writer. 3. Support for Socialism
V.K.R.V: Rao was deeply interested During the early phases of planning
in three large themes. They were: in India, Rao supported the case of a
i. National Income, socialist India, where the state would
ii. Food, nutrition and the distribution control the commanding heights of
of good; and the economy and the public sector
would play a dominant role in
iii. Employment and occupational
economic development.
distributions.
1. National Income Methodology 4. Rao’s Views on Industrialization

As an applied economist, Rao’s name In his pamphlet “What is wrong with

is remembered for his pioneering Indian Economic Life?’ (1938), Rao
work on the enumeration of national gave the following reasons for low
income of India. Rao was a pupil per capita income and low levels of
of J.M. Keynes and he worked with per capita nutrition in India.
Colin Clark. H.W Singer considered i. Uneconomic holdings with sub-
V.K.R.V Rao as “ the best equipped divisions and fragmentation;
of all Keynes’ pupils. He attempted ii. Low levels of water availability for crops;
(i) to develop the national income iii. Excess population pressure on
concepts suited to India and agriculture due to the absence of a
developing countries generally; (ii) large industrial sector;
to analyze the concepts of investment,
iv. Absence of capital;
saving and the multipliers in an
underdeveloped economy; and (iii) v. Absence of autonomy in currency
to study the compatibility of the policy, and in general in monetary
national incomes of industrialized matters encouraging holding of gold.
and underdeveloped countries. 5. Village Clusters
Rao’s paper on “Full Employment
Rao felt that rural communities had
and Economic Development” was
to be given a viable base.Therefore
one of the earliest contributions in
he suggested that a cluster of
the field of development towards
villages should form a unit for rural
employment.
development, so that both social
2. International Food Aid and economic interactions between
Rao was influential in creating villages could develop, and they
ideas and shaping policy in the could effectively generate and fashion
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 their own development with a more and drew attention to the incidence of
meaningful participation by people. absolute and relative deprivation.
6. Investment, Income and Multiplier 2. Poverty and Inequality
Rao’s examination of the “interrelation Sen has carried out massive work
between investment, income and on poverty and inequality in
multiplier in an under developed India. Sen’s major point has been
economy” (1952) was his major that the distribution of income/
contribution to macroeconomic consumption among the persons
theory. As a thinker, teacher, below the poverty line is to be taken
economic adviser and direct policy into account.
maker, V.K.R.V. Rao followed the 3. The Concept of Capability
footsteps of his great teacher, John
The concept of capabilities developed
Maynard Keynes.
by Sen has been cited as a better
7. Institution Builder index of wellbeing than commodities
He founded three national level or utilities. Capability, as defined
research institutes namely Delhi by Sen, is the ability to transform
School of Economics, Institute of Rawlsian primary goods to the
Economic Growth (both at Delhi) achievement of wellbeing.
and Institute for Social and Economic 4. Entitlement
Change (Bangalore)
Sen has included the concept of
entitlement items like nutrition,
food, medical and health care,
7.8.7 Amartya Kumar Sen
employment, security of food
The Nobel citation supply in times of famine etc. He
refers to Sen’s considered famine as arising out of
contributions to the failure of establishing a system of
social choice theory, entitlements.
development 5. Choice of Technique
economics, study on poverty and famines Sen’s ‘Choice of Technique ‘ was a
and concept of entitlements and capability research work where he argued that in
development (1998). a labour surplus economy, generation
1. Poverty and Famines of employment cannot be increased
Sen's Poverty and Famines: An Essay at the initial stage by the adaptation
on Entitlement and Deprivation” of capital- intensive technique.
(1981) is both a theoretical and an Conclusively, Amartyasen, more
applied work. In the book, several than just an economist, is an ethical
famines have been studied in the philosopher. He is a lover of freedom
working of a general theoretical and a humanist. He has focused on the
framework from an original angle. He poor, viewing them not as objects of
examined various meanings of poverty pity requiring charitable hand–outs,
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 but as disempowered folk needing
empowerment, education,health, Per Capita Average national
nutrition, gender equality,safety net Income income per head
in times of distress; all are needed to of population. It is
empower people. obtained by dividing
the National Income by
population size.
7.9
Conclusion
Natural Goods and services
Resources provided by the nature.
This lesson mainly focused on some of
In other words, any
the aspects of the Indian Economy and
stock or reserve that
its resources, infrastructure facilities
can be drawn from
and energy, It also discussed the
nature.
principles of Indian Economic thinkers
to motivate the students to read good
books on Economics Written by the great Renewable Resources that can be
economists. Resources regenerated in a given
span of time.
Glossary
Non- Resources that are
Economic Transformation of an Renewable exhaustive and cannot
Growth economy from a state of Resources be regenerated
under development to
a state of development Deforestation Clearing of forests,
which is measured trees and thereby forest
by Gross Domestic land is converted to a
Product (GDP). non-forest use.
Economic An improvement in
Development citizens quality of Energy Crisis Situation in which
life and well being energy resources are
of a country which less than the demand
is measured by per and there is shortage of
capita income along energy.
with several other
development indicators.
Doctrine of Doners who act as
Gross Total monetary value
Trusteeship the trustees of their
Domestic of the goods and
property or business.
Product services produced by
that country over a
specific period of time,
normally a year.
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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. The main gold mine region in 6. The weakness of Indian Economy is

Karnataka is ……….. …….
a. Kolar a. Economic disparities
b. Ramgiri b. Mixed economy
c. Anantpur c. Urbanisation
d. Cochin d. Adequate employment
2. Economic growth of a country opportunities
is measured by national income
7. A scientific study of the characteristics
indicated by …..
of population is ….
a. GNP b. GDP
a. Topography
c. NNP d. Per capita income
b. Demography
3. Which one of the following is a
c. Geography
developed nations ?
d. Philosophy
a. Mexico
b. Ghana 8. The year 1961is known as …..
c. France a. Year of small divide
d. Sri Lanka b. Year of Population Explosion

4. The position of Indian Economy c. Year of Urbanisation

among the other strongest economies d. Year of Great Divide
in the world is ..
9. In which year the population of India
a. Fourth
crossed one billion mark ?
b. Seventh
a. 2000 b. 2001
c. Fifth
c. 2005 d. 1991
d. Tenth
10. The number of deaths per thousand
5. Mixed economy means …… population is called as …
a. Private sectors and banks a. Crude Death Rate
b. Co-existence of Public and Private b. Crude Birth Rate
sectors
c. Crude Infant Rate
c. Public sectors and banks
d. Maternal Mortality Rate
d. Public sectors only

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 11. The number of births per thousand 16. Ambedkar the problem studied by in
population is called as the context of Indian Economy is …….
a. Crude death rate a. Small land holdings and their
b. Mortality rate remedies

c. Morbidity rate b. Problem of Indian Currency

d. Crude Birth Rate c. Economics of socialism

d. All of them
12. Density of population =
a. Land area / Total Population 17. Gandhian Economics is based on the
Principle
b. Land area / Employment
a. Socialistic idea
c. Total Population / Land area of the
region b. Ethical foundation

d. Total Population / Employment c. Gopala Krishna Gokhale

d. Dadabhai Naoroji
13. Who introduced the National
Development Council in India? 18. V.K.R.V Rao was a student of
a. Ambedkar a. J.M. Keynes
b. Jawaharlal Nehru b. Colin Clark
c. Radhakrishanan c. Adam smith
d. V.K.R.V. Rao d. Alfred Marshal

14. Who among the following propagated 19. Amartya Kumara Sen received the
Gandhian Ecomomic thinkings. Nobel prize in Economics in the year
a. Jawaharlar Nehru a. 1998
b. VKRV Rao b. 2000
c. JC Kumarappa c. 2008
d. A.K.Sen d. 2010

15. The advocate of democratic socialism 20. Thiruvalluvar economic ideas mainly
was dealt with
a. Jawaharlal Nehru a. Wealth
b. P.C. Mahalanobis b. Poverty is the curse in the society
c. Dr. Rajendra Prasad c. Agriculture
d. Indira Gandhi d. All of them

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 Part- A - Answers

1 2 3 4 5 6 7 8 9 10
a b c b b a b b b a
11 12 13 14 15 16 17 18 19 20
d c b c a b b a a d

Part-B 
Answer the following questions in one or two sentences.

21. Write the meaning of Economic 25. Give the meaning of non-renewable
Growth. energy.

22. State any two features of developed 26. Give a short note on Sen’s ‘Choice of
economy. Technique’.

23. Write the short note on natural 27. List out the reasons for low per capita
resources. income as given by V.K.R.V. Rao.

24. Point out any one feature of Indian

Economy.

Part-C Answer the following questions in one paragraph.

28. Define Economic Development. 32. Write the V.K.R.V.Rao’s contribution

on multiplier concept.
29. State Ambedkar’s Economic ideas on
agricultural economics. 33. Write a short note on Welfare
Economics given by Amartya Sen.
30. Write a short note on village
sarvodhaya. 34. Explain Social infrastructure.

31. Write the strategy of Jawaharlal Nehru

in India’s planning.

Part-D Answer the following questions in about a page

35. Explain the strong features of Indian 37. Bring out Jawharlal Nehru’s contribution
economy to the idea of economic development.

36. Write the importance of mineral 38. Write a brief note on the Gandhian
resources in India. economic ideas.

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 ACTIVITY
1. Visit a village nearby you and find out the number households
living without basic facilities

References

Indian
1. Ramesh
Economy
Singh-by
- Indian
RameshEconomy
Singh 5th edition - McGraw Hill Publication
Indian
Gaurav
2.  Economy
datt &-Datt
Aswani
& Sundharam
Mahajan - Datt & Sundharam Indian Economy 72nd edition
- S.Chand
India’s Publication
Reforms: How They Produced Inclusive GrowthBy Jagdish Bhagwati; Arvind
Panagariya
3. Jagdish Bhagwati; Arvind Panagariya - India’s Reforms: How They Produced
Inclusive
Reforms Growth Transformation in IndiaBy Jagdish Bhagwati; Arvind Panagariya
and Economic
Jagdish
4. 
India: Bhagwati;GiantBy
The Emerging Arvind Arvind
Panagariya - Reforms and Economic Transformation in
Panagariya
India
http://www.economicsdiscussion.net/indian-economy/top-11-features-of-a-
5. Arvind Panagariya - India: The Emerging Giant
developing-economy/18987
http://www.economicsdiscussion.net/indian-economy/top-11-features-of-a-
developing-economy/18987

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 CH A P TER

8 Indian Economy Before

and After Independence

Freedom is never dear at any price. It is the breath of life.

What would a man not pay for living?
–Tyler Cowen

Learning Objectives

1 To understand the experience of India during

British Rule

2 To analyse the efforts taken by the Government of India after Independence,

8.1 important economic activities. India had

the bitter experience of colonialism.
Introduction

This chapter discusses the major events

8.2
that took place in India before and after
Independence. India was a colony for Indian Economy during
long. Colonialism refers to a system of the British Period
political and social relations between two
countries, of which one is the ruler and the Indian’s sea route trade to Europe started
other is its colony. The ruling country not only after the arrival of Vasco da Gama in
only has political control over the colony, Calicut, India on May 20, 1498. The
but it also determines the economic Portuguese had traded in Goa as early as
policies of the subjugated country. Thus, 1510. In 1601 the East India Company was
the people living in a colony cannot chartered, and the English began their first
take independent decisions in respect of inroads into the Indian Ocean. In 1614
utilisation of the country’s resources and Sir Thomas Roe was successful in getting

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 permission from Jahangir for setting up establishing monopoly trade in the
factories and slowly moved all parts of goods with India and the East India’s.
India. „„During this period, India had been
considered as the best hunting ground
for capital by the East Indian company
to develop industrial capitalism in
Britain.
„„When Bengal and South India came
under political shake of the East
India company in 1750s and 1760s,
the objective of monopoly trade was
fulfilled.
„„The company administration succeeded
in generating huge surpluses which
were repatriated to England, and the
Hundred years after Battle of Plassey, the Indian leaders linked this problem of
rule of the East India Company finally did land revenue with that of the drain.
come to an end. In 1858, British Parliament
„„Above all, the officers of the company
passed a law through which the power
were unscrupulous and corrupt.
for governance of India was transferred
from the East India Company (EIC) to
the British crown. Even the transfer of 8.2.2 Period of Industrial
power from the East India Company to Capital
the British Crown did not materially alter „„The period of Industrial capital was
the situation. from 1813 to 1858.
Britain had exploited India over „„During this period, India had become
a period of two centuries of its colonial a market for British textiles.
rule. On the basis of the form of colonial
„„India’s raw materials were exported
exploitation, economic historians have
to England at low price and imported
divided the whole period into three phases:
finished textile commodities to India
namely the period of merchant capital, the
at high price. In this way, Indians were
period of industrial capital, the period of
exploited.
finance capital.
„„India’s traditional handicrafts were
thrown out of gear.
8.2.1 Period of Merchant
Capital 8.2.3 Period of Finance
„„The period of merchant capital was Capital
from 1757 to 1813. „„The third phase was the period of
„„The only aim of the East India finance capital starting from the
Company was to earn profit by closing years of the 19th century and
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 continuing till independence. During „„Through discriminatory tariff policy,
this period, finance imperialism the British Government purposefully
began to entrench itself through the destroyed the handicrafts.
managing agency firms, export – „„With the disappearance of nawabs and
import firms, exchange banks and kings, There was no one to protect
some export of capital. Indian handicrafts.
„„Britain decided to make massive „„Indian handicraft products could not
investments in various fields (rail, compete with machine-made products.
road, postal system irrigation,
„„The introduction of railways in India
European banking system, and a
increased the domestic market for the
limited field of education etc) in India
British goods.
by plundering Indian capital.
„„Railway construction policy of the
British led to unimaginable as well 8.3
as uneconomic. The poor Indian
The Land Tenure
taxpayers had been compelled to
Systems in India
finance for the construction of railways.
The political power was handed over
to the British Government by the East Land Tenure refers to the system of land
India Company in 1858. ownership and management.The features
that distinguish a land tenure system from
the others relate to the following:

(a) Who owns the land ;

(b) Who cultivates the land;

(c) 
Who is responsible for paying the
land revenue to the government.

Based on these questions, three different

types of land tenure existed in India before
Independence. They were Zamindari system,
Mahalwari system and Ryotwari system.

8.3.1 Zamindari System or
8.2.4 Decline of Indian the Land lord-Tenant
Handicrafts System
„„The Indian handicrafts products had This system was created by the British East
a worldwide market. Indian exports India Company, when in 1793, LordCornwallis
consisted chiefly of hand weaved introduced ‘Permanent Settlement Act’.
cotton and silk fabrics, calicoes, Under this system the landlords or the
artistic wares, wood carving etc. Zamindars were declared as the owners of
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 the land and they were responsible to pay the (a) Industrial growth during the 19th
land revenue to the government. The share century
of the government in total rent collected was During the 19th century, British investors
fixed at 10/11th, the balance going to the started to pioneer industrial enterprises in
Zamindars as remuneration. India as they had experiences of running
industries at home. British enterprises also
8.3.2 Mahalwari System or received maximum state support. Although
Communal System of the Britishers initiated industrialisation
Farming process in the 19th century, they were
primarily interested in making profit and
After introduction of this system, it was
not in accelerating the economic growth
later extended to Madhya Pradesh and
in India. At the end of 19th century,
Punjab. The ownership of the land was
there were about 36 jute mills, 194 cotton
maintained by the collective body usually
mills and a good number of plantation
the villagers which served as a unit of
industries. The production of coal had
management. They distributed land
risen to over 6 million tonnes per annum.
among the peasants and collected revenue
from them and pay it to the state.
(b) Industrial progress during the 20th
century
8.3.3 Ryotwari System or During the first part of 20th century,
the Owner-Cultivator Swadeshi movement stimulated the
System industrialisation process in India. The
This system was initially introduced existing industries and new industries
in Tamil Nadu and later extended to had maintained a slow but steady growth
Maharashtra,Gujarat, Assam, Coorg, East till the outbreak of the First World War
Punjab and Madhya Pradesh. Under this in 1914.By this time more than 70 cotton
system the ownership rights of use and mills and 30 jute mills were set up. Coal
control of land were held by the tiller himself. production was doubled. The foundation
There was the direct relationship between of iron and steel industry was laid. Railway
owners and tillers. This system was the least network was extended.
oppressive system before Independence. During the period 1924-39, various
major industries like iron and steel, cotton
textiles, jute, matches, sugar, paper and
8.4 pulp industry etc. were brought under
Process of Industrial protection scheme. This led to rapid
Transition and Colonial expansion of protected industries in India.
Capitalism These protected industries captured the
entire Indian market and eliminated
This process of industrial transition in foreign competition totally.
India during the British period can be Thus in the early part, British rule
broadly classified into two as given below: tried to transform the Indian economy as
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 the producer of industrial raw materials
and tried to capture Indian market for 8.6
their industrial finished goods and thus Important Industrial
started exploiting Indian economy in a Policies Prior to 1991
different way. Later on, British capitalists
gradually developed various industries India is the Asia’s third largest economy.
like, jute, tea, coffee, cotton and textiles, The 70 years of Independence have
paper and paper pulp, sugar etc, in India brought a remarkable change in the socio
for locational advantages and exploited – economic landscape of India.
Indian labourers extensively.

8.5 Industrial Policy

Problems of British of India
Rule
1948, 1956, 1977, 1980, 1990 & 1991

1. The British rule stunted the growth

of Indian enterprise.
2. The economic policies of British
Economic development of a country
checked and retarded capital
particularly depends on the process
formation in India.
of industrialisation. At the time of
3. The drain of wealth financed capital Independence, India inherited a weak
development in Britain. and shallow industrial base. Therefore
4. Indian agricultural sector became during the post–Independence period,
stagnant and deteriorated even when the Government of India took special
a large section of Indian population emphasis on the development of a solid
was dependent on agriculture for industrial base. The Industrial Policy
subsistence. Resolutions of 1948 and 1956 clearly
5. The British rule in India led the stated the need for developing both small
collapse of handicraft industries scale industries and large scale industries.
without making any significant
contribution to development of any 8.6.1 Industrial Policy
modern industrial base. Resolutions 1948
6. Some efforts by the colonial British The Government of India recognized
regime in developing the plantations, the significant contribution of
mines, jute mills, banking and industrialization. Therefore the
shipping, mainly promoted a system Government of India declared its first
of capitalist firms that were managed Industrial Policy on 6th April 1948. The
by foreigners. These profit motives main importance of this policy was that
led to further drain of resources from it ushered in India the system of mixed
India. economy.
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 1. Industries were classified into
four groups such as public sector
(strategic industries), public–cum
–private Sector (key industries),
controlled private sector, private and
co-operative sectors.
production in the large scale sector by
2. This policy endeavoured to protect
differential taxation or by direct subsidies.
cottage and small scale industries.
3. This industrial policy emphasized
3. The central and state governments
the necessity of reducing the regional
had a virtual monopoly in rail roads
disparities in levels of development.
and exclusive rights to develop
minerals, iron ore etc. 4. The Government recognized the need
for foreign capital for progressive
4. The Government encouraged the
Indianisation of foreign concerns.
significance of foreign capital for
industrialization but the government
decided that the control should 8.7
remain with Indian hands.
Green Revolution

8.6.2 Industrial Policy
The term Green Revolution refers to the
Resolution 1956
technological breakthrough in agricultural
1. The Industrial Policy of 1956 sought practices. During 1960’s the traditional
to give a dominant role to public agricultural practices were gradually
sector. At the same time, it assured a
fair treatment to the private sector.
2. The Government would support and
encourage cottage and small scale
enterprises by restricting volume of

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 replaced by modern technology and (v) Green Revolution had positive
agricultural practices in India. Initially the effect on development of industries,
new technology was tried in 1960-61 as a which manufactured agricultural
pilot project in seven districts. It was called tools like tractors, engines,
as the High Yielding Varieties Programme threshers and pumping sets.
(HYVP). (vi) Green Revolution had brought
prosperity to rural people.
Achievement of Green Increased production had generated
Revolution employment opportunities for rural
(i) The major achievement of the masses. Due to this, their standard
new strategy was to boost the of living had increased.
production of major cereals (vii) Due to multiple cropping and more
viz., wheat and rice. India was use of chemical fertilizers, the
depending on the US for the food demand for labour increased.
grain. The US by using Public Law (viii) Financial resources were provided
480 (PL480) exported wheat to by banks and co-operative societies.
India. Indians were waiting for the These banks provided loans to
ships to sip their food. On the other farmers on easy terms.
hand, India has lots of minerals.
The US could strategically exploit
Indian mineral resources at The New Agricultural strategy
cheapest price for manufacturing was also called by various names.
missiles and weapons, which gave Modern agricultural technology,
job opportunity for larger US seed – fertilizer – water technology,
youth and largely contributed to or simply green revolution.
US GDP. But now India is food
surplus, exporting food grains to Weaknesses of Green
the European countries. Revolution
(ii) The Green revolution was confined
(i) Indian Agriculture was still a gamble
only to High Yielding Varieties
of the monsoons.
(HYV) cereals, mainly rice, wheat,
maize and jowar. (ii) This strategy needed heavy investment
in seeds, fertilizers, pesticides and
(iii) This Strategy was also directed
water.
to increase the production of
commercial crops or cash crops such (iii) The income gap between large,
as sugarcane, cotton, jute, oilseeds marginal and small farmers had
and potatoes. increased. Gap between irrigated and
rain fed areas had widened.
(iv) Per hectare productivity of all crops
had increased due to better seeds. (iv) Except in Punjab, and to some extent in
Haryana, farm mechanization had created

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 widespread unemployment among „„Contribution of private sector to
agricultural labourers in the rural areas. market the usage of GM foods.
(v) Larger chemical use and inorganic „„Government can play a key role in
materials reduced the soil fertility expediting irrigation schemes and
and spoiled human health. Now managing water resources.
organic farming is encouraged. „„Linking of rivers to transfer surplus
water to deficient areas.
Second Green Revolution
The Government of India had implemented 8.8
‘Second Green revolution’ to achieve higher
Large Scale Industries
agricultural growth. The target of Second
Green Revolution was to increase 400
million tonnes of food grain production The term “Large scale industries” refers
as against about 214 million tonnes in to those industries which require huge
2006-07. This is to be achieved by 2020. infrastructure, man-power and have influx
In agricultural sector, the growth rate of of capital assets. The term ‘large scale
5% to 6% has to be maintained over next industries’ is a generic one including various
15 years. There may be changes in these types of industries in its purview. All the
statistics. heavy industries of India like the iron and
steel industry, textile industry, automobile
Requirements of Second Green manufacturing industry fall under the large
revolution: scale industrial arena. However in recent
„„Introduction of Genetically Modified years due to the IT boom and the huge
(GM) seeds which double the per amount of revenue generated by it, the IT
acreage production. industry can also be included within the
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 jurisdiction of the large scale industrial Burnpur (WB) Acquired from
sector. Indian economy is heavily dependent private sector in
on these large industries for its economic 1976
growth, generation of foreign currency and
for providing job opportunities to millions
Vishakhapattnam Russia
(AP)
of Indians. The following are the major large
scale industries in India. Salem (Tamil Nadu) Government of
India (No external
assistance)
Vijai Nagar Government of
(Karnataka) India
Bhadrawati Nationalisation of
(Karnataka) Vishveshvarayya
Iron and Steel
Ltd(owned by
Centre and State
government)

zz All these are managed by SAIL (at

1. Iron and steel industry
present all important steel plants
zz First steel industry at Kulti, Near except TISCO, are under public sector)
Jharia, West Bengal - Bengal iron
zz Steel Authority of India Ltd
works company in 1870.
(SAIL) was established in 1974
zz First large scale steal plant TISCO and was made responsible for the
at Jamshedpur in 1907 followed by development of the steel industry.
TISCO at Burnpur in 1919. Both
zz Presently India is the eighth largest
belonged to private sector.
steel producing country in the
zz The first public sector unit was world.
“Vishveshvaraya Iron and Steel
2. Jute industry
works” at Bhadrawati.
zz Jute industry is an important industry
Public sector steel plants for a country like India, because not
only it earns foreign exchange but
Location Assistance also provides substantial employment
opportunities in agriculture and
Rourkela (Odissa) Germany
industrial sectors.
Bhilai (MP) Russia zz Its first modernised industrial unit
was established at Reshra in West
Durgapur (WB) UK
Bengal in 1855.
Bokaro (Jharkhand) Russia zz The jute industry in the country is
traditionally export oriented. India
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 ranks number one in the raw jute zz The paper industry in India is
and jute goods production and ranked among the 15 top global
number two in export of jute goods paper industries.
in the world.
7. Silk industry
3. Cotton and textile industry zz India is the second-largest(first
being China) country in the world
zz Oldest industry of India, and
in producing natural silk. At
employs largest number of workers.
present, India produces about 16%
zz It is the largest organised and broad- silk of the world.
based industry which accounts for
zz India enjoys the distinction of being
4% of GDP, 20% of manufacturing
the only country producing all the
value-added and one third of total
five known commercial varieties of
export earnings.
silk viz Mulberry, Tropical Tussar,
zz The first Indian modernised cotton Oak Tussar, Eri and Muga.
cloth mill was established in 1818
at Fort Gloaster near Calcutta. But 8. Petroleum and natural gas
this mill was not successful. The zz First successful Oilwell was dug in
second mill named “Mumbai’s India in 1889 at Digboi, Assam.
Spinning and Weaving Co.” was zz At present a number of regions with
established in 1854 at Bombay by oil reserves have been identified and
KGN Daber. oil is being extracted in these regions

4. Sugar industry zz For exploration purpose, Oil

and Natural Gas Commission
zz Sugar industry is the second largest (ONGC) was established in 1956 at
industry among agriculture-based Dehradun, Uttarakhand
industries in India.
zz India is now the largest producer
8.9
and consumer of sugar in the world.
Maharashtra contributes over one Small Scale
third of the Indian total sugar output, Industries
followed closely by Uttar Pradesh.
Small scale industries play an important
5. Fertiliser industry role for the development of Indian
zz India is the third largest producer economy in many ways. About 60 to
of nitrogenous fertilisers in the 70 percent of the total innovations
world. in India comes from the SSIs. Many
of the big businesses today were all
6. Paper industry
started small and then nurtured into big
zz The first mechanised paper mill businesses. The role of SSIs in economic
was set up in 1812 at Serampur in development of the country is briefly
West Bengal. explained in forthcoming paragraphs.
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 zz They help in improving the
standard of living of people
residing in suburban and rural
areas in India.
zz The entrepreneurial talent is tapped
in different regions and the income
is also distributed instead of being
concentrated in the hands of a few
individuals or business families.

Role of SSIs in Economic 3. Help in Mobilization of Local

Development Resources
zz SSIs help to mobilize and utilize
1. Provide Employment
local resources like small savings,
zz SSIs use labour intensive techniques. entrepreneurial talent etc., of
Hence, they provide employment the entrepreneurs, which might
opportunities to a large number otherwise remain idle and unutilized.
of people. Thus, they reduce the
zz They pave way for promoting
unemployment problem to a great
traditional family skills and
extent.
handicrafts. There is a great demand
zz SSIs provide employment to for handicraft goods in developed
artisans, technically qualified countries.
persons and professionals, people
zz They help to improve the growth
engaged in traditional arts, people
of local entrepreneurs and self-
in villages and unorganized sectors.
employed professionals in small
zz The employment-capital ratio is towns and villages in India.
high for the SSIs.
4. Pave for Optimisation of Capital
2. Bring Balanced Regional
zz SSIs require less capital per unit of
Development
output. They provide quick return
zz SSIs promote decentralized
on investment due to shorter
development of industries as most of
gestation period. The payback
the SSIs are set up in backward and
period is quite short in SSIs.
rural areas.
zz SSIs function as a stabilizing force
zz They remove regional disparities by by providing high output-capital
industrializing rural and backward ratio as well as high employment-
areas and bring balanced regional capital ratio.
development.
zz They encourage the people living
zz They help to reduce the problems in rural areas and small towns to
of congestion, slums, sanitation and mobilize savings and channelize
pollution in cities. They are mostly them into industrial activities.
found in outside city limits.

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 5. Promote Exports zz SSIs help to increase the per capita
zz SSIs do not require sophisticated income of India in various ways.
machinery. Hence, import the zz They facilitate development of
machines from abroad is not backward areas and weaker sections
necessary. On the other hand, there is of the society.
a great demand for goods produced zz SSIs are adept in distributing
by SSIs.Thus they reduce the pressure national income in more efficient
on the country’s balance of payments. and equitable manner among the
However, in the recent past large various participants of the society.
scale industries are able to borrow
large funds with low interest rate and
spend large sums on advertisements. 8.10
Hence SSSs are gradually vanishing.
Micro, Small and
zz SSIs earn valuable foreign exchange MediumEnterprises
through exports from India. (MSMEs)
6. Complement Large Scale Industries
zz SSIs play a complementary role to As on now, the following monetary limits
large scale sector and support the have been used for defining different
large scale industries. kinds of industrial service units. However,
these limits are subject to changes over
zz SSIs provide parts, components,
time.
accessories to large scale industries
and meet the requirements of large
scale industries through setting up Manufacturing Enterprises
units near the large scale units.
a. Micro Manufacturing Enterprises:
zz SSIs serve as ancillaries to large The investment in plant and machinery
scale units. does not exceed ₹25 lakhs.
7. Meet Consumer Demands b. Small Manufacturing Enterprises:
zz SSIs produce wide range of products The investment in plant and machinery
required by consumers in India. is more than twenty five lakh rupees
zz Hence, they serves as an anti- but does not exceed ₹5 crores.
inflationary force by providing c. Medium Manufacturing Enterprises:
goods of daily use. The investment in plant and machinery
8. Develop Entrepreneurship is more than ₹5 crores but not exceeding
₹10 crores.
zz SSIs help to develop a class of
entrepreneurs in the society. They help
the job seekers to become job givers. Service Enterprises
zz They promote self-employment and a. Micro Service Enterprises: The
spirit of self-reliance in the society. investment in equipment does not
exceed ₹10 lakhs.

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 b. Small Service Industries: The Bank etc. However, the government keeps
investment in equipment is more reducing the stake in PSU banks as and
than ₹10 lakhs but does not exceed when they sell shares. So, to that extent they
₹2 crores. can also become minority shareholders in
c. Medium Service Enterprises: The these banks. This is in accordance with the
investment in equipment is more privatization policy.
than ₹2 crores but does not exceed
₹5 crores. Private Sector Banks
In these banks, most of the equity is
owned by private bodies, corporations,
8.11 institutions or individuals rather
Public Sector and than government. These banks are
Private sector managed and controlled by private
banks promoters.
Of the total banking industry in India,
Public Sector Banks public sector banks constitute 72.9% share
Public sector bank is a bank in which the while the rest is covered by private players.
government holds a major portion of the In terms of the number of banks, there are
shares. Say for example, SBI is public sector 27 public sector banks and 22 private sector
bank, the government holding in this banks.As part of its differentiated banking
bank is 58.60%. Similarly PNB is a public regime, RBI, the apex banking body,
sector bank, the government holds a stake has given license to Payments Bank and
of 58.87%. Usually, in public sector banks, Small Finance Banks (SFBs). This is an
government holdings are more than 50 attempt to boost the government’s Financial
percent. Public sector banks are classified Inclusion drive. (But, there may be other
into two categories: 1. Nationalised Banks problems).
2. State Bank and its Associates. As a result, Airtel Payments Bank
In case of nationalized banks, the and Paytm Payments Bank Limited have
government controls and regulates the come up. How far these banks would help
functioning of the banking entity.Some the poor people is not known.
examples are SBI, PNB, BOB, OBC,Allahabad

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 8.12 Objectives of Nationalisation

Nationalisation The Government of India nationalized the

of Banks commercial banks to achieve the following
objectives.
After Independence, the Government 1. The main objective of nationalisation
of India adopted planned economic was to attain social welfare. Sectors
development. For this purpose, Five Year such as agriculture, small and village
Plans came into existence since 1951. industries were in need of funds
The main objective of the economic for their expansion and further
planning aimed at social welfare. Before economic development.
Independence commercial banks were 2. Nationalisation of banks helped to
in the private sector. These commercial curb private monopolies in order to
banks failed in helping the Government ensure a smooth supply of credit to
to achieve social objectives of planning. socially desirable sections.
Therefore, the government decided
3. In India, nearly 70% of population
to nationalize 14 major commercial
lived in rural areas. Therefore it was
banks on 19 July 1969. In 1980, again
needed to encourage the banking habit
the government took over another
among the rural population.
6 commercial banks.

Nationalization

1969 14 banks with deposits above ₹. 50 crores were Nationalized.

1980 6 banks with deposits above ₹. 200 crores were Nationalized
19 July 1969 15 April 1980
1. Allahabad Bank 1. Andhra Bank
2. Bank of Baroda 2. Corporation Bank
3. Bank of Maharashtra 3. New Bank of India
4. Canara Bank 4. Oriental Bank of Commerce
5. Central Bank of India 5. Punjab & Sindh Bank
6. Dena Bank 6. Vijaya Bank
7. Indian Bank
8. Indian Overseas Bank
9. Punjab National Bank
10. Syndicate Bank
11. Union Bank
12. United Bank of India
13. UCO Bank
14. Bank of India

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 4. Nationalisation of banks was required „„Its main focus was on the agricultural
to reduce the regional imbalances development of the country.
where the banking facilities were not „„This plan was successful and achieved
available. the GDP growth rate of 3.6% (more
5. Before Independence, the numbers than its target)
of banks were certainly inadequate.
After nationalization, new bank Second Five Year Plan
branches were opened in both rural (1956-1961)
and urban areas. „„It was based on the P.C. Mahalanobis
6. Banks created credit facilities mainly Model.
to the agriculture sector and its allied „„Its main focus was on the industrial
activities after nationalization. development of the country.
„„This plan was successful and achieved
After New Economic Policy 1991, the
the growth rate of 4.1%
Indian banking industry has been facing
the new horizons of competitions,
Third Five Year Plan
efficiency and productivity. With all these
(1961-1966)
developments people in villages and slums
depend largely on local money lenders for „„This plan was called ‘GadgilYojana’ also.
their credit need. This is unfortunate. „„The main target of this plan was to
make the economy independent and
to reach self propelled position or take
8.13 off.
Performance of India’s „„Due to Indo -China war, this plan could
Five Year Plans not achieve its growth target of 5.6%

Economic planning is the process in which Plan Holiday (1966-1969)

the limited natural resources are used
„„The main reason behind the plan
skillfully so as to achieve the desired goals.
holiday was the Indo-Pakistan war &
The concept of economic planning in India
failure of third plan.
or five year plan is derived from Russia
(then USSR). India has launched 12 five „„During this period, annual plans were
year plans so far. Twelfth five year plan was made and equal priority was given to
the last one. The government of India has agriculture, its allied sectors and the
decided to stop the launching of five year industry sector.
plans and it was replaced by NITI Aayog.
Fourth Five Year Plan
First Five Year Plan (1969-1974)
(1951-1956) „„There are two main objectives of this
„„It was based on the Harrod-Domar plan i.e. growth with stability and
Model. progressive achievement of self reliance.

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 „„This plan failed and could achieve „„For the first time, due to the pressure
growth rate of 3.3% only, against the from private sector the private sector
target of 5.7%. got the priority over public sector.
„„Its growth target was 5.0% but it
Fifth Five Year Plan achieved 6.0%.
(1974-1979)
Annual Plans
„„In this plan top priority was given to
agriculture, next came industry and Eighth five year Plan could not take place
mines. due to volatile political situation at the
„„Overall this plan was successful, centre. So two annual programmes are
which achieved the growth rate of formed in 1990-91& 1991-92.
4.8% against the target of 4.4%.
Eighth Five Year Plan
„„The draft of this plan was prepared
(1992-1997)
and launched by D.P. Dhar. This plan
was terminated in 1978. „„In this plan the top priority was
given to development of the human
Rolling Plan resources i.e. employment, education
and public health.
This plan was started with an annual plan
„„During this plan, New Economic
for 1978-79 and as a continuation of the
Policy of India was introduced.
terminated fifth year plan.
„„This plan was successful and got
annual growth rate of 6.8% against the
Sixth Five Year Plan target of 5.6%.
(1980-1985)
„„The basic objective of this plan was Ninth Five Year Plan
poverty eradication and technological (1997-2002)
self reliance. Poverty eradication „„The main focus of this plan was
(GARIBI-HATAO) was the motto. “growth with justice and equity”.
„„It was based on investment yojana. „„This plan failed to achieve the growth
„„Its growth target was 5.2% but it target of 7% and Indian economy grew
achieved 5.7%. only at the rate of 5.6%.

Seventh Five Year Plan Tenth Five Year Plan

(1985-1990) (2002-2007)

„„Objectives of this plan included the „„This plan aimed to double the per capita
establishment of the self sufficient income of India in the next 10 years.
economy and opportunities for „„It aimed to reduce the poverty ratio to
productive employment. 15% by 2012.

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 „„Its growth target was 8.0% but it
Government of India. It includes the
achieved only 7.2%.
matters of national and international
importance on the economic front,
Eleventh Five Year Plan
dissemination of best practices from
(2007-2012)
within the country and from other
„„Its main theme was “faster and more nations, the infusion of new policy ideas
inclusive growth”. and specific issue-based support. In
„„Its growth rate target was 8.1% but it order to understand the achievements
achieved only 7.9% of the NITI Aayog, researches need to
be done then and there.
Twelfth Five Year Plan
(2012-2017)
„„Its main theme is “Faster, More 8.14
Inclusive and Sustainable Growth”. Development
„„Its growth rate target is 8%. Indicators

Here it can be concluded that since the 8.14.1 Human Development

Indian Independence the five year plans Index (HDI)
of India played a very prominent role in United Nations Development Programme
the economic development of the country. has been publishing Human Development
These plans had guided the Government Report annually since 1990. HDI helped
as to how it should utilise scarce resources the government to the real uplifting of
so that maximum benefits can be gained. standard of living of the people.
It is worthy to mention here that Indian
Government adopted the concept of five
year plans from Russia. Human Development Index (HDI)
HDI was developed by the Pakistani
Economist Mahbub ul Haq and the
NITI Aayog Indian Economist Amartya Kumar
The Planning Commission has been Sen in 1990 and was published by
replaced by the NITI Aayog on the United Nations Development
1st January, 2015. NITI (National Programme (UNDP). It is constructed
Institution for Transforming India) based on Life Expectancy Index,
Aayog will monitor, coordinate and Education Index and GDP Per Capita.
ensure implementation of the accepted
sustainable development goals. NITI HDI is based on the following three
Aayog serves as a knowledge hub and indicators
monitors progress in the implementation
of policies and programmes of the 1. Longevity is measured by life
expectancy at birth,

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 2. Educational attainments, Development bracket. The other nations
3. Standard of living, measured by real such as Bangladesh, Bhutan, Pakistan, Kenya,
GDP per capita (PPP$). Myanmar and Nepal attained the medium
human development. The HDR 2016 stated
Before calculating HDI, the fixed
that regional disparities in education, health
minimum and maximum values of each
and living standards within India has caused
indicator are chosen.
India’s downfall to 27 % on HDI score. India’s
The performance in each dimension HDI rank value in 2015 stood at 0.624, which
is expressed as a value between 0 and 1 by had increased from 0.580 in 2010. India’s
applying the following formula rank in 2014 was 131.
Dimension Index = (Actual value
– Minimum value) / (Maximum value -
Top three countries of HDI
Minimum value)
Norway (0.949)
According to Planning Commission’s
Australia (0.939)
National Human Development Report 2011,
Switzerland (0.939)
HDI has improved significantly between
1980 and 2011. That is, The HDI went up
from 0.302 in 1981 to 0.472 score in 2011. Biswajeet Guha has stated that
As per latest Human Development the calculation of HDI neglected many
Report (2016) by the United Nations important aspects of human development.
Development Programme (UNDP), India has He has created four indices of HDI as HDI1,
been ranked 131st out of 188 countries. Out of HDI2, HDI3, and HDI4. HDI1 is based on
188 countries, India lies in Medium Human UNDP methodology as given in Human

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 Development Report. He has enlarged happened during British Rule. They
the scope of HDI by adding three more eradicated systems like ‘sati’, introduced
dimensions such as quality of life, poverty railway services, English language and
eradication, and urbanization. education, infrastructure and basic
Various countries including principle of capitalist economy. After
India are continuously making efforts to Independence, the Government of India
improve and enlarge the scope of available formulated many policies with the help
statistical information. of Five year plans to achieve the growth
target in various sectors. Among the
other things, the major challenges that
8.14.2 Physical Quality of Life still continue are: poor health standard,
Index (PQLI) female foeticide, declining child sex
ratio, open defecation, social & economic
Morris D Morris developed the Physical
inequalities, increasing slumming, urban
Quality of Life Index (PQLI). The PQLI is a
congestion and declining qualities of
measure to calculate the quality of life (well
basic environmental resources namely
being of a country). For this, he included
air, land and water
three indicators such as life expectancy, infant
mortality rate and literacy rate. A scale of each
indicator ranges from the number 1 to 100.
Number 1 represents the worst Glossary
performance by any country. 100 is the best „„Zamindari: The owner of the land
performance. For example, in case of life who pays the land revenue to the
expectancy, the upper limit of 100. This was Government.
assigned to 77 years which was achieved by
„„Mahalwari: The collective body
Sweden in 1973. The lower limit of 1 was
usually the villagers which serve as a
assigned to 28 years which was achieved by
unit of management.
Guinea-Bissau in 1960.
„„Ryotwari: The ownership rights of
The main difference between the use and control of land were held by
two is the inclusion of income in HDI the tiller himself.
and exclusion of income from PQLI. HDI
„„Green Revolution: The renovation of
represents both physical and financial
agricultural practices through modern
attributes of development and PQLI has
technology.
only the physical aspects of life.
„„Public Sector Banks: A bank in which
the government holds a major portion
8.15 of the shares.
Conclusion „„Private Sector Banks: Most of
the equity is owned by private
To conclude, the British were more bodies, corporations, institutions
focused on the money from Indians than and individuals rather than
good governance. Some positive things government.
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 „„Nationalisation: The process of education and per capita income
transforming private assets ownership indicators.
into government ownership. „„Physical Quality of Life Index: It is a
„„Human Development Index: It is a measure to calculate the quality of life
composite statistic of life expectancy, (well being of a country).

MODEL QUESTIONS

Part-A Multiple Choice Questions

1. The arrival of Vasco da Gama in 4. Ryotwari system was initially

introduced in
Calicut, India
a. Kerala
a. 1498
b. Bengal
b. 1948 c. Tamil Nadu
c. 1689 d. Maharastra
d. 1849 5. First World War started in the year
a. 1914
2. In 1614 Sir Thomas Roe was successful
b. 1814
in getting permission from
c. 1941
a. Akbar
d. 1841
b. Shajakan
6. When did the Government of India
c. Jahangir declared its first Industrial Policy ?

d. Noorjakhan a. 1956
b. 1991
3. The power for governance of India
c. 1948
was transferred from the East India
d. 2000
Company (EIC) to the British crown in
7. The objective of the Industrial Policy
a. 1758 1956 was ……..
b. 1858 a. Develop heavy industries

c. 1958 b. Develop agricultural sector only

c. Develop private sector only
d. 1658
d. Develop cottage industries only

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 8. The industry which was de-reserved 13. In the first five year plan, The top
in 1993 ? priority was given to ……. Sector.
a. Railways a. Service
b. Mining of copper and zinc b. Industrial
c. Atomic energy c. Agriculture
d. Atomic minerals d. Bank

9. The father of Green Revolution in 14. Tenth Five year plan period was…….
India was ………… a. 1992-1997
a. M.S. Swaminathan b. 2002-2007
b. Gandhi c. 2007-2012
c. Visweswaraiah d. 1997-2002
d. N.R. Viswanathan 15. According to HDR (2016), India
ranked …… out of 188 countries.
10. How many commercial banks were
nationalised in 1969 ? a. 130 b. 131

a. 10 c. 135 d. 145

b. 12 16. Annual Plans formed in the year

c. 14 ……….

d. 16 a. 1989-1991
b. 1990-1992
11. The main objective of nationalisation
of banks was ……. c. 2000-2001
d. 1981-1983
a. Private social welfare
b. Social welfare 17. The Oldest large scale industry in
India
c. To earn
a. cotton b. jute
d. Industries monopoly
c. steel d. cement
12. The Planning Commission was setup
18. Human development index (HDI) was
in the year …..
developed by
a. 1950
a. Jawaharlal Nehru
b. 1955
b. M.K. Gandhi
c. 1960
c. Amartiya Sen
d. 1952
d. Tagore

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 19. The main theme of the Twelth Five 20. The PQLI was developed by
Year Plan …………….
a. faster and more inclusive growth a. Planning Commission
b. growth with social Justice b. Nehru
c. socialistic pattern of society c. Morris
d. faster, more inclusive and D Morrisd.Biswajeet
sustainable growth

Part-A Answers

1 2 3 4 5 6 7 8 9 10
a c b c a c a b a c
11 12 13 14 15 16 17 18 19 20
b a c b b b a c d c

Part-B 
Answer the following questions in one or two
sentences.

21. What are the Phases of colonial 24. List out the weaknesses on Green
exploitation of India? Revolution.

22. Name out the different types of 25. What are the objectives of Tenth five
land tenure existed in India before year plan ?
Independence.
26. What is the difference between HDI
23. State the features that distinguish a and PQLI ?
land tenure system from other system.
27. Mention the indicators which are used
to calculate HDI.

Part-C Answer the following questions in one paragraph.

28. Explain about the Period of Merchant 31. State the reasons for nationalization of
Capital. commercial banks.

29. The Handicrafts declined in India in 32. Write any three objectives of Industrial
British Period. Why? Policy 1991.

30. Elucidate the different types of land 33. Give a note on Twelfth Five Year Plan.
tenure system in colonial India.
34. What is PQLI ?

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 Part-D Answer the following questions in about a page

35. Discuss about the Indian economy 37. Explain the objectives of
during British Period. nationalization of commercial banks.

36. Explain the role of SSIs in economic 38. Describe the performance of 12th five
developmet? year plan in India.

ACTIVITY
1. To know the value of freedom, students can collect pictures
of places like Jalian Walapak, Meerut, Thandi and photos of
freedom fighters.
2. Display the demonstration effect of present Indians in culture,
dressing and life style to emphasize the Swadhesi.

References

1. Gaurav Datt and Ashwani Mahajan, ‘Datt&Sundharam Indian Economy’ S. Chand

& Company Pvt. Ltd. 68th Revised Edition, 2013.
2. JagdishBhagwati; Arvind Panagariya - Reforms and Economic Transformation
in India

Websites

www.gatewayforindia.com/history/eastindiacompanybefore1857
www.threecolonialportcitiesinindia/geographicalreviewvol.78.issue.1 pg:32-47.-
M.Kosambi, 1978.
www.planningcommission.nic.in
https://www.scribd.com/doc/18643336/characteristics-of-indian-economy-pre-
colonial-and-colonial
https://en.wikipedia.org/wiki/Economy_of_India

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 CH A P TER

9 Development
Experiences in India

“Reform, Perform, Transform”

Learning Objective

1 To understand the reforms introduced in the recent years.

9.1
Introduction
twin problems of rampant poverty and
At the time of Independence in 1947, widespread unemployment, both resulting
India was a typically backward economy. in low standard of living.
Owing to poor technological and The year 1991 is an important landmark in
scientific capabilities, industrialization the economic history of post-independent
was limited and lop-sided. Agricultural India. The country went through a severe
sector exhibited features of feudal and economic crisis in the form of serious Balance
semi-feudal institutions, resulting into of Payments problem. Indian economy
low productivity. Means of transport and responded to the crisis by introducing a set
communications were underdeveloped. of policies known as Structural Reforms.
Educational and health facilities were These policies were aimed at correcting the
grossly inadequate and social security weaknesses and rigidities in the various
measures were virtually non-existent. sectors of the economy such as Industry,
In brief, the country suffered from the Trade, Fiscal and Agriculture.

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 9.2
Meaning of Liberalization,
• Expansion of • Cut throat
Privatization and Market Competition

Globalization (LPG) • Development of

Infrastructure
• Rise in
Monopoly

• Higher Living • Discourage

Standards Domestic Firms

• International • Increase in
Cooperation Inequalities

to Foreign Direct Investment (FDI) and

• Increase in
Foreign investment • Increase in Foreign Portfolio Investment (FPI) are
• Increase in Unemployment
Production • Decrease in
some of the measures towards globalization.
• Technological Tax Receipt
advancement
• Increase in
GDP growth rate 9.3
Arguments infavour of
LPG
The triple pillars of New Economic Policy
are Liberalization, Privatization and a. Liberalization was necessitated
Globalization (LPG) because various licensing policies were
Liberalization: Liberalization refers to said to be deterring the growth of the
removal or relaxation of governmental economy.
restrictions in all stages in industry.
b. Privatization was necessitated because
Delicensing, decontrol, deregulation,
of the belief that the private sector was
subsidies (incentives) and greater role for
not given enough opportunities to
financial institutions are the various facets
earn more money.
of liberalization.
Privatization: Privatization means c. Globalization was necessitated
transfer of ownership and management of because today a developed country
enterprises from public sector to private can grow without the help of the under
sector. Denationalization, disinvestment developed countries. Natural and
and opening exclusive public sector human resources of the developing
enterprises to private sector are the countries are exploited by the
gateways to privatization. developed countries and the developing
economies are used as market for
Globalization: Globalization refers to
the finished goods of the developed
the integration of the domestic (Indian)
countries. The surplus capital of the
economy with the rest of the world. Import
developed countries are invested in
liberalization through reduction of tariff
backward economies. Obsolute and
and non-tariff barriers, opening the doors
outdated technologies of the developed
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 countries can be easily sold to poor 3. The pattern of consumption started
under developed countries. Ultimately, improving (or deteriorating).
the rich countries can grow further at 4. Infrastructure facilities such as
the cost of developing economies. express highways, metro rails, flyovers
and airports started expanding
9.4 (but the local people were thrown
away).
Arguments against LPG
The benefits of this growth in some sectors
a. Liberalization measures, when have not reached the marginalized sections
effectively enforced, favour an of the community. Moreover, the process
unrestricted entry of foreign of development has generated serious
companies in the domestic economy. social, economic, political, demographic
Such an entry prevents the growth of and ecological issues and challenges.
the local manufacturers. Development brings benefits, but which
b. Privatization measures favour the section gets this benefit depends on socio-
continuance of the monopoly power. economic structure of the society.
Only the powerful people can sustain in Despite all these initiatives in the
business markets. Social justice cannot Indian economy, a large section of the
be easily established and maintained. people of India continue to face basic
As a result, the disparities tend to widen economic problems such as poverty,
among people and among regions. unemployment, discrimination, social
c. As globalization measures tend to exclusion, deprivation, poor healthcare,
integrate all economies of the world rising inflation, agricultural stagnation,
and bringing them all under one food insecurity and labour migration.
umbrella; they pave the way for However, for these problems, Government
redistribution of economic power at policies alone cannot be blamed. As
the world level. Only the already well- new institutional economists suggest,
developed countries are favoured in the values, believes, norms etc. of the
this process and the welfare of the less- individuals also matter.
developed countries will be neglected.
The economic crisis of the developed
countries are easily spread to the
developing economies through trade. Disinvestment
The following are the major changes Disinvestment means selling of
after 1991: government securities of Public
Sector Undertakings (PSUs) to other
1. Foreign exchange reserves started
PSUs or private sectors or banks.
rising.
This process has not been fully
2. There was a rapid industrialization. implemented.

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 9.5 industrial policy itself and de-regulated
the industrial sector substantially. The
Relative Position of on primary objectives of the industrial policy
Indian Economy were to promote major industries from
the clutches of bureaucrats, to abolish
(This discussion is suitable for a particular restrictions on foreign direct investment,
period only, there may be changes to liberate the indigenous enterprise from
afterwards) the restrictions of MRTP Act, to maintain
a sustained growth in productivity
and employment and also to achieve
international competitiveness.

7.4
7.1
Important Initiatives by
7.1 7.0 7.0 7.0
5.6 6.4 the Government towards
3.0
3.3 3.2 Industrial Policy
2.6

The policy has brought changes in the

following aspects of industrial regulation:
1. Industrial delicensing
„„According to International Monetary 2. Dereservation of the industrial sector
Fund, World Economic Outlook 3. Public sector policy (dereservation
(Ocoter-2016), GDP (nominal) of and reform of PSEs)
India in 2016 at current prices was
4. Abolition of MRTP Act
$2,251 billion. India contributed 2.99%
of total world’s GDP in exchange rate 5. Foreign investment policy and
basis. India shared 17.5 percent of the foreign technology policy.
total world population and 2.4 percent
of the world surface area. India was Before 1991 After 1991
now 7th largest economy of the world
Industrial
in 2016. Deregulation
„„India was at 3rd position after China Industrial Licensin
all commodities g for Licensing restricted to
alcohol, drugs etc.,
and Japan among Asian countries. y,railway
Private sector not Only defense,energ
India shared 8.50% of total Asia’s GDP in many industriesallowed for public sector-la
rge scale
estment
privatization, disinv
(nominal) in 2016. Controls on pri
and distributionce fixation Market allowed to
determine prices

9.6
Industrial Sector Reforms

The Prime Minister of India announced 1. Industrial delicensing policy: the

the new industrial policy on July 24, 1991. most important objective of the new
The new policy radically liberalized the industrial policy of 1991 was the
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 end of the industrial licensing or the 5. Foreign investment policy: Another
license raj or red tapism. Under the major feature of the economic reform
industrial licensing policies, private was red carpet welcome to foreign
sector firms had to secure licenses to investment and foreign technology.
start an industry. This measure has enhanced the
2. Dereservation of the industrial industrial competition and improved
sector Previously, the public sector business environment in the country.
was given reservation especially in Foreign investment including FDI
the capital goods and key industries. and FPI were allowed. In 1991, the
Under industrial deregulation, most government announced a specified
of the industrial sectors were opened list of high-technology and high-
to the private sector as well. Under investment priority industries
the new industrial policy, only three wherein automatic permission was
sectors viz., atomic energy, mining granted for foreign direct investment
and railways will continue as reserved (FDI) upto 51 percent foreign equity.
for public sector. All other sectors The limit was raised to 74 percent
have been opened for private sector and subsequently to 100 percent for
participation. many of these industries. Moreover,
many new industries have been
3. Reforms related to the Public sector
added to the list over the years.
enterprises: Reforms in the public
sector were aimed at enhancing Foreign Investment Promotion Board
efficiency and competitiveness of the (FIPB) has been set up to negotiate
sector. The government identified with international firms and approve
strategic and priority areas for the foreign direct investment in select
public sector to concentrate. Loss areas.
making PSUs were sold to the private
sector. 9.7
4. Abolition of MRTP Act: The Impact of LPG on
New Industrial Policy of 1991 Agricultural Sector
has abolished the Monopoly and Reforms
Restrictive Trade Practices Act
1969. In 2010, the Competition Since the inception of economic reforms,
Commission has emerged as the Indian economy has achieved a remarkable
watchdog in monitoring competitive rate of growth in industry and service sector.
practices in the economy. However, this growth process bypassed
The policy caused big changes the agricultural sector, which showed
including emergence of a strong sharp deceleration in the growth rate (3.62
and competitive private sector and a percent during 1984/85 – 1995/96 to 1.97
sizable number of foreign companies percent in 1995/96 – 2004/05). The sector
in India. has recorded wide variations in yield and

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 productivity and there was a shift towards about 25% to 30% of production. Besides,
cash crop cultivation. Moreover, agricultural quality of a sizable quantity of produce
indebtedness pushed several farming also deteriorates by the time it reaches the
households into poverty and some of them consumer. Most of the problems relating to
resorted to extreme measures like suicides. the marketing of fruits and vegetables can
be traced to their perishability. Perishability
9.7.1 Crop Insurance is responsible for high marketing costs,
market gluts, price fluctuations and other
Agriculture in India is highly prone
similar problems. In order to overcome this
to risks like droughts and floods. It is
constraint, the Government of India and
necessary to protect the farmers from
the Ministry of Agriculture promulgated
natural calamities and ensure their
an order known as “Cold Storage Order,
credit eligibility for the next season. For
1964” under Section 3 of the Essential
this purpose, the Government of India
Commodities Act, 1955. However, the cold
introduced many agricultural schemes
storage facility is still very poor and highly
throughout the country.
inadequate.

9.7.3 Post Harvest measures

The annual value of harvest and post-
harvest losses of major agricultural
produce at national level was of the
order of ₹92,651 crores, calculated using
production data of 2012-13 at 2014 and
wholesale prices, estimated by the Indian
Council of Agricultural Research (ICAR).

The Pradhan Mantri Fasal Bima Yojana

(Prime Minister’s Crop Insurance Scheme) Table 9.1 Food Items Waste (%)
was launched on 18 February 2016. Crops Cumulative
It envisages a uniform premium of wastages (%)
only 2 percent to be paid byfarmers forKharif Cereals 5-6
crops and 1.5 percent for Rabi crops. The Pulses 6–8
premium for (annual) commercial and Oil seeds 3-10
horticultural crops will be 5 percent. Fruits &Vegetables 5-16
Milk 1
Fisheries (in land) 5
9.7.2 Cold Storage
Fisheries (Marine) 10
India is the largest producer of fruits and Meat 3
second largest producer of vegetables in the Poultry 7
world. In spite of that per capita availability Source: Ministry of Food Processing
of fruits and vegetables is quite low because Industries, GoI, 2016
of post harvest losses which account for
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 Further, the GoI extended support to arrest
post harvest losses of horticulture and
non-horticulture produce and to provide
integrated cold chain and preservation
infrastructure facilities from the farm gate
to the consumer or from the production
site to the market since 2008-09. However,
the improvement is not visible because it
is not substantial.
Kisan Credit Card Scheme
9.7.4 A
 gricultural Produce
A Kisan Credit Card (KCC) is a credit
Market Committee
delivery mechanism that is aimed at
enabling farmers to have quick and Agricultural Produce Market Committee
timely access to affordable credit. It was (APMC) is a statutory body constituted by state
launched in 1998 by the Reserve Bank government in order to trade in agricultural or
of India and NABARD. The scheme horticultural or livestock products.
aims to reduce farmer's dependence on
the informal banking sector for credit Functions of APMC
– which can be very expensive and
Functions of APMC are:
suck them into a debt spiral. The card is
offered by cooperative banks, regional 1. To promote public private partnership
rural banks and public sector banks. in the ambit of agricultural markets.
Based on a review of the working of 2. To provide market led extension
the KCC, the government has advised services to farmer.
banks to convert the KCC into a smart 3. To bring transparency in pricing
card cum debit card. system and transactions taking place
in market in a transparent manner.
4. To ensure payments to the farmers
In order to reduce wastage of agricultural
for the sale of agricultural produce
produce and minimize post-harvest losses,
on the same day.
the Ministry of Food Processing Industries
(MOFPI) has implemented various 5. To promote agricultural activities.
components of Central Sector Schemes, 6. To display data on arrivals and rates
namely: of agricultural produce from time to
time- in the market prevailing.
Mega Food Parks; Integrated Cold
Chain; Value Addition Preservation
Infrastructure; Modernization of 9.7.5 A
 grarian Crisis after
Slaughter house Reforms
Scheme for Quality Assurance; Codex a) High input Costs:The biggest input for
Standards; Research and Development farmers is seeds. Before liberalisation,
and Other promotional activities. farmers across the country had access
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 to seeds from state government 9.8
institutions. The institutions produced
own seeds and were responsible for their Trade Reforms:
quality and price. With liberalization,
India’s seed market was opened upto „„Trade Policy Reforms: The main
global agribusinesses. Also, following features of the new trade policy as it
the deregulation many state government has evolved over the years since 1991
institutions were closed down in 2003. are as follows:
These hit farmers doubly hard: seed zzFree imports and exports: Prior
prices shot up, and fake seeds made an to 1991, in India imports were
appearance in a big way. regulated. From 1992, imports
b) Cutback in agricultural subsidies: were regulated by a limited
Farmers were encouraged to shift from negative list. For instance, the
growing a mixture of traditional crops trade policy of 1 April 1992 freed
to export oriented ‘cash crops’ like chill, imports of almost all intermediate
cotton and tobacco. Liberalisation and capital goods. Only 71 items
policies reduced the subsides on remained restricted. This would
pesticide, fertilizer and electricity. affect the domestic industries.
As a result prices have increased by zzRationalization of tariff structure
300%. However, the prices of and removal of quantitative
agricultural goods have not increased restrictions: The Chelliah
to that extent. Committee’s Report had suggested
c) Reduction of import duties: With drastic reduction in import duties.
a view to open India’s markets, the It had suggested a peak rate of 50
liberalization reforms also withdrew percent. As a first step towards a
tariffs and duties on imports. By 2001, gradual reduction in the tariffs, the
India completely removed restrictions 1991-92 budget had reduced the
on imports of almost 1,500 items peak rate of import duty from more
including food. As a result, cheap than 300 percent to 150 percent.
imports flooded the market, pushing The process of lowering the
prices of crops like cotton and pepper customs tariffs was carried further
down. in successive budgets. This also
affected the domestic industries.
d) Paucity of credit facilities: After 1991
the lending pattern of commercial banks,
9.8.1 Export and Import Policy
including nationalised bank drastically
changed. As a result, loan was not The Government of India, Ministry of
easily avilable and adequate. This has Commerce and Industry announced New
forced the farmers to rely on Foreign Trade Policy on 1st April 2015 for
moneylenders who charge exorbitant the period of 2015-2020.
rate of interest.

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 Salient Features of “EXIM As part of the economic reforms,
POLICY (2015-2020)” the system of taking over land by the
government for commercial and industrial
The new EXIM policy has been formulated
purposes was introduced in the country.
focusing on increasing in exports scenario,
As per the Special Economic Zones Act of
boosting production and supporting the
2005, the government has so far notified
concepts like Make in India and Digital India.
about 400 such zones in the country. Since
„„Reduce export obligations by 25% and the SEZ deprives the farmers of their land
give boost to domestic manufacturing and livelihood, it is harmful to agriculture.
supporting the “Make in India” In order to promote export and industrial
concept. growth in line with globalisation the SEZ
„„As a step to Digital India concept, was introduced in many countries.
online procedure to upload digitally
signed document by CA/CS/Cost
Accountant are developed and further
mobile app for filing tax, stamp duty
has been developed.
„„Repeated submission of physical
copies of documents available on
Exporter Importer Profile is not
required.
„„Export obligation period for export
items related to defence, military
store, aerospace and nuclear energy to
be 24 months.
„„EXIM Policy 2015-2020 is expected
to double the share of India in World India was one of the first in Asia to recognize
Trade from present level of 3% by the effectiveness of the Export Processing
the year 2020. This appears to be too Zone (EPZ) model in promoting exports,
ambitions. with Asia’s first EPZ set up in Kandla in
1965. The broad range of SEZ covers free
trade zones, export processing zones,
9.8.2 Special Economic Zones
industrial parks, economic and technology
With a view to overcome the shortcomings development zones, high-tech zones,
experienced on account of the multiplicity science and innovation parks, free ports,
of controls and clearances, absence enterprise zones, and others.
of world-class infrastructure, and an
unstable fiscal regime and with a view to Major Objectives of SEZs
attract larger foreign investments in India,
the Special Economic Zones (SEZs) Policy 1. To enhance foreign investment,
was announced in April 2000. especially to attract foreign direct

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 investment (FDI) and thereby consumption. Some of the important policy
increasing GDP. initiatives introduced for correcting the
2. To increase shares in Global Export fiscal imbalance were: reduction in fertilizer
(International Business). subsidy, abolition of subsidy on sugar and
disinvestment of a part of the government’s
3. To generate additional economic
equity holdings in select public sector
activity.
undertakings. Gradually expenditures on
4. To create employment opportunities. welfare measures were reduced; tasks on
5. To develop infrastructure facilities. corporate sectors were reduced; and tasks on
6. To exchange technology in the global poor people were increased.
market.
9.9.1 Goods and Services Tax
Main Characteristics of SEZ (GST)
a. Geographically demarked area with Goods and Services Tax (GST) is defined
physical security as the tax levied when a consumer buys
b. Administrated by single body/ a good or service. It is proposed to be a
authority comprehensive indirect tax levied on
manufacture, sale and consumption of
c. Streamlined procedures
goods as well as services. GST aims to
d. Having separate custom area replace all indirect taxes levied on goods
e. Governed by more liberal economic and services by the Indian Central and
laws. State governments. GST would eliminatie
f. Greater freedom to the firms located in the cascading effect of taxes on the
SEZs. As a result, they need not respect production and distribution of goods and
the Government’s rules and regulations. services. It is also a “one-point tax” Unlike
The social and environmental impacts VAT which was a multipoint tax.
were disastrous. The Goods and Service Tax Act was
passed in the Parliament on 29th March 2017.
The Act came into effect on 1st July 2017.The
9.9 motto is one nation, one market, one tax.
Fiscal Reforms
Current GST Rates in India
A key element in the stabilization effort
was to restore fiscal discipline. It means
reduction of fiscal deficit to the extent
of just 3% of GDP, as suggested by Fund
Bank Policies. In this way, the budget aimed
at containing government expenditure
and augmenting revenues; reversing the
downtrend in the share of direct taxes to
total tax revenues and curbing conspicuous
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 Advantages of GST and elimination of administrative
constraints.
„„Removing cascading tax effect
d. Liberalisation of bank branch licensing
„„Single point tax
policy in order to rationalize the
„„Higher threshold for registration existing branch network.
„„Composition scheme for small e. Banks were given freedom to relocate
business branches and open specialized
„„Online simpler procedure under GST branches
„„Defined treatment for e-ecommerce f. Guidelines for opening new private
„„Increased efficiency in logistics sector banks.
„„Regulating the unorganized sector g. New accounting norms regarding
classification of assets and provisions of
bad debt were introduced in tune with
9.10
the Narasimham Committee Report.
Monetary and Financial
Sector Reforms
9.11
Monetary reforms aimed at doing Conclusion
away with interest rate distortions and
rationalizing the structure of lending rates. There is no doubt that the Indian economy
recorded ample achievements in some
The new policy tried in many ways
sectors after new economic policy. If the size
to make the banking system more efficient.
of an economy provides the first impression
Some of the measures undertaken were:
of a country’s political and economic
a. Reserve Requirements: Reduction strength, then India has indeed grown since
in statutory liquidity ratio (SLR) and 1991. In dollar terms, India’s GDP crossed
the cash reserve ratio (CRR) were the $2-trillion mark in 2015-16. Currently,
recommended by the Narasimham the country is ranked ninth in the world
Committee Report, 1991. It was in terms of nominal GDP. Once India was
proposed to cut down the SLR from 38.5 rebuked for its “Hindu rate of growth”, a
percent to 25 percent within a time span term used by Rajkrishna to refer to low rate
of three years. Similarly, it was proposed of economic growth. The GDP growth rate of
that the CRR be brought down to 3 to India is very much appreciated. This growth
5% over a period of four years. is also due to changes in accounting system.
b. Interest Rate Liberalisation: Earlier, That is why the increased GDP growth rate
RBI controlled (i) the interest rates has failed to alleviate the miseries of the
payable on deposits, (ii) the interest common people and to reduce the socio,
rates which could be charged for bank economic and environmental imbalances.
loans. The basic problems of unemployment,
c. Greater competition among public poverty,ill-health and inequalities remain
sector, private sector and foreign banks unsolved.

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 Glossary Foreign Direct An investment in a
Liberalization Liberalization refers Investment business by an investor
to the relaxation of the from another country.
government restriction Foreign It comprises Foreign
usually in the area of Private Direct Investment
social and economic Investment and Foreign Portfolio
policies. Investment.
Privatization It refers to the Cold storage A storage of
participation of private agricultural
entities in businesses and commodities in a cold
services and transfer of place for preservation.
ownership from public SEZ It is an area in which
sector to private sector business and trade laws
as well. are different from rest
Globalization Globalization stands of the country mainly
for the consolidation of aiming at increasing
the various economies trade, investment and
of the world. job creation.
SLR Statutory Liquidity
Disinvestment The action of a
Ratio refers to the
government selling
amount that the
or liquidating public
commercial banks
asset.
require to maintain
Industrial Abolishing in the form of cash or
delicensing government control gold or government
by removing the approved securities
earlier restriction and before providing credit
licenses. to the customers.

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 MODEL QUESTIONS

Part-A Multiple Choice Questions

1. Which of the following is the way of 6. Foreign investment includes__________

Privatisation? a. FDI only
a. Disinvestment b. FPI and FFI
b. Denationalization c. FDI and FPI
c. Franchising d. FDI and FFI
d. All the above
7. The Special Economic Zones policy
2. Countries today are to be _____ for was announced in ___________
their growth. a. April 2000
a. Dependent b. July 1990
b. Interdependent c. April 1980
c. Free trade d. July 1970
d. Capitalist
8. Agricultural Produce Market
3. The Arguments against LPG is Committee is a ___________
_________ a. Advisory body
a. Economic growth b. Statutory body
b. More investment c. Both a and b
c. Disparities among people and d. non of these above
regions
9. Goods and Services Tax is
d. Modernization
_______________
4. Expansion of FDI ____________ a. a multi point tax
a. Foreign Private Investment b. having cascading effects
b. Foreign Portfolio c. like Value Added Tax
c. Foreign Direct Investment d. a single point tax with no
d. Forex Private Investment cascading effects.
5. India is the largest producer of 10. The New Foreign Trade Policy was
___________in the world. announced in the year_____________
a. fruits a. 2000
b. gold b. 2002
c. petrol c. 2010
d. diesel d. 2015
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 11. Financial Sector reforms mainly 16. The Raja Chelliah Committee on
related to _______________ Trade Policy Reforms suggested the
a. Insurance Sector peak rate on import duties at

b. Banking Sector a. 25%

c. Both a and b b. 50%

d. Transport Sector c. 60%

d. 100%
12. The Goods and Services Tax Act came
in to effect on ________ 17. The first ever SEZ in India was set
a. 1st July 2017 up at

b. 1st July 2016 a. Mumbai

c. 1st January 2017 b. Chennai

d. 1st January 2016 c. Kandla

d. Cochin
13. The new economic policy is concerned
with the following 18. ‘The Hindu Rate of Growth’ coined by
a. foreign investment Raj Krishna refers to

b. foreign technology a. low rate of economic growth

c. foreign trade b. high proportion of Hindu

population
d. all the above
c. Stable GDP
14. The recommendation of Narashimham
d. none
Committee Report was submitted in
the year________ 19. The highest rate of tax under GST is
a. 1990 ___________ (as on July1, 2017)

b. 1991 a. 18%

c. 1995 b. 24%

d. 2000 c. 28%
d. 32%
15. The farmers have access to credit
under Kisan credit card scheme 20. The transfer of ownership from public
through the following except sector to private sector is known as
a. co-operative banks _____.

b. RRBs a. Globalization

c. Public secstor banks b. Liberalization

d. all the above c. Privatization

d. Nationalization
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 Part-A Answers

1 2 3 4 5 6 7 8 9 10
d b c c a c a b d d
11 12 13 14 15 16 17 18 19 20
c a d b d b c a c c

Part-B  nswer the following questions in one or two

A
sentences.

21. Why was structural reform 25. Write three policy initiative
implemented in Indian Economy? introduced in 1991 – 92 to correct the
fiscal imbalance.
22. State the reasons for implementing
LPG. 26. State the meaning of Special Economic
Zones.
23. State the meaning of Privatization.
27. State the various components of
24. Define disinvestment
Central government schemes under
post - harvest measures.

Part-C Answer the following questions in one paragraph.

28. How do you justify the merits of 31. Give short note on Cold storage.
Privatisation?
32. Mention the functions of APMC.
29. What are the measures taken towards
33. List out the features of new trade
Globalization?
policy.
30. Write a note on Foreign investment
34. What is GST? Write its advantages.
policy?

Part-D Answer the following questions in about a page

35. Discuss the important initiatives taken 37. Describe the salient features of EXIM
by the Government of India towards policy (2015 – 2020)
Industrial Policy.

36. Explain the objectives and

characteristics of SEZs.

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 ACTIVITY
1. Collect various bills from the neighbouring store and find out
the Nature of Product sold and GST rate

References

1. Ramesh Singh - Indian Economy 5th edition - McGraw Hill Publication

2. Gaurav datt & Aswani Mahajan - Datt & Sundharam Indian Economy 72nd edition
- S.Chand Publication
3. 
Jagdish Bhagwati; Arvind Panagariya - India’s Reforms: How They Produced
Inclusive Growth
4. Jagdish Bhagwati; Arvind Panagariya - Reforms and Economic Transformation in
India
5. Arvind Panagariya - India: The Emerging Giant
https://www.jagranjosh.com/general-knowledge/new-economic-policy-of-1991-
objectives-features-and-impacts-1448348633-1

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 CH A P TER

10 Rural Economy

‘India Lives in Villages’ – Mahatma Gandhi

Learning Objectives

1 To understand the features of rural economy and to highlight the need to

develop rural areas, and

2 To bring into the light the problems of rural villages and to familiarise the
initiatives undertaken.

10.1
Introduction

Rural Economics deals with the application

of economic principles in understanding
and developing rural areas. In general,
rural areas are geographical areas located
outside towns and cities. According to the
Census of India, the basic unit for rural
areas is the revenue village. Rural economy
refers to villages, and rural community
refers to people living in villages. Rural productivity, lower prices of agricultural
areas have problems like backwardness of products, surplus labour force, larger
agriculture, low income , low employment population, high level of migration and
opportunities, poverty, low infrastructural high dependency on natural resources and
development, low illiteracy, low labour nature. According to the 2011 Population

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 Census, there are 6,40,867 villages in India 5. Employment: There exists
and 68.84 percent of the 121crore total unemployment, seasonal unemployment
population live in rural areas. and underemployment in rural areas.
Unemployment refers to the situation
10.2 of people with willingness and ability
to work but is not getting employed.
Features of Rural Economy
Underemployment also called disguised
unemployment is the situation of people
Main characteristics of rural economy are: employed in excess, over and above the
1. Village is an Institution: The requirement. Disguised unemployment
Village is a primary institution and is a situation Where people work but
it satisfies almost all the needs of the no increase in production. Both the
rural community. The rural people situations are common in rural areas.
have a feeling of belongingness and a 6. Poverty: Poverty is a condition
sense of unity towards each other. where the basic needs of the people
2. Dependence on Agriculture: The like food, clothing and shelter are not
rural economy depends much on being met. According to the 2011-12
nature and agricultural activities. estimates, About 22 crores of people
Agriculture and allied activities are in rural areas are poor and live below
the main occupation in rural areas. the poverty line.
3. Life of Rural People: Lifestyles 7. Indebtedness: People in rural
in villages are very simple. Public areas are highly indebted owing to
services like education, housing, poverty and underemployment, lack
health and sanitation, transport and of farm and non-farm employment
communication, banking, roads and opportunities, low wage employment,
markets are limited and unavailable. seasonality in production, poor
Rural people rely much on faith, marketing network etc. A famous
superstitions and traditional cultural British writer Sir Malcolm Darling
practices. The standards of living (1925) stated that ‘An Indian farmer
of majority of rural people are poor is born in debt, lives in debt, dies
and pitiable. In terms of methods of in debt and bequeaths debt’. Since
production, social organization and formal loan facilities are not available
political mobilization, rural sector to the villagers, they depend on local
is extremely backward and weak. In money lenders who, like a parasite,
recent years, the incidence of alcohol squeeze the villagers. Hence the
drinking has gone up. villagers commit suicide frequently.
4. Population Density: Population 8. Rural Income: The income of the
density, measured by number of rural people is constrained as the
persons living per sq. km is very low rural economy is not sufficiently
and houses are scattered in the entire vibrant to provide them with jobs
villages. or self – employment opportunities.

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 Large proportion of labourers and 10.3
skilled persons are underemployed
Meaning of Rural
and the scope for increasing their
Development
income is limited.
9. Dependency: Rural households are
Rural Development is defined as an overall
largely dependent on social grants and
improvement in the economies and social
remittances from family members
well being of villagers and the institutional
working in urban areas and cities.
and physical environments in which they
10. Dualism: Dualism means the live. According to the World Bank, ‘Rural
co-existence of two exteremely Development is a strategy designed to
different features like developed improve the economic and social life of a
and underdeveloped, organised specific group of people - rural poor’. In short,
and unorganised, traditional and rural development is a process of improving
modern, regulated and unregulated, the rural areas, rural people and rural living.
poor and rich, skilled and unskilled
and similar contradicting situations
in a region. These characteristics are 10.4
very common in rural areas.
Need for Rural
11. Inequality: The distributions of Development
income, wealth and assets are highly
skewed among rural people. There are
Rural development is very urgent in
number of historical, social, economic
the context of the overall growth and
and political reasons behind the
development of Indian economy due to
existence of inequality. Landlords
the following reasons.
and landowners dominate the rural
activities. Land, livestock and other 1. A major share of population lives in
assets are owned by a few people. rural areas, and their development
and contributions are very much
12. Migration: Rural people are forced to
supportive for the nation building
migrate from villages to urban areas
activities. India cannot be developed
in order to seek gainful employment
by retaining rural as backward.
for their livelihood. This character
of the development gives rise to the 2. The rural economy supports the urban
formation of cities. Enmity and Lack sectors by way of supplying drinking
of basic amenities in rural areas also water, milk, food and raw materials.
push the people to migrate to urban Hence, the backwardness of the rural
areas. This is called’ double poisoning’ sector would be a major impediment
by Schumacher, one side villages to the overall progress of the economy.
are empty, on the other side towns 3. Improvements in education, health and
are congested. His book ‘’ Small is sanitation in villages can help avoid
Beautiful “describes the dangers of many urban problems namely, begging,
the present kind of development. rack picking and road side slumming.
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 4. Development of agriculture and of illiteracy, lack of technical knowhow,
allied activities are necessary for low level of confidence, dependence
providing gainful employment in on sentiments and beliefs etc.
rural areas and improving overall 2. Agriculture Related Problems:
food production. The problems related to agriculture
5. The evils of brain-drain and rural- include 1.Lack of expected awareness,
urban migration can be reduced if knowledge, skill and attitude,
rural areas are developed. 2.Unavailability of inputs, 3.Poor
6. In order to better utilise the unused marketing facility, 4.Insufficient
and under-utilised resources, there is extension staff and services,
a need to develop the rural economy. 5.Multidimensional tasks to extension
7. Rural development should minimise personnel, 6.Small size of land holding,
the gap between rural and urban 7.Sub-division and fragmentation
areas in terms of the provision of of landholdings, 8.Absence of
infrastructural facilities. It was infrastructure to work and stay in rural
called as PURA by former President areas, 9.Primitive technology and low
Abdul Kalam. adoption of modern technologies
8. In order to improve the nation’s 10. Reduced public investment and
status in the global arena in terms of absence of role for farmers in fixing
the economic indicators like Human the prices for their own products..
Development Index (HDI), Women 3. Infrastructural Related Problems:
Empowerment Index (WEI), Gender Poor infrastructure facilities like, water,
Disparity Index (GDI), Physical electricity, transport, educational
Quality of Life Index (PQLI) and institutions, communication, health,
Gross National Happiness Index employment, storage facility, banking
(GNHI) rural economy should be and insurance are found in rural areas.
given due attention. 4. Economics related Problems: The
economic problems related to rural
areas are: inability to adopt high
10.5 cost technology, high cost of inputs,
Problems of Rural Economy

Rural areas are facing number of problems Agriculture

Related
Problems
relating to, 1) People, 2) Agriculture, 3) People
Related Infrastructural

Infrastructure, 4) Economy, 5) Society and Problems Related

Problems

Culture, 6) Leadership and 7) Administration. Problems of

Rural
The problems of rural economy are Administrative
Problems
Economy
Economics
discussed below. related
Problems

1. People Related Problems: The Leadership

Social
Related
problems related to individuals Problems & Cultural
Problems

and their standard of living consist

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 under privileged rural industries, low 10.6
income, indebtedness and existence of
inequality in land holdings and assets. Rural Poverty
In fertile areas, a few absentee landlords
own large area and they do not evince Rural poverty refers to the existence of
greater Interest in improving the poverty in rural areas. Poverty in India has
performance of agriculture. been defined as the situation in which an
individual fails to earn sufficient income
5. Social and Cultural Problems: Caste
to buy the basic minimum of subsistence.
system makes villages almost rigid.
Poverty line is a hypothetical line based
Dominant Caste in village holds all
on income or consumption levels that
land holdings so they will be the
divides the population as people below
superior class too. Both class and caste
poverty line and above poverty line. On
exploitation will be at their peaks.
the basis of recommended nutritional
Poverty, mal – nourishment, illiteracy,
intake, persons consuming less than
child marriages and many more
2,400 calories per day in rural areas
can be seen in Indian villages. Inter
are treated as they are under rural
caste/ Religion marriage will leads to
poverty.
assassination in rural areas. Child
marriage leads to lots of unethical As per the Planning Commission
issues. Female feticide leads to gender estimates, the percentage of people living
related issues in rural areas. below poverty in rural areas was 54.10
6. Leadership Related Problems: The which accounted for 33.80 per cent
specific leadership related problems during 2009-10. Poverty is deepest among
found in rural areas are: Leadership members of scheduled castes and tribes
among the hands of inactive and in the rural areas. In 2005 these groups
incompetent people, self-interest accounted for 80 per cent of rural poor,
of leaders, biased political will, although their share in the total rural
less bargaining power and negation population is much smaller. In 2015, more
skills and dominance of political leaders. than 80 crores of India’s people lived in
villages. One quarter of village population
7. Administrative Problems: The rural
(22 crores people) list below the poverty
administrative problems consist
line. India is the home to 22 per cent of the
of political interference, lack of
world’s poor. It is needless to state that the
motivation and interest, low wages
country has been successful in reducing
in villages, improper utilization of
the proportion of poor people, in spite of
budget, and absence of monitoring
increasing of population.
and implementation of rural
development programme.
10.6.1 Causes for Rural
Rural poverty, rural unemployment, rural
Poverty
industries, micro finance, rural heath and
sanitation and rural infrastructures are the issues Various factors responsible for rural
that are considered for detailed discussion. poverty are highlighted below:

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 1. The distribution of land is highly Therefore, poor are not in a position
skewed in rural areas. Therefore, to get employed and to come out
majority of rural people work as hired from the poverty in villages.
labour to support their families. 9. Social Evils: Social evils prevalent
2. Lack of Non-farm Employment: in the society like custom, beliefs etc.
Non-farm employment opportunities increase unproductive expenditure.
do not match the increasing labour
force. The excess supply of labour 10.6.2 Remedial Measures to
in rural areas reduces the wages and Rural Poverty
increases the incidence of poverty.
Since rural unemployment and rural
3. Lack of Public Sector Investment: The poverty are interrelated, creation of
root cause of rural poverty in our country employment opportunities would support
is lack of public sector investment on elimination of poverty. Poverty alleviation
human resource development. schemes and programmes have been
4. Inflation: Steady increase in prices implemented, modified, consolidated,
affects the purchasing power of the expanded and improved over time. However,
rural poor leading to rural poverty. unemployment, begging, rag picking and
5. Low Productivity: Low productivity slumming continues. Unless employment
of rural labour and farm activities is a is given to all the people, poverty cannot be
cause as well as the effect of poverty. eliminated. Who will bell the cat?
6. Unequal Benefit of Growth: Major
Poverty Eradication Schemes
gains of economic development are
enjoyed by the urban rich people Schemes Year of
leading to concentration of wealth. Due launch
to defective economic structure and 20 Point Programme 1975
policies, gains of growth are not reaching Integrated Rural development 1978
the poor and the contributions of poor Programme(IRDP)
people are not accounted properly. Training Rural Youths for Self- 1979
7. Low Rate of Economic Growth: Employment (TRYSEM)
The rate of growth of India is always Food for Work Programme 1977
below the target and it has benefited (FWP)
the rich. The poor are always denied National Rural Employment 1980
of the benefits of the achieved growth Programme (NREP)
and development of the country.
Rural Landless 1983
8. More Emphasis on Large Industries: Employment Guarantee
Huge investment in large industries Programme(RLEGP)
catering to the needs of middle and Jawahar Rozgar Yojana(JRY) 1989
upper classes in urban areas are
Mahatma Gandhi National Rural 2006
made in India. Such industries are
Employment Guarantee Scheme
capital-intensive and do not generate
(MGNREGS)
more employment opportunities.
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 Development Schemes India are categorised into three classes:
(i) Open Unemployment (ii) Concealed
Pradhan Mantri Adarsh Gram 2010
Unemployment or Under employment
Sadak Yojana (PMAGSY)
and (iii) Seasonal Unemployment. In
Bharat Nirman Yojana 2005 Open Unemployment, unemployed
Indira Awas Yojana 1985 persons are identified as they remain
Jawaharlal Nehru National Urban 2005 without work. This type of unemployment
Renewal Mission (JNNURM) is found among agricultural labourers,
Rajiv Awas Yojan (RAY) 2009 rural artisans and literate persons. In
National Rural Health Mission 2005 Concealed Unemployment, it is difficult
to identify who are under employed; for
National Rural Livelihood 2011
many are employed below their productive
Mission
capacity and even if they are withdrawn
National Food Security Scheme 2013
from work the output will not diminish.
It is also called Disguised Unemployment
10.7 or Under employment. This type of
unemployment is found among small and
Rural Unemployment marginal farmers, livestock rearers and
rural artisans. This kind of unemployment
Unemployment is a situation in which a situation is more serious in villages than in
person is actively searching for employment urban areas. Disguised unemployment in
but unable to find work at the prevailing rural India is 25 per cent to 30 per cent. In
wage rate. It is a tragic waste of manpower Seasonal Unemployment, employment
and under utilisation of human resources. occurs only on a particular season
As long as there is unemployment, social supported by natural circumstances
problems cannot be stopped; and, economy and the remaining period of a year the
cannot achieve development. rural people are unemployed or partially
employed. In seasons like ploughing,
Peter Diamond, sowing, weeding and harvesting there is
Dale Mortensen and scarcity of labour and in the rest of the
Christopher Pissarides year there is unemployment. It is pathetic
shared 2010 Economics to note that a farmer who cultivates one
Nobel prize for jobs study.Their model, crop in a year usually goes without a job
called DMP model, helps us understand for almost 5 to 7 months and ultimately
how regulation and economic policies affect commit suicide.
unemployment, job vacancies and wages.
According to the Agricultural
As on 4 th
October 2016, rural Labour Enquiry Committee Report,
unemployment was 7.8 per cent which is “the extent of under employment is on
less than urban unemployment (10.1 per the average, 82 days of unemployment
cent) and all India unemployment rate in a year for 84 per cent of agricultural
(8,5 per cent). Rural unemployment in labours.”

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 5. Capital-Intensive Technology: The
10.7.1 Causes for Rural expanding private industrial sector
Unemployment is largely found in urban areas and
Causes for rural unemployment in India not creating additional employment
are discussed below: opportunities due to the application
of capital intensive technologies.
1. Absence of skill development
Government must establish firms to
and employment generation:
absorb surplus labour power.
Lack of Government initiatives to
give required training and then to 6. Defective System of Education: The
generate employment opportunities. present system of education has also
aggravated the rural unemployment
2. Seasonal Nature of Agriculture:
problem.Large number of degree-
Agricultural operations are seasonal
producing institutions has come
in nature and depend much on nature
in the recent years. Students also
and rainfall. Therefore, the demand
want to get degrees only, not any
for labour becomes negligible
skill. Degrees should be awarded
during off-season. So, non-farm
only on the basis of skills acquired.
employment opportunities must be
The unemployed youth should get
created.
sufficient facilities to update their
3. Lack of Subsidiary Occupation: skills.
Rural people are not able to start
subsidiary occupations such as
10.7.2 Remedies for Rural
poultry, rope making, piggery etc. due
Unemployment
to shortages of funds for investment
and lack of proper marketing In order to reduce rural unemployment
arrangements. This restricts the in the country there is a need to take
employment opportunity and rural integrated and coordinated efforts from
family incomes. Government must various levels. A few remedial measures
arrange funds for these people. are listed below:
However, as now they pay huge 1. Subsidiary Occupation: To reduce
interest to the local money lenders, the seasonal unemployment rural
for they are unable to get loans from people should be encouraged to
formal sources. adopt subsidiary occupations.
4. Mechanization of Agriculture: The Loans should be granted and proper
landlords are the principal source arrangements should be made for
of employment to the farm labour. marketing their products.
Mechanization of agricultural 2. Rural Works Programme: Rural
operations like ploughing, irrigation, Works Programme such as
harvesting, threshing etc. reduces construction and maintenance of
employment opportunities for the roads, digging of drains, canals, etc
farm labour. should be planned during off-season

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 to provide gainful employment to 1. These industries are carried out by
the unemployed. artisans in their own homes at their
3. Irrigation Facilities: Since rainfall is own risk and for their own benefit.
uncertain irrigation facilities should Artisans may combine this work
be expanded to enable the farmers with another regular job.
to adopt multiple cropping. The 2. No or little outside labour is
increased cropping intensity creates employed. Normally, the members of
additional demand for labour. the household provide the necessary
4. Rural Industrialization: To provide labour.
employment new industries should 3. These industries are generally
be set up in rural areas. This will open hereditary and traditional in
new fields of employment and also character.
change the attitude of rural people 4. No or little power is used.
towards work. For this, government
5. These industries usually serve the
has to do something. Private sector
local market and generally work on
would not take up this responsibility.
the orders placed by other industries.
5. Technical Education: Employment
Examples of cottage industries are mat,
oriented courses should be
coir and basket making industries. The
introduced in schools and colleges to
principal cottage industries of India are
enable the litrate youth to start their
hand-loom weaving (cotton, silk, jute,
own units.
etc.) pottery, washing soap making, conch
shell, handmade paper, horn button,
10.8 mother-of-pearl button, cutlery, lock and
Rural Industries key making industries.

Village Industries: Village industries are

Rural industries embrace all industries
traditional in nature and depend on local
which are run by rural people in rural areas.
raw-material. They cater to the needs
These industries are based primarily on the
of local population. Examples of village
utilization of locally available raw materials,
industries are gur and khandsari, cane and
skills and small amount of capital. The rural
bamboo basket, shoe making, pottery and
industries can be broadly classified into
leather tanning. These are almost similar
a) cottage industries, b) village industries,
to the cottage industries.
c) small industries, d) tiny industries and
e) agro-based industries. Small Scale Industries (SSIs): Most small
scale industries are located near urban
Cottage Industries: Cottage industries
centres. They produce goods for local as
are generally associated with agriculture
well as foreign markets. Examples of such
and provide both part-time and full-time
small scale industries are manufacture
jobs in rural areas.
of sports goods, soaps, electric fans, foot
The important characteristics of wear, sewing machines and handloom
this type of industries are as follows: weaving.
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 SSIs are also known as Micro, Small &
Medium Enterprises (MSMEs). They are
defined and categorized by the Micro,
Small & Medium Enterprises Development
Act, 2006. The Act categorizes different
scale of industries on the basis of
investment in plant and machinery in case
of manufacturing industries and on the
basis of investment in equipment in case
of service sector industries.
The farmers borrow loan for various
purposes like agricultural operations,
supporting the family in the lean season or
purchase of equipments in the recent years,
expenses on celebrations, liquor consumption
and medicines go on increasing without any
limit. Due to lower income, the villagers are
unable to repay the loans or pay the pending
interest on the principal amount.

Agro-based Industries: These industries

are based on the processing of agricultural According to the Government of
produce. Agro-based industries may India’s Socio Economic and Caste
be organised on a cottage-scale, small- Census (SECC), 2015, around 73
scale and large-scale. These industries per cent of households in India are
tend to develop household settlements rural. Of these, 18.5 per cent are
around them as they employ more labour scheduled caste households and 11
on a regular basis. Examples are textile, per cent belong to the scheduled tribe
sugar, paper, vegetable oil, tea and coffee category.
industries.

The data of the National Sample Survey

10.9
Organisation (NSSO, 2002-03) reveals
Rural Indebtedness that only about 30 per cent of the poor
borrowers get credit from the formal
Rural indebtedness refers to the situation banks. According to the All India Debt
of the rural people unable to repay the loan and Investment Survey (AIDIS) 2002, the
accumulated over a period. Existence of share of institutional credit has declined
the rural indebtedness indicates the weak from 66.3 per cent in 1991 to 57.1 percent
financial infrastructure of our country, in 2002, with a corresponding increase
in reaching the needy farmers, landless in informal channels of credit (RBI,
people and the agricultural labourers. 2006).
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 leads to perpetuate indebtedness of
10.9.1 Features of Rural
the farmer.
Indebtedness
Nearly three fourth of rural families in the
10.9.3 Measures to Remove
country are in debt. The amount of debt
Rural Indebtedness
is heavier in the case of small farmers.
Cultivators are more indebted than the Several remedial measures have been
non-cultivators. Most of the debts taken introduced to reduce rural indebtedness.
are short term and of unproductive nature. It includes regulation of money lenders,
The proportion of debts having higher development of rural banks, Regional Rural
rates of interest is relatively high. Most Banks (RRBs), Micro Finance, formation
of the villagers are indebted to private of Self Help Groups (SHGs), Primary
agencies particularly money lenders. Cooperative Banks and Land Development
Banks, Crop Loan Schemes, Lead Bank
Schemes, Micro Units Development
10.9.2 Causes for Rural and Refinance Agency Bank (MUDRA),
Indebtedness promotion of subsidiary occupation, off
The causes for rural indebtedness may be farm employment opportunities, skill
summarized as below: development programmes and so on.
However, the interest rate charged plus
1. Poverty of Farmers: The vicious transaction cost for poor people and Self-
circle of poverty forces the farmers to Help Groups are much higher as compared
borrow for consumption, cultivation to that for rich people. For instance,
and celebrations. Thus, poverty, debt education loan is costlier than car loans.
and high rates of interest hold the
farmer in the grip of money lenders.
Regional Rural Banks (RRBs)
2. Failure of Monsoon: Frequent
Regional Rural Banks came into existence
failure of monsoon is a curse to the
based on the recommendation made by a
farmers and they have to suffer due
working group on rural banks appointed by
to the failure of nature. Therefore,
the Government of India in 1975. RRBs are
farmers find it difficult to identify
recommended with a view to developing
good years to repay their debts.
rural economy by providing credit and
3. Litigation: Due to land disputes other facilities particularly to the small and
litigation in the court compels them marginal farmers, agricultural labourers,
to borrow heavily. Being uneducated artisans and small entrepreneurs. RRBs
and ignorant, they are caught in the are set up by the joint efforts of the Centre
litigation process and dry away their and State Governments and commercial
savings and resources. banks. At present, there are 64 Regional
4. Money Lenders and High Rate of Rural Banks in India. The RRBs confine
Interest: The rate of interest charged their lending’s only to the weaker sections
by the local money lenders is very and their lending rates are at par with the
high and the compounding of interest prevailing rate of cooperative societies.
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 Micro Finance
In 2009-10, the number of new SHGs
Micro finance, also known as micro credit, having credit-linked with banks
is a financial service that offers loans, was 1.59 million and a bank loan of
savings and insurance to entrepreneurs ₹14,453 Crores was disbursed to these
and small business owners who do not SHGs. Further, the number of SHGs
have access to traditional sources of which maintained savings accounts
capital, like banks or investors. The goal of with banks at the end of March 2010
micro financing is to provide individuals was 6.95 million.
with money to invest in themselves or
their business. Microfinance is available
through micro finance institutions, which they lend small amounts to their members
range from small nonprofit organizations for interest. Based on their performance,
to larger banks. In India, Non Government they are linked with the bank for further
Organizations (NGOs) play a pivotal role in assistance under SHG Bank Linked
the development of micro finance service. Programme (SBLP) started in 1992. It is a
Microfinance industry in India have grown holistic programme of micro-enterprises
vastly in the last two decades. In 2009, the covering all aspects of self-employment,
total number of micro finance institutions organization of the rural poor into
in India was around 150 (Tripathi, 2014). self Help groups and their capacity
building, planning of activity clusters,
Self-Help Groups (SHGs) infrastructure build up, technology, credit
and marketing.
The main objective of this programme is to
bring the beneficiaries above the poverty
line by providing income generating
assets to them through bank credit and
government subsidy. NABARD estimates

Under NABARD SHG Linkage

Self Help Groups are informal Programme, SHGs can borrow
voluntary association of poor people, from credit from bank on showing their
the similar socio-economic background, successful track record of regular
up to 20 women (average size is 14). They repayments of their borrowers. It
come together for the purpose of solving has been successful in the states like
their common problems through self-help Andhra Pradesh, Tamil Nadu, Kerala
and mutual help. The SHG promotes small and Karnataka during 2005-06. These
savings among its members. They save States received approximately 60 per
small amounts ₹10 to ₹50 a month. The cent of SHG linkage credit (Taruna
savings are kept with a bank. After saving and Yadav, 2016).
regularly for a minimum of 6 months,

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 that there are 2.2 million SHGs in India,
representing 33 million members that
have taken loans from banks under
its linkage program to date. The SHG
Banking Linkage Programme since its
beginning has been predominant in
certain states, showing spatial preferences
especially for the southern regions like
Andhra Pradesh, Tamil Nadu, Kerala
and Karnataka. These SHGs have helped
* Micro Units Development and Refinance Agency
the Banks to accumulate more funds. * Regulate and Refinance and
Actually the banks charge higher interest Microfinance Institutions

for the SHGs than car owners.

The principal objectives of the
Major Features of SHGs are MUDRA Bank are the following

1. SHG is generally an economically 1. Regulate the lender and the borrower

homogeneous group formed through of microfinance and bring stability
a process of self-selection based upon to the microfinance system .
the affinity of its members. 2. Extend finance and credit support to
Microfinance Institutions (MFI) and
2. Most SHGs are women’s groups with
agencies that lend money to small
membership ranging between 10 and
businesses, retailers, self-help groups
20.
and individuals.
3. SHGs have well-defined rules and
3. Register all MFIs and introduce a
by-laws, hold regular meetings and
system of performance rating and
maintain records and savings and
accreditation for the first time.
credit discipline.
4. Offer a Credit Guarantee scheme for
4. SHGs are self-managed institutions
providing guarantees to loans being
characterized by participatory and
offered to micro businesses.
collective decision making.
5. Introduce appropriate technologies
to assist in the process of efficient
Micro Units Development
lending, borrowing and monitoring
and Refinance Agency
of distributed capital.
Bank (MUDRA Bank)
It is a public sector financial institution
10.10
which provides loans at low rates to micro-
finance institutions and non-banking Rural Health, Nutrition and
financial institutions which then provide Sanitation
credit to Micro, Small and Medium
Enterprises (MSMEs). It was launched on Health is an important component for
8th April 2015. ensuring better quality of life. Large
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 masses of the Indian poor continue to especially the vulnerable groups. NRHM
fight hopeless and constantly losing the seeks to provide equitable, affordable and
battle for survival and health. Indian quality health care to the rural population,
rural people are suffering with various especially the vulnerable groups.
epidemics such as small pox, cholera, NRHM focuses on Reproductive,
malaria, typhoid, dengue, chicken guniya, Maternal, Newborn, Child Health and
etc. This is mainly due to lack of medical Adolescent (RMNCH+A) Services.
facilities, deep ignorance and poverty. The emphasis here is on strategies for
Indian Constitution clearly lays down improving maternal and child health
that “States shall regard the rising of the through a continuum of care and the life
level of nutrition and standard of living cycle approach.
of its people and improvement of public
health as among its primary duties”.
To meet this constitutional directive. 10.11
Several programmes for nutrition have
Rural Infrastructure
been implemented. These include
Supplementary Feeding Programmes
including Mid Term Meal Programme, Rural Housing
Nutrition Education through Printed House is one of the basic needs of every
Media and Television and Compulsory family. Provision of better housing facilities
Fortification of Common Salt with Iodine. increases the productivity of labour. The
Still in terms of health standard, Sri Lanka housing problem is getting aggravated due to
is better than India, and in india, Kerala is rapid adoptation of nuclear families. Housing
better than Tamil Nadu. does not mean provision of house alone but
also proper water supply, good sanitation,
proper disposal of sewage etc. The problem
National Rural Health Mission of housing can be tackled by the development
The National Rural Health Mission of low cost technology in house construction,
(NRHM) was launched on 12th April provision of adequate housing finance and
2005, to provide accessible, affordable and provision of land sites to landless workers in
quality health care to the rural population, rural areas.
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 As per the NSSO data, 38 per cent of the farmers to bring their produce to the
the households lived in with one room while urban markets and to have access to distant
another 36 per cent lived with two rooms. markets and other services.

Rural Market Rural Electrification

Road Market refers to the infrastructure Rural Electrification refers to providing
created to buy and sell the products electrical power to rural areas. The main
produced in rural areas and also to aims of rural electrification are to provide
purchase the needed products and farm electricity to agricultural operations and
inputs produced in urban and other to enhance agricultural productivity, to
regions. The rural marketing is still increase cropped area, to promote rural
defective as farmers lack bargaining industries and to lighting the villages. In
power, long chain of middlemen, lack order to improve this facility the supply of
of organisation, insufficient storage electricity is almost free for agricultural
facilities, poor transport facilities, absence purpose in many states and the electricity
of grading, inadequate information and tariff charged in rural areas is kept very
poor marketing arrangements. low. In India 99.25% of villages were
electrified at the end of March 2017. As
on 31.03.2017, 100 percent electrification
Rural roads in India constitute 26.50
was achieved in villages of 20 States/UTs
lakh kms, of which 13.5 percent of
namely, Chandigarh, Delhi, Haryana,
the roads are surfaced.
Himachal Pradesh, Punjab, Rajasthan,
Daman & Diu, D & N Haveli, Goa, Gujarat,
Maharashtra, Andhra Pradesh, Kerala,
India’s road network is one of the Lakshadweep, Puducherry, Tamil Nadu,
world’s largest. The road length of Telangana, Andaman & Nicobar Island,
India increased from about 4 lakh Sikkim and Tripura.
kms in 1950-51 to 34 lakh kms at The factors hindering the progress
present (2018). of rural electrification in India are:
1. Lack of Funds: The generation and
Rural Roads transmission of power involves huge
expenditure and the fund allocation
Road transport is an important constituent
is low.
of the transport system. Rural roads
constitute the very life line of rural economy. 2. Inter-state Disputes: As there are
A well-constructed road network in rural inter-state disputes in managing power
area would bring several benefits including projects, power distribution is affected.
the linking of remote villages with urban 3. Uneven Terrain: As rural topography
centres, reduction in cost of transportation is uneven without proper connection,
of agricultural inputs and promotion of developing new lines are costlier and
marketing for rural produces. It helps difficult.

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 4. High Transmission Loss: Transmission 3. Coordinated and integrated
loss in power distribution is almost 25 programmes for solving the
per cent in rural areas. present problems and to achieve
5. Power Theft: Unauthorized use and sustainable development need to be
diversion of power are evil practices designed.
adopted by affluent people that hinders 4. Persons and leaders with an
the rural electrification process. understanding of reality of rural
problems and with the required
10.12 foresight vision should be consulted
Requirements for Rural while designing development
Development programmes.

10.13
Slater Villages: Gilbert Slater, the first Conclusion
professor of economics at Madras
University, published his book, Crucial steps to strengthening the rural
Some South Indian Villages, in 1918 economy are already being taken through
following a survey of some villages various policies. These steps include
like Vadamalaipuram (Ramnad), investments in areas ranging from health,
Gangaikondan (Tirunelveli), information technology, education,
Palakkuurichi (Tanjore) and Dusi infrastructure and small business. The
(North Arcot) in Tamil Nadu by his Administration is committed to building
students. It was subsequently done by on these unprecedented measures in the
different groups of researchers in the months and years to come. PURA (Provision
1930s, 1950s, 1960s, and two of the of Urban facilities for Rural Areas) needs
villages only in the early 21st century. to be given due emphasis, without which
The resurveys became an important Indian villages cannot prosper.
historical record. They provided a
baseline for several later revisits to Glossary
his villages, and have inspired many
successors. Much of our knowledge Rural Economics Application of
of rural change depends on Economic Principles
these studies. in rural areas.
Population Number of persons
Density living per sq.km
or per sq. mile.
1. Efforts need to be made to raise farm Unemployment Situation of people
and non-farm rural real incomes. with willingness
2. Investment in basic infra-structure and ability to work
and social services need to be but not getting
increased. employed.

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 Open Unemployed persons Poverty Condition where
Unemployment are identified as they the basic needs
remain without of the people like
work. food, clothing and
Seasonal Employment occurs shelter are not
Unemployment only in a particular being met.
season and workers Dualism Co-existence of
remain unemployed in two extremely
the remaining period different features.
of a year. Rural Pro cess of
Under Situation where Development improving the rural
employment people employed areas, rural people
in excess over and rural living.
and above the Rural Providing
requirements. Electrification electrical power to
rural areas.

MODEL QUESTIONS

Part - A Choose the Best Answer

1. Which is considered as the basic unit 3. Identify the feature of rural economy.
for rural areas? a. Dependence on agriculture
a. Panchayat b. High population density
b. Village c. Low level of population
c. Town d. Low level of inequality
d. Municipality
4. What percentage of the total
2. Which feature is identified with rural population live in rural area, as per
areas? 2011 censes?
a. Low population density a. 40
b. High population density b. 50
c. Low natural resources c. 60
d. Low human resources d. 70

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 5. How do you term people employed in 10. Indicate the cause for rural poverty.
excess over and above the requirements? a. Lack of non-farm employment
a. Unemployment b. High employment
b. Underemployment or c. Low inflation rate
Disguised Unemployment
d. High investment.
c. Full employment
10. Indicate the cause for rural poverty.
d. Self-employment
a. Lack of non-farm employment
6. What is the term used to denote the
b. High employment
coexistence of two different features
in an economy? c. Low inflation rate

a. Technology d. High investment.

b. Dependency 11. What is the other name for concealed

unemployment?
c. Dualism
a. Open
d. Inequality
b. Disguised
7. The process of improving the rural
c. Seasonal
areas, rural people and rural living is
defined as d. Rural

a. Rural economy 12. How do you term the employment

occurring only on a particular season?
b. Rural economics
a. Open
c. Rural employment
b. Disguised
d. Rural development
c. Seasonal
8. Identify the agriculture related d. Rural
problem of rural economy.
13. Identify an example for rural industries?
a. Poor communication
a. Sugar factory
b. Small size of landholding
b. Mat making industry
c. Rural poverty
c. Cement industry
d. Poor banking network
d. Paper industry
9. The recommended nutritional intake 14. How much share of rural families in
per person in rural areas. India is in debt?
a. 2100 calories a. Half
b. 2100 calories b. One fourth
c. 2300 calories c. Two third
d. 2400 calories d. Three fourth
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 15. Identify the cause for rural 18. Identify the year in which National
indebtedness in India. Rural Health Mission was launched.
a. Poverty a. 2000 b. 2005
b. High population c. 2010 d. 2015
c. High productivity 19. Identify the advantages of rural roads.
d. Full employment a. Rural marketing
16. In which year, Regional Rural Banks b. Rural employment
came into existence? c. Rural development
a. 1965 b. 1970 d. All the above
c. 1975 d. 1980
20. “ An Indian farmer is born in debt, lives
17. Identify the year of launch of MUDRA in debt, dies in debt and bequeaths
Bank? debt”-who said this?
a. 1995 b. 2000 a. Adam Smith
c. 2010 d. 2015 b. Gandhi
c. Amartya Sen
d. Sir Malcolm Darling

Answers Part - A

1 2 3 4 5 6 7 8 9 10
b a a c b c d b d a
11 12 13 14 15 16 17 18 19 20
b c b d a c d b d d

Part - B Answer the following questions in one or two sentences

21. Define Rural Economy. 26. Define Cottage Industry.

22. What do you mean by Rural 27. What do you mean by Micro Finance?
Development?
28. State any two causes of housing
23. Rural Poverty – Define. problem in rural areas.

24. Define Open Unemployment. 29. Define Rural Electrification.

25. What is meant by Disguised 30. State any two factors hindering Rural
Unemployment? Electrification in India.

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 Part - C  nswer the following questions in about a paragraph
A
each

31. State the importance of Rural 34. What are the remedial measures for
Development. Rural Unemployment?

32. Explain the causes for Rural 35. Write a note on Regional Rural Banks.
Backwardness.
36. Mention the features of SHGs.
33. Enumerate the remedial measures to
37. List out the objectives of MUDRA
Rural Poverty.
Bank.

Part - D Answer for each question in about a page

38. ‘The features of Rural Economy are 40. Analyse the causes for Rural
peculiar’- Argue. Indebtedness.

39. Discuss the problems of Rural

Economy.

ACTIVITY

1. Take a case of a village where you or nearby you live. Collect

the basic information such as, geographical area, boundary
areas, population, number of houses, area under cultivation,
major crops cultivated, type of infrastructure etc., with the
collected information, prepare a report about the village.

References

1. Annual Report, Ministry of Rural Development, GOI.

2. Rural Economics by Patel KV, A C Shah and LD’Mello, Himalaya
Publishing House, Bombay.
3. Rural Economics by Grewal PS, Kalyani Publishers, New Delhi.
4. Rural Economics by Dhingara IC, Sultan Chand & sons, New Delhi.
5. Agricultural Economics and Rural Development by Tyagi BP, Jai
Prakash Nath & Co., Meerut.
Integrated Rural Development by Ramasamy AS, Oxford & IBH
6. 
Publishing Co Pvt Ltd, New Delhi.

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 CH A P TER

11 Tamil Nadu Economy

“If the nature of the work is properly appreciated and applied, it

will stand in the same relation to the higher facilities as food is to the
physical body”
–J.C.Kumarappa

Learning Objectives

1 To understand the resource position of Tamil Nadu

economy

2 To analyse the performance of Tamil Nadu economy in relation to other

states.

of contribution to GDP, third highest in

11.1
terms of per capita income, investment,
Introduction Foreign Direct Investment (FDI) and
industrial output. It has been ranked as
The economic and social development the most economically free state by the
of states in India are not uniform. Wide Economic Freedom.
regional disparities exist. The western region
and southern regions are better off than the In the social and health sector also Tamil
other regions. Tamil Nadu is geographically Nadu’s performance is better than many
eleventh largest and population wise third other states and better than national
largest. Tamil Nadu fares well with many average in terms of health, higher
achievements. It stands to second in terms education, IMR and MMR.

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 NAGAPATTINAM
}

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 11.2 11.3
Highlights of Tamil Nadu Performance of Tamil Nadu
Economy Economy

„„Growth of SGDP in Tamil Nadu has Some of the States like Gujarat and
been among the fastest in India since Maharashtra seem to perform well in some
2005. of the economic indicators. Kerala tops in
„„Poverty reduction in Tamil Nadu has literacy, IMR and MMR. In recent years Tamil
been faster than that in many other Nadu’s performance is outstanding and far
States. ahead of all other states in the spheres of health,
higher education, growth of MSMEs, poverty
„„Tamil Nadu contains a smaller
alleviation and employment generation.
proportion of India’s poor population.
„„Tamil Nadu is the second largest
contributor to India’s GDP. Tamil Nadu is placed third in health
„„Tamil Nadu ranks 3rd in Human index
Development Index (source: UNDP- The Tamil Nadu state has come third
2015) after Kerala and Punjab in a health
„„Tamil Nadu ranks 3rd in terms of index report. The neo natal mortality
invested capital (₹2.92 lakh crore) and rate is 14 lower than that of many other
value of total industrial output (₹6.19 states and that the under 5 mortality has
lakh crore). dropped from 21 in 2014 to 20 in 2015
„„Tamil Nadu ranks first among the - Healthy States, Progressive India
states in terms of number of factories Report, (2018) –NITI AAYOG
with 17% share and industrial workers
(16% share) of the country.
The reasons for the relative success
„„Tamil Nadu is placed third in health
of Tamil Nadu lie in extending social
index as per the NITI AAYOG report.
policies to cover most of the population.
„„Tamil Nadu has a highest Gross For instance the Public Distribution
Enrolment Ratio in higher education. System, midday meals and public health
„„Tamil Nadu has the largest number of infrastructure have near universal coverage.
engineering colleges
„„Tamil Nadu has emerged as a major 11.4
hub for renewable energy.
Natural Resource
„„Tamil Nadu has highest credit Deposit
Ratio in commercial and Cooperative
banks. 11.4.1 Water Resources
„„Has highest ranks first on investment
Tamil Nadu is not endowed with rich
proposals filed by MSMEs.
natural resources compared to other

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 States. It accounts for three per cent of
water sources, four per cent of land area
against six per cent of population.

North East monsoon is the major source of with Thermal power plants, Fertilizer and
rainfall followed by South West monsoon. Carbonisation plants. Magnesite mining
There are 17 river basins in Tamil Nadu. is at Salem from which mining of Bauxite
The main rivers are Palar, Cheyyar, ores are carried out at Yercaud and this
Ponnaiyar, Cauvery, Bhavani, Vaigai, region is also rich in Iron Ore at Kanjamalai.
Chittar, Tamiraparani, Vellar, Noyyal Molybdenum is found in Karadikuttam in
Siruvani, Gundar, Vaipar, Valparai etc. Madurai district.
Wells are the largest source of irrigation
in Tamil Nadu (56%). Table 11.2 Mineral Resources
Mineral Reserve National
Table 11.1 Water Resources (Tonnes) Share
Source of Numbers Lignite 30,275,000 87%
Irrigation Vermiculite 2,000,000 66%
Reservoirs 81 Garnet 23,000,000 42%
Canals 2239 Zircon 8,000,000 38%
Tanks 41262 Graphite 2,000,000 33%
Tube Wells 3,20,707 Ilmenite 98,000,000 28%
Open Wells 14,92,359 Rutile 5,000,000 27%
Source: Tamil Nadu Government Season & Monazite 2,000,000 25%
Crop Report 2012-13
Magnesite 73,000,000 17%
(Source: Department. of Geology and
11.4.2 Mineral Resources Mining)
Tamil Nadu has a few mining projects based
11.5
on Titanium, Lignite, Magnesite, Graphite,
Limestone, Granite and Bauxite. The first one 11.5.Population
is the Neyveli Lignite Corporation that has
led development of large industrial complex Tamil Nadu stands sixth in population
around Neyveli in Cuddalore district with 7.21 crore against India’s 121 crore as
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 per 2011 census. However, Tamil Nadu’s 995 which is far better compared to most
population is higher than that of several of the States and all India level. Tamil Nadu
countries according to UN Report. stands third next only to Kerala state and
Puduchery Union Territory in sex ratio.
Table 11.3 Population
Table 11.4 H
 ealth and Social
State / Country Population Indicators
(in Crore)
Sl. Indicator Tamil India
Tamil Nadu 7.2 No Nadu
U.K. 6.5
1 IMR 17 34
France 6.5
2 MMR 79 159
Italy 5.9
3 Life Expectancy
South Africa 5.6
Total 70.6 67.9
Spain 4.7
Male 68.6 66.4
Sri Lanka 2.1 Female 72.7 69.6
(Source: Projections published by the United
Nations in the 2017 Revision of World
4 Literacy Rate
Population Prospects.) Total 80.33 % 74.04 %
Male 86.81 % 82.14 %
11.5.1 Density Female 73.86 % 65.46 %
The density of population which measures 5 Sex Ratio 995 940
population per sq.km is 555 in 2011
against 480 in 2001. Tamil Nadu ranks 12th
in density among the Indian States and
11.5.4 Infant Mortality Rate
382 is the national average.
(mortality before
completing 1 year)
11.5.2 Urbanisation
Tamil Nadu is well ahead of national
Tamil Nadu is one of the most urbanized average and other states in IMR. According
state with 48.4% of urban population to NITI AAYOG, the IMR is 17 (per
against 31.5% for India as a whole. 1000) for Tamil Nadu which is just half of
The State accounts for 9.61% of total national average of 34 as on 2016.
urbanites in India against 6% share of
total population.
11.5.5 Maternal Mortality
11.5.3 
Sex ratio (Number of Rate (MMR) (Mother’s
female per 1000 males) death at the time of
delivery per 1 lakh)
Balanced sex ratio implies improvement in
quality of life of female population. The sex Tamil Nadu has a good record of
ratio in Tamil Nadu is nearing balance with controlling MMR, ranking third with

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 79 (Kerala 61, Maharashtra 67) against Table 11.5 Gross State
national average of 159 again half of the Domestic Product
national average [NITI AAYOG].
State / Country GSDP /GDP
(Billion)
11.5.6 Life Expectancy at Tamil Nadu-GSDP $ 207.8
birth
Iraq-GDP $ 171
The average period that a person may New Zealand-GDP $ 184
expect to live is called life expectancy.
Sri Lanka-GDP $ 81
However, life expectancy in India still falls
short of most developed and developing (Source: IMF Outlook, April 2017)
nations.

11.5.7 Literacy 11.6.1 Sectoral Contribution

The literacy rate of Tamil Nadu is Is higher
than in many States

11.6
 ross State Domestic
G
Product (GSDP)

Just like GDP, the Gross State Domestic

Product refers to the total money value
of all the goods and services produced
annually in the State.
Tamil Nadu is the second largest The tertiary sector (service sector) is
economy in India with a GSDP of $ the major contributor to Tamil Nadu’s
207.8 billion in 2016-17 according to the GSDP at 63.70%. The secondary sector
Directorate of Economics and Statistics, (Industry) contribution is gradually on
Tamil Nadu. The GSDP of Tamil Nadu is the rise and now it is 28.5%. Agriculture
equal to the GDP of Kuwait on nominal occupies a prominent position in
term and GDP of UAE on PPP terms. occupation but its contribution to GSDP
The GSDP of Tamil Nadu is far higher is declining and now it is just 7.76%. This
compared to many countries as shown means that the tertiary and secondary
below. This is mainly due to population sectors have grown faster, the agricultural
effect. Per capita GSDP would be better for sector has grown slow. Agriculture
intercountry or interstate comparisons. sector provides employment and food to
Tamil Nadu may go below if per capita larger proportion of Indians and Tamils.
GSDP is considered for comparison. But, the same sector is growing slowly

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 Table 11.6 Per capita income
means it is not good. With this trend
sustainable development may not be State / Country Per capita Income
possible. (in USD)
Tamil Nadu 2200
11.6.2 Per capita Income India 1670
The Per capita GSDP of Tamil Nadu also Nigeria 2175
($ 2,200) which is higher than that of Nicaragua 2151
many other States in India. Per capita Pakistan 1443
GSDP of Tamil Nadu is nearly 1.75 times Bangladesh 1358
higher than the national average, as per Zimbabwe 1029
2018 data. In term of ₹ the per capita Nepal 729
income in Tamil Nadu was ₹ 1,03,600 in (Source: World Bank National Accounts data, and
2010-11 and it has increased to ₹1,88,492 OECD National Accounts data files. -https://data.
in 2017-18 as per the Budjet figures 2018. worldbank.org/indicator/NY.GDP.PCAP.CD)

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 The Per capita income of Tamil Nadu crops is 27.1%. Among the food crops
among the southern States is given below: paddy takes a major share. Among the
non-food crops, groundnut and coconut
Table 11.7 Per capita take a major share.
Income (2015-16) Net sown area has been gradually
State PI (₹) declining; and, rural land, labour and
capital are moving towards urban projects.
Tamil Nadu 1,57,116
As a result, villages are emptied and cities
Kerala 1,55,516 are over-crowded and congested, leading
Karnataka 1,46,416 to spatially unbalanced bulging.
Telangana 1,58,360
Andhra Pradesh 1,37,000 11.7.1 Foodgrain Production
(Source: Reserve Bank of India, New Delhi.
February 2017.)

11.7
Agriculture

Tamil Nadu, with seven agro climatic zones

and varied soil types is better suited for
the production of fruits, vegetables, spices,
plantation crops, flowers and medicinal Rice production dominates among food
plants. The State is the largest producer of grain production with 79.49 lakh tones on
loose flowers and the third largest producer 2014-15 followed by millets at 40.79 lakh
of fruits. Tamil Nadu has historically been tons. There is significant jump in pulses
an agricultural State. At present, Tamil Nadu production from 3.59 lakhs ton in 2011-
is the India’s second biggest producer of rice, 12 to 7.67 lakh ton in 2014-15. There
next only to West Bengal. The state is one may be changes in these statistics. Hence
of the major producers of turmeric. It is updation is unavoidable.
also the leading producer of Kambu, Corn,
Groundnut, Oil seeds and Sugarcane. It 11.7.2 Productivity Position
ranks first in production of plantation crops, of Tamil Nadu and
banana and coconut, second in rubber and India
cashew nut, third in pepper and fourth in
The Government of Tamil Nadu lays
sugarcane.
emphasis on agricultural production and
The gross cropped area under productivity. As a result, Tamil Nadu
all crops was 58.97 lakh hectares in the tops in productivity, in food crops as
year 2013-14. The area under food crops well as non-food crops, among the States
account for 72.9% and that of non-food in India.

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 Table 11.8 Productivity 11.8
Position of Tamil Nadu
Industry
Crop Position of Tamil Nadu
at National Level Chennai is sometimes referred to as
Maize 1 the Health Capital of India or the Banking
Kambu 1 Capital of India, having attracted
Groundnut 1 investments from International Finance
Total Oilseeds 1 Corporationsand the World Bank. It is
Cotton 1 also called as Detroit of Asia.
Coconut 2 Tamil Nadu has a network of
Rice 2 about 110 industrial parks/estates that
Sugarcane 3 offer developed plots with supporting
Sunflower 3 infrastructure. Also, the Government
Jowar 3 is promoting other industrial parks
like Rubber Park, Apparel Park,
Coarse cereals 4
Floriculture Park, TICEL Park for
Total Pulses 8
Biotechnology, Siruseri IT Park and Agro
Source: Tamil Nadu Agriculture Department
Export Zones.
Policy Note 2017-18)
The heavy engineering
Tamil Nadu ranks first in maize, manufacturing companies are centered
kambu, groundnut, oil seeds and cotton; around the suburbs of Chennai. Chennai
second in rice and coconut, third in boasts of global car manufacturing giants
sugarcane, sunflower and jowar. as well as home grown companies.

INDUSTRY CLUSTERS IN TAMIL NADU

RANIPET : Leather

AMBUR : Leather
VANIYAMBADI : Leather
SALEM : Powerlooms, Home textiles, Steel, Sago

SANKAGIRI : Lorry fleet operators

TIRUCHENGODE: Borewell drilling services

NAMAKKAL : Transportation, Poultry
KARUR : Coach-building, Powerlooms
ERODE : Powerlooms, Turmeric
COIMBATORE : Spinning mills, Engineering industries
TIRUPUR : Knitwear, Readymade garments

RAJAPALAYAM : Surgical cotton products

SIVAKASI : Safety matches, Fireworks, Printing

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 Karur is known for its bus body mill capacity is in Tamil Nadu. The western
building which contributes 80% of part of Tamil Nadu comprising Coimbatore,
South Indian bus body building. TNPL Tirupur, Erode, Dindigul and Karur has the
is the Asia›s largest ecofriendly paper majority of spinning mills manufacturing
mill. Salem is called as steel city and has cotton/polyester/blended yarn and silk
many sago producing units and mineral yarn used by garment units in Tamil Nadu,
wealth. Sivakasi is the leader in printing, Maharastra etc. Yarn is also exported to
fireworks, safety matches production China, Bangladesh etc. Tirupur known as
in India. It contributes to 80% of India’s “Knitting City” is the exporter of garments
total safety matches production and 90% worth USD 3 Billion. Karur is the major
of India’s total fireworks production. home for textile manufacturing (Curtain
Thoothukudi is the gateway of Tamil cloth, bed linens, kitchen linens, toilet
Nadu. It is a major chemical producer linens, table linens, wall hangings etc.) and
next only to Chennai. export hub in India. Erode is the main cloth
market in South India for both retail and
wholesale ready-mades.
11.8.1 Textiles

11.8.2 Leather
Tamil Nadu accounts for 30 per cent of
leather exports and about 70 per cent of
leather production in the country. Hundreds
of leather and tannery industries are located
around Vellore, Dindigul and Erode. Every
year the State hosts the India International
Leather Fair in Chennai.

11.8.3 Electronics
Tamil Nadu is the largest textile hub of Chennai has emerged as EMS Hub of India.
India. Tamil Nadu is known as the “Yarn Many multi – national companies have
Bowl” of the country accounting for 41% chosen Chennai as their South Asian
of India’s cotton yarn production. The manufacturing hub.
textile industry plays a significant role in
the Indian economy by providing direct
employment to an estimated 35 million 11.8.4 Automotives
people, and thereby contributing 4% of Chennai nicknamed as “The Detroit of
GDP and 35% of gross export earnings. Asia”is home to a large number of auto
The textile sector contributes to 14% of component industries. Tamil Nadu has
the manufacturing sector. From spinning 28% share each in automotive and auto
to garment manufacturing, entire textile components industries, 19% in the trucks
production chain facilities are in Tamil segment and 18% each in passenger cars
Nadu. About half of India’s total spinning and two wheelers.
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 The town of Sivakasi is a leader in the
11.8.5 Cement Industry
areas of printing, fireworks, and safety
Tamil Nadu ranks third in cement production matches. It was fondly called as “Little
in India (First Andhra Pradesh, Second Japan” by Jawaharlal Nehru. It contributes
Rajasthan). Among 10 largest cement to 80% of India’s fireworks production.
companies in India as on 2018, Ramco Cement Sivakasi provides over 60% of India’s total
and India Cement find prominent place. And offset printing solutions.
also Tamil Nadu stands second in number of
cement plants with 21 units against 35 units in
11.8.7 Other Industries
Andhra Pradesh.
One of the global electrical equipment
public sector companies viz BHEL has
11.8.6 Fire works
manufacturing plants at Tiruchirappalli and
Ranipet. The Tamil Nadu State Government
owns the Tamil Nadu Newsprint and
Papers (TNPL), the world’s biggest bagasse-
based paper mill in Karur. Tamil Nadu
is a leading producer of cement in India
and with manufacturing units located at
Ariyalur, Virudhunagar, Coimbatore and
Tirunelveli. The region around Salem is
rich in mineral ores. The country’s largest
steel public sector undertaking, SAIL has a
steel plant in Salem.

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 Coimbatore is also referred to as “the 11.9
pump City” as it supplies two thirds of India’s
Energy
requirements of motors and pumps. The city
is one of the largest exporters of jewellery, wet
grinders and auto components and the term Tamil Nadu tops in power generation
“Coimbatore Wet Grinder” has been given among the southern States as seen in
a Geographical indication following table.

Thoothukudi is known as Installed capacity of power utilities

“Gateway of Tamil Nadu”. Thoothukudi in States in southern region
is the major chemical producer in the
state. It produces the 70 per cent of the Table 11.11 Energy
total salt production in the State and 30 State Units Ranks
per cent in the country. Tamil Nadu 26,865 MW I
Karnataka 18,641 MW II
11.8.8 MSMEs Andhra Pradesh 17,289 MW III
The Micro, Small and Medium Enterprises Telungana 12,691 MW IV
are defined under the MSMED Act 2006. The Kerala 4,141 MW V
enterprises are classified as Manufacturing 79,627 MW
and Service enterprises based on the (Source: Central Electricity Authority, Ministry
investment in plant and machinery and of Power, Government of India. Retrieved
equipment (excluding land and building) the Jan.2017.)
classification of Micro, Small and Medium
Enterprises is given in Table- 11.11. Tamil Nadu is in the forefront of
all other Indian States in installed
Tamil Nadu accounts for 15.07% capacity. Muppandal wind farm is
Micro, Small and Medium Enterprises a renewable energy source, supplying
(MSMEs) in the country( the highest the villagers with electricity for work.
among all States) with 6.89 lakhs registered Wind farms were built in Nagercoil and
MSMEs. Producing over 8000 varieties of Tuticorin apart from already existing
product for a total investment of more than ones around Coimbatore, Pollachi,
₹32,000 crore. Dharapuram and Udumalaipettai. These
MSMEs produce a wide variety areas generate about half of India’s
of products in almost all sectors. The 2,000 megawatts of wind energy or two
prominent among them are the engineering, percent of the total power output of India.
electrical, chemicals, plastics, steel paper,
matches, textiles, hosiery and garments
11.9.1 Nuclear Energy
sector. Around 15.61 lakh entrepreneurs
have registered, providing employment The Kalpakkam Nuclear Power Plant and
opportunities to about 99.7 lakhs persons the Koodankulam Nuclear Power Plant
with total investment of ₹1,68,331 crore.

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 Table 11.13 Thermal Power
Source Million Units %
Thermal 13304 49.52
Hydel 2203 8.20
Nuclear 986 3.67
Others (Wind, 10372 38.61
Solar)
Total 26865 100.00
are the major nuclear energy plants for the (Source: Central Electricity Authority, Ministry
energy grid. of Power, Government of India. Retrieved 15
Jan.2017.)

Table 11.12 Nuclear Energy 11.9.3 Hydel Energy

Units Existing Installed There are about 20 hydro electric units

Capacity (2018) in Tamil Nadu. The prominent units are
Hundah, Mettur, Periyar, Maravakandy,
Kudankulam 1834 MW (2 x 917)
Parson Valley etc.
Kalpakkam 470 MW (2 x 235)
11.9.4 Solar Energy
Tamil Nadu tops in solar power generation
in India as seen in following table.
Southern Tamil Nadu is considered
as one of the most suitable regions in

Table 11.14 Solar Energy

Ranking States Total capacity

(MW) 2017
1 Tamil 1590.97
Nadu
11.9.2 Thermal Power
2 Rajasthan 1317.64
In Tamil Nadu the share of thermal power
3 Gujarat 1159.76
in total energy sources is very high and
the thermal power plants are at Athippattu 4 Telangana 1073.41
(North Chennai) Ennore, Mettur, Neyveli 5 Andhra 979.65
and Thoothukudi. Pradesh
The generation of power under (Source :Data from MNRE)
various sources is given below.
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 the country for developing solar power Credit Deposit Ratio of 119.15% in the
projects. country whereas this ratio is 77.5% at the
national level.
11.9.5 Wind Energy
11.10.2 Education
Tamil Nadu has the highest installed wind
energy capacity in India. The State has very a. School Education
high quality of off shore wind energy potential Tamil Nadu is grouped among high Net
off the Tirunelveli coast and southern Enrolement Ratio (NER) States. According
Thoothukudi and Rameswaram coast. to NITI Aayog 2015-16 NER at primary
level in Tamil Nadu is 89.24% which is
11.10 higher than that of Kerala (79.94%) and
national average 74.74%. The all India
SERVICES average is 43% and the world average is
59%.
Banking, insurance, energy, transport and
Table 11.15 Tamil Nadu’s
communication fall under tertiary sector
primary education statistics
i.e., services. 2016-17

11.10.1 Banking Number Primary 35,414

of schools Middle 9,708
In Tamil Nadu, Nationalised banks account
for 52% with 5,337 branches, Private High and Higher 12,911
Commercial Banks 30% (3,060) branches, Secondary
State Bank of India and its associates 13%
(Source: Tamil Nadu State portal, State interim
(1,364), Regional Rural Banks 5% (537)
Budget 2016-17)
branches and the remaining 22 foreign
bank branches. Gross Enrolment Ratio is 118.8%
Total deposits of the banks in Tamil for primary level(class 1-5); 112.3% for
Nadu registered an year-on year increase upper primary level (class 6-8), 62.7% for
of 14.32% by March 2017 and touched secondary level (class 9-10), 49.26% at
₹6,65,068.59 crores. Total credit of the Higher Secondary level (class 11-12). This
banks in Tamil Nadu registered a year-on has been possible mainly due to the supply
year increase of 13.50% by March 2017 and of free food, cloth, foot-wear, scholarship,
touched ₹6,95,500.31 crores. The share of laptop etc.
Priority Sector Advances stands at 45.54% b. Higher Education
as against the national average of 40%.
The percentage of Agricultural advances In Gross Enrolment Ratio under higher
to total advances as at the end of March education (Tertiary level) Tamil Nadu
2017 works out to 19.81% as against the continues to be at the top level well ahead
national average of 18%. Banks in Tamil of other states. The GER is 46.9% in
Nadu have maintained one of the highest Tamil Nadu which is far higher against
national average and all other States This
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 higher GER is thanks to the distribution 24.8%. Both Karnataka & Kerala together
of free food,cloth, footwear, laptop and accounted for more than 60% of the total
scholarship. educational loan amount by Private Banks.

Table 11.16 Gross 11.10.4 Health

Enrolment Rate %
Tamil Nadu has a three – tier health
State 2016-17 infrastructure comprising hospitals,
Tamil Nadu 46.9 primary health centres, health units,
community health centres and sub-
Maharashtra 30.2
centres. As of March 2015, the State had
Uttar Pradesh 24.9
34 district hospitals, 229 sub-divisional
Odisha 21.0 hospitals, 1,254 primary health centres,
Bihar 14.4 7,555 Sub-centres and 313 community
All India 25.2 health centres.

(Source: All India Survey on Higher Education

(AISHE) released by the Ministry of Human
11.10.5 Communication
Resource Development- January 2018) Maharashtra has the highest number of
internet subscribers in the country at
Tamil Nadu has 59 Universities, 29.47 million, followed by States like Tamil
40 Medical colleges, 517 Engineering Nadu, Andhra Pradesh and Karnataka.
colleges, 2,260 Arts and Science
According to government data,
colleges, 447 Polytechnics and 20 dental
India had a total of 342.65 million internet
colleges. Tamil Nadu produces nearly
subscribers at the end of March, 2016.
four lakh engineering and polytechnic
Tamil Nadu had 28.01 million subscribers,
students every year, the highest in the
while its neighbours Andhra Pradesh and
country.
Karnataka had 24.87 million and 22.63
million, respectively.
11.10.3 Educational Loans
As far as educational loans disbursed by 11.10.6 Transport
Public Sector Banks under priority sector Tamil Nadu has a well established
are concerned, 20.8% of the total amount transportation system that connects all
was disbursed in Tamil Nadu between parts of the State. This is partly responsible
2013-14 and 2015-16. Andhra Pradesh for the investment in the State. Tamil Nadu
was second with 11.2% of the total loan is served by an extensive road network in
amount followed by Maharashtra (10.2%). terms of its spread and quality, providing
Of the total amount of educational links between urban centres, agricultural
loans disbursed by Private Banks during market-places and rural habitations in the
the same period, Kerala accounted for countryside. However, there is scope for
37.8% followed by Tamil Nadu with improvement.

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 a. Road c. Air
There are 28 national highways in the Tamil Nadu has four major international
State, covering a total distance of airports. Chennai International Airport
5,036 km. The State has a total road length is currently the third largest airport in
of 167,000 km, of which 60,628 km are India after Mumbai and Delhi. Other
maintained by Highways Department. It international airports in Tamil Nadu include
ranks second in India with a share of over Coimbatore International Airport, Madurai
20% in total road projects under operation International Airport and Tiruchirapalli
in the public-private partnership (PPP) International Airport. It also has domestic
model. airports at Tuticorin, Salem, and Madurai.
which connect several parts of the country.
Increased industrial activity has given rise
b. Rail
to an increase in passenger traffic as well as
freight movement which has been growing
at over 18 per cent per year.

d. Ports

Tamil Nadu has a well-developed rail network

as part of Southern Railway, Headquartered
at Chennai. The present Southern Railway Tamil Nadu has three major ports; one
network extends over a large area of India’s each at Chennai, Ennore, and Tuticorin,
Southern Peninsula, covering the States of as well as one intermediate port in
Tamil Nadu, Kerala, Puducherry, minor Nagapattinam, and 23 minor ports. The
portions of Karnataka and Andhra Pradesh. ports are currently capable of handling
Tamil Nadu has a total railway track length over 73 million metric tonnes of cargo
of 6,693 km and there are690 railway stations annually (24 per cent share of India).
in the State. The system connects it with most All the minor ports are managed by the
major cities in India. Main rail junctions Tamil Nadu Maritime Board, Chennai
in the State include Chennai, Coimbatore, Port. This is an artificial harbour and the
Erode, Madurai, Salem, Tiruchirapalli and second principal port in the country for
Tirunelveli. Chennai has a well-established handling containers. It is currently being
Suburban Railway network, a Mass Rapid upgraded to have a dedicated terminal for
Transport System and is currently developing cars capable of handling 4,00,000 vehicles.
a Metro system, with its first underground Ennore Port was recently converted from
stretch operational since May 2017. an intermediate port to a major port and
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 handles all the coal and ore traffic in Tamil and foreign tourists. Tourism in Tamil
Nadu. Nadu is promoted by Tamil Nadu Tourism
Development Corporation (TTDC), a
Government of Tamil Nadu undertaking.
11.11
The State currently ranks the highest
Tourism among Indian States with about 25 crore
arrivals (in 2013). The annual growth
Tamil Nadu has since ancient past been rate of this industry stood at 16 per cent.
a hub for tourism. In recent years, the Approximately 28 lakh foreign and 11
state has emerged as one of the leading crore domestic tourists visit the State.
tourist destinations for both domestic

11.12 22nd with unemployment rate of 42

Unemployment and per 1000. There are different kinds of
Poverty unemployment with different economic
implications. All those aspects need
National average of unemployment to be studied to fully understand the
rate stands at 50 andTamil Nadu ranks employment situation.

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 Tamil Nadu is one of India’s richest
states Since 1994, the state has seen a
steady decline in poverty. Today, Tamil
Nadu has lower levels of poverty than

Percentage
most other States in the country. After
2005, Tamil Nadu was among India’s
fastest growing states, with growth being
driven mainly by services.

Year

34 33 32
Percentage

32
29

21 20 19
17 17
12 12

BH OD AS MP UP KA WB NL MH GJ MG TN

States

11.13 three ranks in health index, education,

development of MSMEs. It has a good record
Conclusion
of poverty alleviation and employment
generation. However, India in general and
The Tamil Nadu economy which is Tamil Nadu in particular need to work
not rich in natural resources has good more to eliminate female foeticide, reduce
record of agricultural growth, industrial the population living in slums, sleeping
progress, infrastructural development and on roadsides, beggers and rag pickers.
good record of robust growth of service Development is meaningless as long as the
sector especially banking, education, above eyesore continues.
transport and tourism. It occupies top

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 Appendix-I
Population Growth in Tami Nadu: At a Glance (2011 Census)
• Total Population 72138958
• Male 36158871
• Female 35980087
• Crude birth rate (per thousand) 15.7
• Crude death rate (per thousand) 7.4
• Growth Rate (per thousand) 8.3
• Districts with Highest Population (Chennai, Kancheepuram, Vellore and
Thiruvallur)
• Districts with Lowest Population (Perambalur, The Nilgiris, Ariyalur and
Theni)
• Population Density (per sq km): 555 (2011), 480 (2001)
• Maximum Density Chennai (26903);
Kanyakumari (1106)
• Minimum Density The Nilgiris (288);
Thiruchirappalli (602)
• Sex Ratio (per 1000 males) 995 females (2011)
987 females (2001)
• District with Highest Sex Ratio The Nilgiris (1041 females)
Thanjavur (1031 females)
Nagapattinam (1025 females)
• District with Lowest Sex Ratio Theni (900 females)
Dharmapuri (946 females)
• Child Sex Ratio (0-6 age group) 946 female children (2011)
942 female children (2001)
• District with Highest Child Sex Ratio The Nilgiris (985), Kanyakumari (964)
• District with Lowest Child Sex Ratio Cuddalore (896); Ariyalur (897)
• Literacy Rate 80.33% (2011)
73.45% (2001)
• Male Literacy 86.81% (2011)
82.33% (2001)
• Female Literacy 73.86% (2011)
64.55% (2001)
• District with Highest Literacy Kanyakumari (92.14%); Chennai 90.33%)
• District with Lowest Literacy Dharmapuri(64.71%; Ariyalur (71.99%)

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 Glossary C-D Ratio - Ratio of Bank advances to
deposits
Per capita Income - In come per head
(GSDP / Population) Bio-diesel - Extraction of oil from plants
like jatropha
GSDP - Money value of all goods and
services produced annually in the MSMEs - Micro, Small and Medium
State Enterprises
Neo natal Mortality - Death of kids soon Micro Enterprise - Enterprise with a
after delivery capital investment, not exceeding 25
lakhs (These may change)
Infant Mortality Rate - Death of children
before completing one year after birth. Small Enterprise - Unit with investment
on plant and machinery above 25 lakhs
Child Mortality Rate - Death of child
but below 10 cr. (These may change)
before the age of five

MODEL QUESTIONS

Part-A Multiple Choice Questions

1. In health index, Tamil Nadu is ahead of 4. The main source of irrigation in Tamil
a) Kerala Nadu is

b) Punjab a) river
b) tank
c) Gujarat
c) well
d) all the above
d) canals
2. In sex ratio, Tamil Nadu ranks
5. Knitted garment production is
a) first concentrated in
b) second a) Coimbatore
c) third b) Tiruppur

d) fourth c) Erode
d) Karur
3. Tamil Nadu is rich in
6. Which of the following is wrongly
a) Forest resource matched?
b) human resource a) Gateway of Tamil Nadu –
c) mineral resource Thoothukudi
d) all the above b) Home textile city - Erode
c) Steel city - Salem
d) Pump city - Coimbatore
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 7. Which of the following cities does not 12. Which district in TN has the highest
have international airport? sex ratio?
a) Madurai a) Nagapattinam
b) Tiruchirappalli b) Nilgiris
c) Paramakudi c) Tiruchirappalli
d) Coimbatore d) Thanjavur

8. TN tops in the production of the 13. Which district has the lowest child sex
following crops except ratio?
a) Banana a) Madurai
b) Coconut b) Theni
c) plantation crops c) Ariyalur
d) cardamom d) Cuddalore

9. Largest area of land is used in the 14. Which Union Territory has the highest
cultivation of sex ratio?
a) Paddy a) Chandigarh
b) sugarcane b) Pondicherry
c) Groundnut c) Lakshadeep
d) Coconut d) Andaman Nicobar

10. In literacy rate, TN ranks 15. The largest contribution to GSDP in

a) second Tamil Nadu comes from

b) fourth a) agriculture

c) sixth b) industry

d) eighth c) mining
d) services
11. In investment proposals filed by
MSMEs, TN ranks 16. In human development index, TN is
a) I ranked

b) II a) Second

c) III b) fourth

d) IV c) sixth
d) seventh

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 17. SPIC is located in 19. In India’s total cement production,
a) Chennai Tamil Nadu ranks

b) Madurai a) third

c) Tuticorin b) fourth

d) Pudukkottai c) first
d) second
18. The TICEL park is
a) Rubber Park 20. The Headquarters of Southern Railway
is at
b) Textile park
a) Tiruchirappalli
c) Food park
b) Chennai
d) Bio park
c) Madurai
d) Coimbatore.

Answers Part-A

1 2 3 4 5 6 7 8 9 10
c c b c b b c d a d
11 12 13 14 15 16 17 18 19 20
a b c b d d c d a b

Part-B 
Answer the following questions in one or two
sentences.

21. State any two districts with favourable 24. What are major ports in Tamil Nadu?
sex ratio. Indicate the ratios.
25. What is heritage tourism?
22. Define GSDP.
26. What are the nuclear power plants in
23. Mention any four food crops which Tamil Nadu?
are favourable to Tamil Nadu.
27. Define Micro industry

Part-C Answer the following questions in one paragraph.

28. Write a note on mineral resources in 31. Compare productivity of any two food
Tamil Nadu. crops between Tamil Nadu and India.

29. Explain GSDP in Tamil Nadu. 32. Explain the prospect for development
of tourism.
30. Describe development of textile
industry in Tamil Nadu.
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 33. What are the renewable sources of 34. Describe the performance of Tamil
power in Tamil Nadu? Nadu economy in health.

Part-D Answer the following questions in about a page

35. Describe the qualitative aspects of 37. Explain the public transport system in
population. Tamil Nadu.

36. Explain the various sources of energy

in Tamil Nadu.

ACTIVITY

1. Visit your near by village and make a spot study about crops
production, source of irrigation and living condition of farmers.

References

1. A. G. Leonard - Tamil Nadu Economy – 2006, Laxmi Publications

2. V. Rajalakshmi - Tamil Nadu Economy – 1 Jun 2002, BPI (India) PVT Ltd
https://www.ibef.org/states/tamil-nadu.aspx
https://www.quora.com/Can-Tamil-Nadu-become-the-biggest-economy-in-India
https://www.indiatoday.in › India
statisticstimes.com/economy/economy-of-tamil-nadu.php

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 CH A P TER

12 Mathematical Methods
for Economics

“The master economist must possess a rare combination of gifts. He

must be mathematician, historian, statesman, philosopher to some degree”
- J.M.Keynes

Learning Objectives

1 To understand why mathematics is required for

economics,

2  o learn the knowledge of mathematical methods, as a facility for self-expression

T
not only in descriptive economics, but also in quantitative economics.

12.1 policy making. Hence, the mathematical

methods would help economists to use
Introduction
the quantitative variables in a better way
and to obtain accurate results.
Economic analysis is a systematic
The lengthy and descriptive
approach to (a) determine the optimum
economic contents can be clearly set in
use of scarce resources and (b)choose
simple notation in mathematical models for
available alternatives and select the
clear and easy understanding. For example,
best alternative to achieve a particular
the number of pens demanded in a given
objective. Mathematical methods are
time period in a Higher Secondary School
helpful for achieving the objectives of the
is 200 when price is zero. This decreases
economic analysis.
by 10 for every ₹1 rise in the price of pen.
It is expressed mathematically as
12.1.1 Why Study Q = 200 - 10 P, here Q is the
Mathematics? quantity demanded and P is the price.
The subject Economics deals with many Thus large information can be expressed
quantitative variables and functions, in and communicated with simple functions
consumption, production, distribution and and equations.
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 12.1.2 Mathematics in 12.2
Economics
Functions
Sir William Petty
declared that he wanted
to reduce political and 12.2.1 Definition
economic matters in A function is a mathematical relationship
terms of number, weight in which the values of a dependent
and measure. He was the variable are determined by the values of
first one to use Sir William Petty one or more independent variables.
mathematics in 1623-1687 Functions with a single
economics. The first independent variable are called Simple
known writer to apply mathematical method Univariate functions. There is a one to one
to economic problems was Giovanni Ceva correspondence. Functions,with more
(1711), an Italian. than one independent variable, are called
Multivariate functions. The independent
12.1.3 Uses of Mathematical variable is often designated by X. The
Methods in Economics dependent variable is often designated
1. Mathematical Methods help to by Y. For example, Y is function of X
present the economic problems in a which means Y depends on X or the value
more precise form. of Y is determined by the value of X.
Mathematically one can write Y = f(X).
2. Mathematical Methods help to
explain economic concepts.
3. Mathematical Methods help to 12.2.2 Linear Equation
use a large number of variables in A statement of relationship between two
economic analyses. quantities is called an equation. In an equation,
4. Mathematical Methods help to if the largest power of the independent
quantify the impact or effect of any variable is one, then it is called as Linear
economic activity implemented by Equation. Such equations when graphed give
Government or anybody. There are straight lines. For example Y = 100-10X.
of course many other uses.
For a straight line, there are two
Think and Do variables namely X and Y. X is called
independent variable and Y is called
„„Who is the father of
dependent variable.
Economics? Did he use
any of the mathematical When ‘X’ value increases by one
tools in his contributions? unit, then the corresponding change in
If yes, list out. the ‘Y’ value is called as the slope of the
„„Find out the mathematical line. Slope of the line is obtained by the
tools, which are used by you formula,
in your daily routine life. m = slope (marginal change)

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 Y2 − Y1 Change inY 2(Y-2) = -10(x-2)
m= , 2Y-4 = -10x +20
X2 − X1 Change in X .
2Y = -10x+24
Where (X 1, Y 1) and (X 2, Y 2) are two Y = -5x +12
arbitrary points
-5 is slope, denoted by m
Slope or Gradient of the line 12 is Y intercept, or constant denoted by c
represents the ratio of the changes in This is of the form Y = mX + c
vertical and horizontal lines.
Y = 12-5X when X = 0; Y = 12

The formula for constructing a straight When Y = 0; X = 12/5 = 2.4

line is (This line looks likes demand line in micro
economics )
(Y - Y1) = m(X - X1)
12
If the two points are (0, 0) and (X, Y) then
the formula is Y = mX 10
Y=12-5X
8

Example 12.1 6
Price

4
Find the equation of a straight line which
passes through two points (2, 2) and (4, -8) 2

which are (X1, Y1) and (X2, Y2) respectively.

0 2 4 6 8 10 12
Note: For drawing a straight line, at least 2.4 Quantity demanded
two points are required. Many straight Diagram 12.1
lines can pass through a single point.
12.2.3 Application in
Solution Economics

Here X1 = 2, Y1 = 2 By applying the above method, the demand

and supply functions are obtained.
X2= 4, Y2 = -8
Demand Function: Qd = f (Px) where Qd
Formula for construction of straight line
stands for Quantity demand of a commodity
Y - Y1 X - X1 and Px is the price of that commodity.
=
Y2 - Y1 X 2 - X 1 Supply Function: Qs = f (Px) where ‘Qs’
stands for Quantity supplied of a commodity
Applying the values
and Px is the price of that commodity.
Y -2 X -2 In the example 12.1 the equation Y
=
-8 - 2 4 - 2 = -5X + 12 has been obtained. It is a linear
Y -2 X -2 function. Since slope is negative here, this
=
-10 2 function could be a demand function.
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 Demand Line Supply Line
YY YY
YY
33 88 (20,7)
(20,7) 1010
77 (10,6)
(10,6)
(2,2)
(2,2) 66 (0,5) 7.5
7.5
22 (0,5)
55

Price
Price
Price

55

Price
Price

44

Price
11 33
22 2.5
2.5
(12,0)
(12,0) 11
00
22 44 66 88 1010 1212 XX
00 55 1010 1515 2020 xx 00
QuantityDemanded
Quantity Demanded
QuantitySupplied
Quantity Supplied
Diagram12.2
Diagram 12.2 Diagram12.3
12.3
Diagram
Price-quantity relationship is negative in supply function can be obtained from the
demand function. Qd = 12-5 X � or Qd = statement that supply increases 10 units
12-5 P . If P = 2, Qd = 2. for each one rupee rise in price, that is
YY
When P assumes 0, only 12 alone (10, 6) & (20, 7).
remains in the equation. This is called
Intercept or Constant, = 0 and Qd = 12.
if surplus
Consumer’s
Consumer’s Psurplus When p = 5, supply is zero. When p = 6,
In Marshallian supply is 10 and so on. When p is less than
,P ) analysis,money
Price
Price

(X0,P
BB (X 0 0)0
P0
P0
terms measured in Y-axis and physical 5, say 4, supply is -10, which is possible
Demand
units are measured in X-axis.
Demand curve
Accordingly,
curve
in mathematics. But it is meaningless
price is measured in Y-axis and quantity in Economics. Normally supply curve
demanded is measured in X-axis originates from zero, noting that when
0 0 price is zero, supply is also zero.
XX0 0 xx
Demand
Demand
Example: 12.2 Diagram
Diagram12.8
12.8
Find the supply function of a commodity The equation of the straight line
such that the quantity supplied is zero, joining two data points (10, 6) and (20, 7)
when the price is ₹5 (or below) and the is given as
supply (quantity) increases continuously The equation of the straight line is
at the constant rate of 10 units for each
Y - Y1 X - X1
one rupee rise when the price is above ₹5. =
Y2 - Y1 X 2 - X 1

Solution: substituting the values of (x1, y1) (x2, y2)

To construct the linear supply function by (10, 6) , (20, 7) respectively,
atleast two points are needed. First data
point of supply function is obtained from Y - 6 X - 10
=
the statement that the quantity supplied is 7 - 6 20 - 10
zero, when the price is ₹5, that is (0, 5). Y - 6 X - 10
=
The second and third data points of 1 10

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 Demand = Supply
(These are hypothetical examples)

Price
100-10P = 50 + 10 P
100-50 = 20P
50 = 20P
Quantity demanded
50
=P
20
Diagram 12.4 P = 2.5
When P = 2.5, Demand = 100-10 (2.5)
X - 10 = 75
Then Y -6 =
10
When P = 2.5, Supply = 50 +10 (2.5)
10(Y - 6) = X - 10 = 75
10Y - 60 = X - 10
Example: 12.3
10Y - 60 + 10 = X
Find the equilibrium price and quantity
10Y - 50 = X
by using the following demand and
-X = -10Y + 50
supply functions Qd = 100-5P and
Multiplying both sides by minus (-), we get Qs = 5P respectively.

X = -50 + 10Y Y

10
Considering X as quantity supplied and Y
as price (P) 7.5 D
S
Then X = 10P - 50 (or) 5
Price

X = -50 + 10 P E
2.5
If Price = 0; Q = -50
If Q = 0; P = 5 0 25 50 75 100 x
Note: The coefficient of ‘P’ is - in demand Demand/Supply

function. Diagram 12.5

The coefficient of ‘P’ is + in supply Solution:

function.
Equilibrium is attained when,
Qs = Q d
12.2.4 Equilibrium
5 P = 100 - 5 P
The point of intersection of demand line and
10P = 100
supply line is known as equilibrium. The
P = 10
point of equilibrium is obtained by using
When P = 10
the method of solving a set of equations.
One can obtain the values of two unknowns In supply function
with two equations. At equilibrium point, Qs = 5 P = 5 x 10 = 50
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 In demand function, Find the linear demand function and its
Qd = 100 - 5 P = 100 - 5(10) = 50 slope.

Hence at Solution:
P = 10, Qd = 50, Qs = 50. Equation of demand function joining two
Quantity demanded is equal to supply at data points (100, 1) and (50, 2) are (x1, y1)
50 units when price is ₹10 and (x2, y2) respectively.

Example: 12.4
Y
The market demand curve is given by D = 4
50 - 5P. Find the maximum price beyond
3
which nobody will buy the commodity.

Price
Y 2

20
S
1
15
E
Price

10 0 50 100 150 200 X

Quantity Demanded
5 Diagram 12.7
D

0 x Y - Y1 X - X1
25 50 75 100
=
Quantity Demanded Y2 - Y1 X 2 - X 1
Diagram 12.6 Y - 1 X - 100
=
2 - 1 50 - 100
Solution:
Y - 1 X - 100
=
Given 1 -50
Qd = 50 - 5P -50 (Y - 1) = 1 (X - 100)
5P = 50 - Qd -50Y + 50 = X - 100
-50Y + 50 + 100 = X
5P = 50 when Qd is zero.
-50Y + 150 = X
50
P= X = 150 - 50Y
5
Hence the demand function is
P = 10 When P = 10, Demand is 0
Hence P = 10, which is the maximum Qd = 150 – 50P and Slope m = – 50
price beyond which nobody will demand
the commodity. Think and Do for
Water Management in
Example: 12.5 your area
The demand for milk is given by Try to find the demand function
for water in your street and the
Price (Y) 1 2 3
daily total demand for water in
Demand (X) 100 50 0 litre for all purposes.

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 12.3 a11 a12 a13
Matrices a21 a22 a23 is a determinant of the
a31 a32 a33
12.3.1 Matrices matrix A denoted by A .

‘Matrix’ is a singular while ‘matrices’ is The value of the determinant is expressed

a plural form. Matrix is a rectangular as a single number.
array of numbers systematically arranged Calculation of the value of
in rows and columns within brackets. determinant for a 2 x 2 matrix is shown
In a matrix, if the number of rows and below
columns are equal, it is called a square
matrix.
a1 b1
If A = then A = a1b2 − a2b1
a2 b2
12.3.2 Determinants
Calculation of determinant value for a
3 x 3 matrix is shown below
For every square matrix, there exists
a determinant. This determinant is an a1 b1 c1
arrangement of same elements of the b c2 a c2 a b2
a2 b2 c2 = a1 2 − b1 2 + c1 2
corresponding matrix into rows and b3 c3 a3 c3 a3 b3
a3 b3 c3
columns by enclosing vertical lines.
For example, = a1(b2c3-b3c2)-b1(a2c3-a3c2)+c1(a2b3-a3b2)

Example: 12.6
1 3 5
  Find the value of the determinant for the
 6 2 4  is a square matrix of order
7 8 9 3 4
  matrix A=  
3 x 3,then 10 −2 

1 3 5 Solution:
6 2 4 is a determinant. 3 4
Given matrix A =   then, the
7 8 9 10 −2 
Determinant
 2 3
  is a square matrix of order 2 x 2, then 3 4
5 7 A= = 3 ( −2 ) − 10(4)
10 −2
2 3
is a determinant. = - 6 - 40 = - 46 is the value of the
5 7
determinant.
 a11 a12 a13 
 
In general, if A =  a21 a22 a23  is a matrix Example: 12.7
a
 31 a32 a33  Find the value of the determinant of the
then, matrix

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 3 4 7 a11 a12 a13
  where, ∆ = a21 a22 a23
A = 2 1 3
7 2 1 a31 a32 a33
 
b1 a12 a13 a11 b1 a13
Solution: ∆ x = b2 a22 a23 , ∆ y = a21 b2 a23 ,
Determinant of the given matrix is, b3 a32 a33 a31 b3 a33
a11 a12 b1
3 4 7
1 3 2 3 2 1 ∆z = a21 a22 b2
A = 2 1 3 =3 −4 +7
2 1 7 1 7 2 a31 a32 b3
7 2 1
= 3 (1 - 6) -4 (2 - 21) Key Note
+ 7 (4 - 7)

= 3 (-5) -4 (-19) + 7 (-3) If the determinant ∆ = 0 , then

solution does not exist.
= -15 +76 -21

A = 40

The value of determinant is 40. Example: 12.8

Find the value of x and y in the equations
12.3.3 Cramer’s Rule by using Cramer’s rule. x + 3y = 1 and
3x - 2y = 14
Cramer’s rule
Solution:
provides the solution
of a system of linear Given equations are
equations with ‘n’ x + 3y = 1
variables and ‘n’ 3x - 2y = 14
equations. It helps Then the equations in the matrix form :
to arrive at a unique 1 3  x   1 
G. CRAMER
solution of a system    =  
(1704-1752)  3 −2   y  14 
of linear equations
with as many equations as unknowns. Calculating ∆, ∆=
1 3
3 −2
If the given equations are
= -2 -9
a11x + a12 y + a13 z = b1
= - 11
a21x + a22 y + a23 z = b2 ∆ ≠ 0, Hence solution exists.
a31x + a32 y + a33 z = b3 1 3
∆x = = −2 − 42 = -44
then 14 −2

∆x ∆y ∆z ∆y =
1 1
= 14 − 3 = 11
x= , y= , z=
∆ ∆ ∆ 3 14

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 ∆x −44 ∆y 11 Solution:
Hence x = = =4, y= = = −1
∆ −11 ∆ −11 The matrix form of the given equation is
∴ x = 4 and y = −1 written as

7 1 1 x1 0
Answer checking:
10 2 1 x2 8
Substituting in equation the values of x 6 3 2 x3 7
and y,
4 + 3(-1) = 1, 7 −1 −1
∆ = 10 −2 +1
3(4) – 2(-1)= 14
6 3 −2

Example: 12.9 = 7(4-3)-(-1)(-20-6)+(-1)(30+12)

Find the solution of the system of equations. = 7(1) + 1(-26) - 1(42)
5x1 + 3x2 = 30 = 7 -26 - 42 = -61
6x1 - 2x2 = 8 0 −1 −1
Δx1 = = 8 −2 1
Solution:
7 3 −2
The coefficient and the constant terms are
given below for the equations = 0(4-3)-(-1)(-16-7) + (-1)(24 + 14)
= 0 + 1(- 23)-1(38)
5 3
∆= = −10 − 18 = −28 = -23 - 38 = -61
6 −2
30 3 7 0 −1
∆x1 = = −60 − 24 = −84
8 −2 Δx2 = = 10 8 1
5 30 6 7 −2
∆x2 = = +40 − 180 = −140
6 8 = 7(-16-7)-0(-20-6)+(-1)(70-48)
∆x1 −84
∴ x1 = = =3 = 7(-23) + 0 - 1(22)
∆ −28
∆x −140 = -161-22 = -183
x2 = 2 = =5
∆ −28
7 −1 0
∴� x1 = 3, x2 = 5 Δx3 = = 10 −2 8
6 3 7
Example: 12.10
= 7(-14-24) - (-1)(70-48) + 0(30 + 12)
Find the solution of the system of equation
= 7(-38) + 1(22) + 0
7x1 - x2 - x3 = 0
= -266 + 22 = -244
10x1 - 2x2 + x3 = 8
∆x1 −61
6x1 + 3x2 - 2x3 = 7 x1 = = =1
∆ −61

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 ∆x2 −183 To find ∆y
x2 = = =3
∆ −61 2 32 1
∆x −244
x3 = 3 = =4 ∆y = 4 52 2
∆ −61
2 60 3

12.3.4 Application in Economics ∆y = 2(156 − 120) − 32(12 − 4) + 1(240 − 104)

= 2(36) − 32(8) + 1(136)
Example 12.11 = 72 − 256 + 136 = −48
Mr.Anbu, purchased 2 pens, 3 pencils and
To find∆z
1 note book. Mr.Barakath , purchased
2 3 32
4 pens, 3 pencils and 2 notebooks.
Mr.Charles purchased 2 pens, 5 pencils ∆z = 4 3 52
and 3 notebooks. They spent ₹32, ₹52 and 2 5 60
₹60 respectively. Find the price of a pen, a
pencil and a note book. ∆z = 2(180 − 260) − 3(240 − 104) + 32(20 − 6)
= 2(−80) − 3(136) + 32 (14)
Solution:
= −1600 − 408 + 448 = −120
Let x be the price of a pen, y be the price of −60
a pencil and z be the price of a notebook, x= = 5 (Pr ice of a pen)
−12
In equations: −48
y= = 4 (Pr ice of a pencil )
2x + 3y + 1z = 32, −12
−120
4x + 3y + 2z = 52, z= = 10 (Pr ice of anotebook )
−12
2x + 5y +3z = 60
In matrix form Answer checking
 2 3 1  x  32  2(5)+3(4)+1(10)=32
    
 4 3 2  y   52  4(5)+3(4)+2(10)=52
 2 5 3  z  60 
  2(5)+5(4)+3(10)=60
  2(9  10 )  3(12  4 )  1(20  6)
 2(1)  3(8 )  1(14 ) Think and Do
 2  24  14  12 Fathima, purchased 6 pens and
To find ∆x 5 Pencils spending ₹49, Rani
purchased 3 Pens and 4 pencils
32 3 1
spending ₹32. What is the price
∆x = 52 3 2
of a pen and pencil?
60 5 3
6 5   x1   49 
3 4   x  = 32 
x 32(9 10) 3(156 120) 1(260 180)   2  
32( 1) 3(36) 1(80) Solution : Price of a pen = ₹4
32 108 80 60 Price of a pencil = ₹5
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 12.4 1
Key Note
DIFFERENTIAL CALCULUS
If the power of any non-zero real
number is zero, it's value is 1
12.4.1 Meaning x 0 = 1 when x ≠ 0

The fundamental operation of calculus

is differentiation. Derivative is used to Example: 12.12
express the rate of change in any function. dy
Derivative means a change in the If Y = 4, then find
dx
dependent variable with respect to small
Solution:
change (closer to zero) in independent
variable. Y = 4, here 4 is a constant.Differentiation
of constant function is zero.
Let the function be,
dy d ( 4 )
So, = =0
y = f(x) dx dx

Differentiating y with respect to x is, Example: 12.13

d ( y) df ( x ) Find the slope of the function y = 6x3 for
=
dx dx any value of x.

Solution:
12.4.2 Some Standard Forms Given y = 6x3
of Differentiation dy
Slope =
dx
(Constant, addition and subtraction
only) dy
= 6 ( 3) x3−1 = 18x2 for any value of x.
dx
d(c)
1. = 0 where C is a constant. Example: 12.14
dx
What is the slope of the function y = 5x4
(Read differentiation of ‘C’ with when x = 10?
respect to ‘x’ is)
Solution:
n
d(x )
2. = nx n−1 Given function y = 5x4
dx
dy
Slope = �
d(x ) dx
3. = 1x1−1 = 1x 0 = 1
dx dy
= 5 ( 4 ) x 4−1
dx
d (u + v) du dv = 20x3
4. = +
dx dx dx When x = 10, then slope = 20 (10)3
d (u − v) du dv = 20,000,
5. = −
dx dx dx Therefore Slope is 20,000.

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 Example: 12.15
12.4.4 Marginal concepts
Differentiate the function Y = 3x2 + 16x3
with respect to x. Marginal concept is concerned with
variations of Y (on the margin of X), that is, it
Solution: is the variation corresponding in Y to a very
small variation in X. (X is the independent
Y = 3x2 + 16x3 variable and Y is the dependent variable)
Differentiating,
dy 12.4.5 Marginal Product
= 3 ( 2 ) x 2−1 + 16 ( 3) x3−1
dx
Marginal product of a factor of production
= 6 x1 + 48 x 2 refers to addition to total product due to
dy the use of an additional unit of a factor.
= 6 x + 48 x 2
dx
MP = d(TP)/dQ = ∆TP/∆Q
Example: 12.16

dy 12.4.6 Marginal Cost

If Y = 2x3 -6x, then find
dx
Solution: Marginal cost is an addition to the total
cost caused by producing one more unit of
Y = 2x3 -6x output. In symbols:
Differentiate ‘y’ with respect to x,
d(TC) Δ(TC)
dy MC = or MC =
= 2 ( 3) x3−1 − 6 (1) x1−1 dQ ΔQ
dx
= 6 x2 − 6 x0 Where, ∆TC represents a change in total
dy cost and ∆Q represents a small change
= 6x2 − 6
dx in output or quantity. (in economics one
worker, one output etc are assumed to be
12.4.3 Application of very small units)
Differential Calculus
Example: 12.17
The relation between two or more
Given the total cost function, TC = 15 + 3Q2
variables can be expressed by means
+ 7Q3, drive the marginal cost function.
of a function. Continuous functions
alone are differentiable. For instance, Solution:
the differential calculus is applicable for
finding the following: TC = 15 + 3Q2 + 7Q3
(1) The rate of change in demand with
MC =
d (15 )
+
(
d 3Q 2 ) + d ( 7Q )
3

respect to price (in micro economics)

dQ dQ dQ
(2) The rate of change in income with = 0+3(2)Q2-1 + 7(3)Q3-1
respect to the investment. (in
macroeconomics) . MC = 6Q +21Q2
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 d (TC )
12.4.7 Marginal Revenue MC (Q) = = 3Q3-1 - 18(2)Q2-1
dQ
Marginal Revenue is the revenue
+ 91(1)Q1-1+0
earned by selling an additional unit of
the product. In other words, Marginal = 3Q2 - 36Q1 + 91Q0 + 0
Revenue is an addition made to the total MC (Q) = 3Q2 - 36Q + 91 (∴Q0 = 1)
revenue by selling one more unit of the When Q = 3
good. MC(Q) = 3(32)-36(3)+91
d (TR ) ∆TR = 3(9)-108+91
MR = or =� = 27-108+91
dQ ∆Q
=118-108
Where ∆TR stands for change in the total =10
revenue, and ∆Q stands for change in output. To find AVC

Example: 12.18 Given TC(Q)= Q3 - 18Q2 + 91Q + 10

We know TVC (Q) = Q3 - 18Q2
Given TR = 50Q - 4Q2,find marginal
+ 91Q (∴constant value is fixed cost)
revenue when Q = 3.
AVC(Q)=TVC(Q)/Q
Solution:
AVC(Q) = Q2 – 18Q + 91
TR = 50Q - 4Q2 When Q = 3
MR = d(TR)/dQ AVC(Q) = 32–18(3)+9
MR = 50(1)Q1-1 - 4(2)Q2-1 =9–54+91
=100–54 = 46
= 50(1)Q0 - 8 Q1
Q 3 − 18Q 2 + 91Q
= 50(1) - 8Q (∴Q = 1,Q =Q)
0 1 ∴AVC(Q) =
Q
MR = 50 - 8Q =Q2 -18Q +91
When Q = 3 Note : Fixed cost= 10
10
Average fixed cost = .
MR = 50 -8(3) =26 Q
Example: 12.19 Q 3 − 18Q 2 + 91Q + 10
Average cost =
A producer has the total cost function Q
TC (Q) = Q3 - 18Q2 + 91Q + 10 where costs
are given in rupees. Find the marginal 10
= Q 2 − 18Q + 91 +
cost (MC) and the average variable cost Q
(AVC), when Q =3. So Average cost = AVC + AFC

Solution: AC = AVC + AFC

Given TC(Q) = Q3 - 18Q2 + 91Q + 10, To TC

AC =
find MC differentiate the function with Q
respect to Q.
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 Example: 12.20
12.4.8 Elasticity of Demand
A manufacturer estimates that, when units
of a commodity are produced each month Elasticity of Demand is the ratio of
the total costs will be TC(Q) = 128 + 60Q the proportionate change in quantity
+ 8Q2 Find the marginal cost, average cost, demanded to the proportionate change in
fixed cost, variable cost, average fixed cost price. In mathematical terms,
and average variable cost. P dx
ed = ( ) ( )
x dp
Solution: In demand function Q = a–bP
Given that TC(Q) = 128 + 60Q + 8Q2 ed = (dQ/dP)(P/Q)
We know TC = Fixed cost + variable Example 12.21
cost 100
If the demand function is x = ,find ed
P
d (TC ) with respect to price at the point where P = 2
MC (Q) =
dQ
Note
= 0 + 60(1)Q1-1 + 8(2)Q2-1
By taking supply function, the
= 0 + 60Q0 + 16Q1(Since, Q0=1) elasticity of supply can be calculated
MC = 60 + 16Q
TC
�
AverageCost =
Q Solution:
128 + 60Q + 8Q 2 Given
=
Q 100
x= = 100 P −1
P
128
AC = + 60 + 8Q dx
Q ∴ = 100(−1)P-1-1
dp
Constant value is known as fixed cost
= 100(−1)P-2

Fixed cost = 128 = -100(P-2)

−100
FC = 128 =
P2
128
Average Fixed cost = At P=2,
Q
dx -100 100
AFC =
128 = = -25 and=x = 50
Q dp 4 2
Substituting the values in formula
Average Variable cost =60 + 8Q (total
variable cost divided by Q) Pdx  2   −100  −200
ed = =   = = −1
xdp  50   4  200
∴� AVC = 60 + 8Q ed = -1
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 12.5 b. The differential symbol ‘dx’ is written
by the side of the function to be
Integral Calculus integrated.
c. ∫f ( x ) dx = F(x)+C, C is the integral constant
12.5.1 Integration
∫f ( x ) dx
means, integration of f(x) with
Differential calculus measures the rate of respect to x.
change of functions. In Economics it is
also necessary to reverse the process of 12.5.3 Basic Rule of Integration
differentiation and find the function F(x)
x (n+1)
whose rate of change has been given. This (i) Power Rule ∫x dx = n
+C
is called integration. The function F(x) is n +1
termed an integral or anti- derivative of (ii) ∫k dx = kx + c, where k is a constant
the function f(x).
(iii) ∫a.xn dx = a∫xn dx
The integral of a function f(x) is
expressed mathematically as Example 12.22

∫ 4 x dx = 4 ∫ x dx
3 3

∫f ( x ) dx = F ( x ) + C
x 3+1
Here the left hand side of the equation is =4 +c
3 +1
read “the integral of f(x) with respect to x4
x” The symbol ∫ is an integral sign, f(x) is =4 +c
4
integrand, C is the constant of integration, 4
= x +c
and F(x)+c is an indefinite integral. It is
so called because, as a function of x, which Example12.23
is here unspecified, it can assume many
∫ (x + x − 1)dx = ∫ x 2dx + ∫ xdx − ∫ dx
2
values.

x 2+1 x1+1
= + −x +c
12.5.2 Meaning 2 +1 1+1

If the differential coefficient of F (x) with x3 x2

= + −x +c
respect to x is f(x), then an integral of f(x) 3 2
with respect to x is F(x). It is a reverse Example 12.24
process of differentiation. In symbols:
∫ 5dx = 5x + c
d  F ( x ) 
If  = f ( x ) , then∫ f ( x ) dx = F ( x ) + C Example12.25
dx
x1+1
Following points need to be remembered: ∫ 4 xdx = 4 1 + 1 + c
a. ∫ is used to denote the process of x2
=4 +c
integration. In fact, this symbol is an 2
elongated ‘S’ denoting sum. = 2x 2 + c
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 12.5.4 Application of TC = ∫ y � dx + c
fin
Integration = (23 16 x 3x 2 )dx c ,
Example 12.26 where c is a constant

Let the marginal cost function of a firm = ∫ 23dx + ∫16 xdx − ∫3x 2 dx+c
be 100-10x+0.1x2 where x is the output. x2 x3
= 23x+16 3 c
Obtain the total cost function of the firm 2 3
under the assumption that its fixed cost TC = 23x + 8x2 - x3 + c
is ₹500. c = 40 given
Solution ∴TC = 23x+8x2-x3 + 40
TC
MC = 100 - 10x + 0.1 x2 Average cost function =
x
40
TC = 100 10x 0.1x 2 d x = 23 + 8x - x2 +
x
Y
x2 x3 Y
= 100x-10 + 0.1 + c 3 8
2 3 12.5.5 Consumer’s Surplus
7
x3 This2 (2,2)was
theory developed by the Alfred 6
= 100x-5 x + + c
2
(0,5)
30 Marshall. The demand function P(x) 5

Price
Price

Fixed cost is given as ₹500 reveals the relationship between the 4

1 3
quantities that the people would buy at
x3 2
∴TC = 100 x − 5x 2 + + 500 given price. It can be expressed as(12,0)
30 1

x3
0
2 4 P 6= f (x)
8 10 12 X
= − 5x 2 + 100 x + 500 0
30 Consumer Quantity
surplusDemanded
is the difference
between the price one is willing to pay and
Example 12.27 the price that Diagram 12.2paid.
is actually

The marginal cost function for producing It is represented in the following

x units is y = 23 + 16x - 3x2 and the total diagram.
cost for producing zero unit is ₹40. Obtain
Y
the total cost function and the average
cost function.
Consumer’s surplus
Solution:
Price

B (X0,P0)
Given the marginal cost function y = 23 + P0
16x - 3x2 ; c = 40 Demand curve
₹40 is the fixed cost.
We know that 0 X0 x
Demand
Total Cost function = ∫ (Marginal cost
Diagram 12.8
function) dx+c
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 Mathematically, the consumer’s surplus Example 12.29
(CS) can be defined as Given the demand function Pd = 25 - Q2
CS = (Area under the demand and the supply function Ps = 2Q + 1.
curve from x = 0 to x = x0) - (Area of the Assuming pure competition, find (a)
rectangle OX0BP0) consumers surplus and (b) producers surplus.
x0
(Pd = Demand price; Ps = Supply price)
CS = [ p x dx]-x0p0
0 Solution:
Example:12.28 For market equilibrium, Pd = Ps
If the demand function is P = 35 - 2x - x2 25-Q2 = 2Q+1
and the demand x0 is 3, what will be the 0 = -25 + Q2 + 2Q+1
consumer’s surplus?
0 = -24 + Q2 + 2Q
Solution Q2 + 2Q - 24 = 0
Given demand function, Q2 + 6Q - 4Q - 24 = 0
P = 35 - 2x - x2 Q(Q + 6) -4(Q + 6) = 0
for x = 3
(Q + 6)(Q- 4) = 0
P = 35 - 2(3) -32
So, Q = 4 or Q = -6. Since Q cannot be
= 35 - 6 - 9
equal to -6,
P = 20 Q=4
Therefore,
When Q=4, Pd =25 -42=9;
CS = (Area of the curve below the
demand curve from 0 to 3) - Area of the Ps =2(4) + 1=9
rectangle (20 x 3 = 60) 4

3
Consumers’ surplus =  ( 25 - Q 2 )dQ -
CS =  (35-2x-x2)dx-(20×3) (9 X 4) 0

0
3 4
 x2 x3   Q3 
= 35x − 2 −  -60 = 25Q -  − 36
 2 3 0  3 0
32 33
= 35(3) -2( ) - -60 =[ (25)(4) -
1
(4)3 ] -(0) -36
2 3 3
= 105 -9 -9 - 60
64
= 27 Units. = [100 - ] - (0) -36 = 42.67
3
Producers’ surplus PS
12.5.6 Producer’s surplus 4
(PS) = (9×4) -  ( 2Q+1)dQ
xo
PS = Po xo -
0
òo
g (x )d x
4
= 36 - (Q2 +Q)
0

= 36 - (16 + 4) = 16
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 Think and Do S.No Information Technologies
„„Find your change in 5 Transmission Internet,
mark by additional hour Teleconference,
of study in any of your Video
subject conferencing,
„„Find your consumption Mobile
of petrol for an additional Technology, Radio
unit of kilometer travelled 6 Exchange E mail, Cell phone
„„Ask your parents about
The evaluation of ICT has five phases.
their spending with
They are evolution in
respect to every additional
unit of wage or salary or (a) Computer
income
(b) PC
(c) Microprocessor

12.6 (d) Internet and

Information and (e) Wireless links

Communication In Economics, the uses of mathematical
Technology (ICT) and statistical tools need the support
of ICT for data compiling, editing,
Information and Communication manipulating and presenting the results.
Technology (ICT) is the infrastructure In general, SPSS and Excel packages are
that enables computing faster and often used by researchers in economics.
accurate. The following table gives an idea Such Software is designed to do certain
of range of technologies that fall under the user tasks.Word processor, spread
category of ICT. sheet and web browser are some of the
examples which are frequently used while
S.No Information Technologies undertaking analysis in the study of
1 Creation Personal economics.
Computers, Digital
Camera, Scanner, 12.6.1 MS Word
Smart Phone
MS word is a word processor, which helps
2 Processing Calculator, PC, to create, edit, print and save documents
Smart Phone for future retrieval and reference.
3 Storage CD, DVD, Pen
Drive, Microchip, The features of word
Cloud processor are
4 Display PC, TV, Projector, a) Document can be created, copied,
Smart Phone edited and formatted.
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 b) Words and sentences can be inserted,
12.6.2 Microsoft Office Excel
changed or deleted.
c) Formatting can be applied. It is used in data analysis by using
formula. A spread sheet is a large sheet
d) Margins and page size can be adjusted.
of paper which contains rows and
f) Spell check can be availed. columns. The intersection of rows and
g) Multiple documents – files can be columns is termed as ‘cell’. MS Excel
merged. 2007 version supports up to 1 million
rows and 16 thousand columns per
How to open a word work sheet.
Document?
One can open MSWord from various Start
options.
You can start excel from various
Click start → All program → MS options.
word or Double click the MS word icon
from the desktop. „„Click Start → Program → Micro Soft
Excel.
Uses of Menu „„Double Click the MS Excel Icon from
the Desk top.
Home menu → It is used to change the
fonts, font size, change
the text color and apply Work Sheet
text style bold, italic, A worksheet is a table like document
underline etc. containing rows and columns with data
Insert → It is used to insert page and formula. There are four kinds of
numbers, charts, tables, calculation operators. They are arithmetic,
shapes, word art forms, comparison, text concatenation (link
equations, symbols and together) and reference. MS Excel helps to
pictures. do data analysis and data presentation in
the form of graphs, diagrams, area chart,
Page Layout → It is used to change the
line chart etc.
margin size, split the
text into more columns,
background colour of a
page. 12.6.3 Microsoft Power Point
Reference → Insert table of authors, It is a software used to perform computer
endnote, footnote based presentation.
Review → Spell check, Grammar, Steps involved in making
Translate. presentation:
View → Print layout, full screen (i) Click Start Menu
reading, document view (ii) Click Program

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 (iii) Select Microsoft Power point –
Click. CONCLUSION

(iv) New Power Point file will open, and This chapter provide the knowledge of
then type the title and subtitle if necessity of mathematics in economics
wanted. by explaining the application of linear
algebra, calculus and Information
(v) A new slide can be inserted by ‘click’
Communication and Technology.
on icon ‘new slide’ or using short
Specifically the knowledge of functions,
key ‘Ctrl + M’
matrices , differential calculus, Integral
(vi) We can type the content, insert the calculus ,MS word, MS Excel and Power
table, pictures, movies, sounds, Point Presentation are depicted with
etc., with the content. suitable applications. The activities are
(vii) 
Tab ‘Design’ helps to design the also added for students to learn it reality
slides (can select common design for about the use of mathematical methods in
all slides or separate slide for each economics.
slide)
(viii) Click icon slide show, one can run
FORMULAE
slide show either starting from
the first slide or starting from the 1. m= y2-y1/x2-x1 for Slope
current slide. 2. (y-y1) = m (x-x1 ) for straight Line
The power point presentation (PPT) 3. A = a 1(b 2c 3 – b 3c 2) – a 2(b 1c 3-
facilitates the key points to be kept in b 3 c 1 )+a 3 (b 1 c 2 -b 2 c 1 ) for 3x3
memory and understand the particular matrices
topic. Recently, the smart class room
4. Differentiation of constant is
teaching uses the PPT to deliver the
zero
information in an effective way to enhance
the quality of teaching. 5. Differentiation of xn is nx(n-1)
6. ed = Marginal function / Average
function
Think and Do
−P dx
7. ed =
„„Make a Document with x dp
MS word on “Incredible
x n+1
India”. 8. Integration of x is +C
n
n +1
„„Prepare an Excel Sheet for
 x0 
your daily pocket expenses 9. CS=  ∫ f (x )dx  − xo po
for each category/item in  0 
last month 10. PS = x 0p 0 – integration of
„„Prepare and present a supply function within limit
“Power Point” for “Day x0

= xo po - ∫ g ( x ) dx
out with your parents” 0

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 ICT CORNER
Drawing Graphs for the Data Collected

Graphs using EXCEL for

the given data is given

Steps:
• Collection of data of Child population (0-6 years) from 1961 to 2011 in Rural and Urban areas in India.
Let us draw the graph for the data.
• Open Microsoft Excel workbook, Type the X-axis data in the First column and then type respective
data in consecutive columns.
• Now select all the typed data, After selecting the data Click “Insert” to get Charts. select scatter type to
get scroll down menu.
• Select “Scatter with Smooth Lines and Markers” you will get the required graph as shown here.
• By selecting 3 icons on the right side to edit “chart elements” Particularly Check on the boxes Axis
Titles and Chart Title.
• Type x-axis and y-Axis, followed by Chart Title. Click “Legend” to change the position
• Now right click on the graph (a) to copy the graph and Then paste in a word page (or)Select move chart
to move In other excel page, Menu willappear to place it in new sheet.
• Now If you want to change the graph type as bar chart or any other type,click on the graph to select and
then click on any type of graph given in the top menu

Step1 Step2 Step3 Step4

Step5 Step6 Step7 Step8

Pictures are indicatives only*

URL:
https://youtu.be/Xn7Sd5Uu42A
(or) scan the QR Code

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 ICT CORNER
Consumer’s and Producer’s Surplus

Lets use Integration to find

Consumer’s and Producer’s
Surplus

Steps:
• Open the Browser type the URL given (or) Scan the QR Code.
• GeoGebra Work book called “XI STD ECONOMICS” will appear, Open the worksheet named
“Consumer’s and Producer’s Surplus Ex:12.29”
• Without integration we cannot find the Area under the curve. For Higher studies atleast you should
know what is Integration and why it is needed.
• In the worksheet Green colour is the Demand Curve and Blue colour is the Supply curve. They intersect
at Point A (4,9). In which x axis value 4 is the demand price. If you integrate the Demand curve
between 0 and 4 we get the area as shown. Click “Show Area Integral1” integrating the demand price
between 0 and 4.
• If you click on “Show Area of Rectangle” you can see the area of the rectangle which is obtained by
Multiplying the length 4 and Breadth 9 (Point A(4,9))
• If you subtract: the area under the curve PD -Area of the rectangle you
get the Consumer’s Surplus.
• Click on “Show Area Integral 2” you see Blue colour area which is
obtained by Integrating Supply Price line between 0 and 4. Subtract:
Area of the rectangle – Area under the line PS you get The Producer’s
Surplus. You can change PS line by moving the sliders ‘m’ and ‘c’. you
can see the changes in Consumer’s Surplus and Producer’s Surplus.

Step1 Step2 Step3 Step4

Pictures are indicatives only*

URL:
https://ggbm.at/ddY3wkjp
(or) scan the QR Code

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 MODEL QUESTIONS

Part-A Multiple Choice 5. A statement of equality between two

Questions quantities is called

1. Mathematical Economics is the a. Inequality

integration of b. Equality
a. Mathematics and Economics c. Equations
b. Economics and Statistics d. Functions
c. Economics and Equations 6. An incremental change in dependent
d. Graphs and Economics variable with respect to change in
independent variable is known as
2. The construction of demand line or
supply line is the result of using a. Slope b. Intercept

a. Matrices c. Variant d. Constant

b. Calculus 7. (y - y1) = m(x - x1) gives the

c. Algebra a. Slope
d. Analytical Geometry b. Straight line

3. The first person used the mathematics c. Constant

in Economics is d. Curve
a. Sir William Petty 8. Suppose D = 50 - 5P. When D is zero
b. Giovanni Ceva then
c. Adam Smith a. P is 10 b. P is 20
d. Irving Fisher c. P is 5 d. P is -10

4. Function with single independent 9. Suppose D = 150 - 50P. Then, the

variable is known as slope is
a. Multivariate Function a. -5 b. 50
b. Bivariate Function c. 5 d. -50
c Univariate Function 10. Suppose determinant of a matrix 0,
d. Polynomial Function then the solution
a. Exists
b. Does not exist
c. is infinity
d. is zero

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 11. State of rest is a point termed as 16. The elasticity of demand is the ratio of
a. Equilibrium a. Marginal demand function and
b. Non-Equilibrium Revenue function

c. Minimum Point b. Marginal demand function to

Average demand function
d. Maximum Point
c. Fixed and variable revenues
12. Differentiation of constant term
d. Marginal Demand function and
gives
Total demand function
a. one
17. If x+y = 5 and x-y= 3 then, Value
b. zero of x
c. infinity a. 4
d. non-infinity b. 3
13. Differentiation of xn is c. 16
a. nx(n-1) d. 8
b. n x (n+1) 18. Integration is the reverse process of
c. zero a. Difference
d. one b. Mixing
14. Fixed Cost is the -----------term in cost c. Amalgamation
function represented in mathematical
d. Differentiation
form.
a. Middle 19. Data processing is done by

b. Price a. PC alone

c. Quantity b. Calculator alone

d. Constant c. Both PC and Calculator

d. Pen drive
15. The first differentiation of Total
Revenue function gives 20. The command Ctrl + M is applied for
a. Average Revenue a. Saving
b. Profit b. Copying
c. Marginal Revenue c. getting new slide
d. Zero d. deleting a slide

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 Part-A Answers

1 2 3 4 5 6 7 8 9 10
a d b c c a b a d b
11 12 13 14 15 16 17 18 19 20
a b a d c b a d c c

Part – B Answer the following questions in one or two

sentences:

1. If 62 = 34 + 4x what is x? (Answer :x is 7) 5. Suppose the price p and quantity q

of a commodity are related by the
2. Given the demand function q = 150 −
equation q = 30 - 4p - p2 find (i) ed at
3p, derive a function for MR.
p = 2 (ii) MR
3. Find the average cost function where
6. What is the formula for elasticity
TC = 60 + 10x +15x2
of supply if you know the supply
4. The demand function is given by x = function?
20 - 2p - p2 where p and x are the price
7. What are the Main menus of MS
and the quantity respectively. Find the
Word?
elasticity of demand for p = 2.5.

Part – C Answer the following questions in one paragraph:

1. Illustrate the uses of Mathematical x1 - x2 + x3 = 2: x1 + x2- x3 = 0 :

Methodsm in Economics. -x1- x2 - x3 = -6

2. Solve for x quantity demanded if 16x − 5. If a firm faces the total cost function
4 = 68 + 7x. (Ans: x is 8 ) TC = 5+ x2 where x is output, what is
TC when x is 10?
3. A firm has the revenue function R =
600q - 0.03q2 and the cost function 6. If TC = 2.5q3− 13q2+ 50q + 12 derive
is C = 150q + 60,000, where q is the the MC function and AC function.
number of units produced. Find AR,
7. What are the steps involved in
AC, MR and MC. (Answersa:AR = 600
executing a MS Excel Sheet?
- 0.03q ; MR = 600 - 0.06 q; AC = 150
+ (60000/q) )

4. Solve the following linear equations

by using Cramer’s rule.

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 Part – D Answer the following questions in about a page:

1. A Research scholar researching the independent variables should be

market for fresh cow milk assumes positive or negative.)
that Qt= f(Pt, Y,A,N, Pc) where Qt
2. Calculate the elasticity of demand
is the quantity of milk demanded,
for the demand schedule by using
Pt is the price of fresh cow milk, Y
differential calculus method P = 60 −
is average household income, A is
0.2Q where price is (i) zero, (ii) ₹20,
advertising expenditure on processed
(iii) ₹40.
pocket milk, N is population and Pc is
the price of processed pocket milk . 3. The demand and supply functions
(a) What does Qt= f (Pt, Y,A,N, Pc) are p d=1600 - x2 and ps = 2x2 + 400
mean in words? respectively. Find the consumer’s
surplus and producer’s surplus at
(b) Identify the independent
equilibrium point.
variables.
(c) Make up a specific form for this 4. What are the ideas of information and
function. (Use your knowledge communication technology used in
of Economics to deduce whether economics?
the coefficients of the different

ACTIVITY
1. The petrol consumption of your car is 16 Kilometers per litre.
Let x be the distance you travel in Kilometers and p the price
per litre of petrol in Rupees. Write expressions for demand for
Petrol.

2. Make up your own demand function and then derive the

corresponding MRfunction and find the output level which
corresponds to zero marginal revenue.

3. Use an Excel spreadsheet to calculate values for Quantity of

demand at various prices for the function Q = 100−10P then
plot these values on a graph.

4. Open MS-Word and put the title as PRESENT AND ABSENT

OF STUDENTS and insert the table and collect the data for all
classes of your school and find the class of highest absentees in
a month. Justify with reason for the absentees in a paragraph
by using MS Word.

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 References

1. Chiang A.C. and K. Wainwright, Fundamental Methods of Mathematical

Economics,Tata McGraw-Hill Education; Fourth edition (2013).
2. Dowling E.T, Introduction to Mathematical Economics, 2nd Edition,
Schaum‘sOutline Series, McGraw-Hill, New York, 2003(ETD).
3. Henderson, J. M. and R.E. Quandt (1980), Microeconomic Theory:
A Mathematical Approach, McGraw Hill, New Delhi.
4. James Bradfield, Jeffrey Baldani, An Introduction to Mathematical Economics,
Cengage Learning India Pvt Ltd (2008)
5. Koutsoyiannis.A Modern Microeconomics, Palgrave Macmillan; 2nd Revised
edition (2003)
6. Mike Rosser, Basic Mathematics for Economists, Second Edition, Routledge
Taylor& Francis London 2003.
7. Mehta and Maddani, Mathematics for Economics, Sultan Chand and Sons
9th editions 2008
https.pdfdrive.net/fundamental methods of mathematical economics.
https.researchgate.net/mathematical economics

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 GLOSSARY

Accelerator முடுக்கி
Advertising elasticity of demand விளம்பரத் தேவை நெகிழ்ச்சி
Alternative uses மாற்று வழிகள்
Annual plan ஓராண்டுத் திட்டம்
Art கலை
Assumption அனுமானம்
Average cost சராசரி செலவு
Average product சராசரி உற்பத்தி
Barter பண்டமாற்று
Behavioural Economics ப�ோக்கு சார் ப�ொருளியல்
Business வணிகம்
Capability செயலாற்றல்
Capital மூலதனம் (K)
Cardinal Utility Analysis இயல்பெண் பயன்பாட்டு ஆய்வு
Cash Reserve Ratio (CRR) ர�ொக்க இருப்பு வீதம்
Characteristics குணாதிசயங்கள்
Child sex Ratio 6 வயதுக்கு கீழே உள்ள 1000 ஆண் குழந்தைகளுக்கு எத்தனை
பெண்கள் இருக்கிறார்கள் என்பது குழந்தைகளின் பாலின விகிதம்
Classical த�ொன்மை
Coefficient கெழு
Colonial capitalism காலனி ஆதிக்க முதலாளித்துவம்
Concealed unemployment,
Disguised unemployment மறைமுக ேவலையின்மை
Concentration ெசறிவு
Constant Returns to Scale மாறா விகித அளவு
Consumer நுகர்பவர்
Consumer’s Surplus நுகர்வோர் உபரி / நுகர்வோர் எச்சம்
Consumption நுகர்வு (C)
Contraction of demand விலை அதிகரிப்பால் நிகழ்வு தேவைச்சுருக்கம்
Criticism திறனாய்வு
Crop insurance பயிர் காப்பீடு
Cross elasticity of demand குறுக்கு தேவை நெகிழ்ச்சி
Crude Birth rate 1000 நபர்களுக்கு பிறந்த குழந்தைகளின் எண்ணிக்கை
Crude Death Rate 1000 நபர்களுக்கு இறந்தவர்களின் எண்ணிக்கை
Data /Statistics /information புள்ளி விவரங்கள்
Decentralization பரவலாக்கப்படல்
Decrease in demand தேவை குறைதல்
Deductive Method பகுத்தாய்வு முறை
Definition வரையறை / இலக்கணம்
Delicensing உரிமம் விலக்கல்
Demand தேவை
Democracy குடியாட்சி

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 Demographic dividend மக்கள் த�ொகையின் அனுகூலம்
Demonstration effect பகட்டு விளைவு
Density of population ம�ொத்த மக்கள் த�ொகையை நிலத்தின் அளவால் வகுக்கக் கிடைப்பது
Determinants நிர்ணயிப்பவைகள்
Determinant அணிக்கோவை
Development Economics மேம்பாட்டுப் ப�ொருளியல்
Development மேம்பாடு
Differential calculus வகை நுண்கணிதம்
Diminishing Returns to Scale குறைந்து செல் விகித அளவு
Diseconomies of Scale சிக்கனமின்மைகள்
Disinvestment ப�ொதுத்துறைச் ச�ொத்துக்களை விற்பது
Dismal Science இருண்ட அறிவியல்
Distribution பகிர்வு
Division of labour வேலைப்பகுப்பு
Domain சார்பகம்
Dualism இரு வேறுபட்ட குணங்கள் காணப்படுவது. எ.கா. மாட்டு வண்டியும்,
SUV மகிழ் உந்து வண்டியும்
Duopoly இருவர் முற்றுரிமை (இரண்டு விற்பனையாளர்கள் மட்டும்)
Dynamic இயங்கு / இயக்கம்
Economics ப�ொருளியியல்
Economies of scale ப�ொருளாதாரச் சிக்கனங்கள்
Economy ப�ொருளாதாரம்
Elasticity of demand தேவை நெகிழ்வு /தேவை நெகிழ்ச்சி
Elasticity of Supply அளிப்பு நெகிழ்வு
Empowerment வலிமை பெறுதல்
Enterprise நிறுவனம்
Entrepreneurship த�ொழில் முயலும்தன்மை
Entrepreneur த�ொழில் முயல்வோர்
Environmental Economics சுற்றுச்சூழல் ப�ொருளியல்
Equal- Marginal utility சம-இறுதி நிலைப் பயன்பாடு
Equation சமன்பாடு
Equilibrium சமநிலை
Ethical அறநெறி சார்ந்த
Exchange பரிமாற்றம்
Expansion of demand விலை குறைவால் நிகழ்ந்த தேவை விரிவு
Explicit cost வெளிப்படையான செலவு
Export promotion zone ஏற்றுமதி ஊக்குவிப்பு மண்டலம்
Export ஏற்றுமதி (X)
External Diseconomies புறச்சிக்கனமின்மைகள்
External Economies of Scale ப�ொருளாதார புறச்சிக்கனங்கள்
Factors of Production உற்பத்திக் காரணிகள்
Factors காரணிகள்
Facts உண்மைகள், எண்களிலாலான விவரங்கள்
Famine பஞ்சம்
Features சிறப்பம்சங்கள்
Finance Capital நிதி மூலதனம்
Financial Economics நிதிப் ப�ொருளியல்
Fiscal reforms அரசுநிதிச் சீர்திருத்தங்கள்

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 Fixed cost மாறாச் செலவு
Floating cost மிதக்கும் செலவு
Foreign Capital வெளிநாட்டு மூலதனம்
உடன்பாடில்லா வேலையின்மை (கிடைக்கின்ற வேலையில்
Frictional unemployment திருப்தியடையாமல் வேறு ஒரு நல்ல வேலை கிட்டும் வரை
வேலையின்றி இருப்பது.)
Gender equality பாலினச் சமத்துவம்
General equilibrium ப�ொதுச்சமநிலை
Globalization உலகமயமாக்குதல்
Goods / Products/ Commodities / things பண்டங்கள் /சரக்குகள்/ப�ொருட்கள்
Goods and Services Tax(GST) பண்டங்கள் மற்றும் பணிகள் வரி (அல்லது) சரக்கு மற்றும் சேவை வரி
Gross sown Area ம�ொத்த விதைக்கப்பட்ட நிலப்பரப்பு, ஒரு ஏக்கர் நிலத்தில் இரண்டு
ப�ோகம் பயிரிட்டால் அது இரண்டு ஏக்கராக்க் கணக்கிடப்படும்
Government Spending அரசுச் செலவு அரசுச் செலவு (G)
Green revolution பசுமைப்புரட்சி
Gross National Happiness Index ம�ொத்த நாட்டு மகிழ்ச்சிக் குறியீடு
Gross state domestic Product ம�ொத்த மாநில உள்நாட்டு உற்பத்தி
Growth வளர்ச்சி
Health Economics உடல் நலப் ப�ொருளியல்
Human Development Index மனித வள மேம்பாட்டுக் குறியீடு
Human welfare மனித நலம்
Hypothesis கருதுக�ோள்
Imitation ப�ோலி செய்தல்
Imperfect competition நிறைகுறைப் ப�ோட்டி
Implicit cost மறைமுகச் செலவு
Import இறக்குமதி (M)
Income elasticity of demand வருமானத் தேவை நெகிழ்ச்சி
Income வருமானம்
Increase in demand தேவை கூடுதல்
Increasing Returns to Scale வளர்ந்து செல்விகித அளவு
Index குறியீடு
Indicators குறிகாட்டிகள்
Indifference curve சம ந�ோக்கு வளைக�ோடு
Indifference Map சம ந�ோக்கு வரைபடம்
Indifference schedule சம ந�ோக்கு அட்டவணை
Inductive Method விதிவருமுறை, த�ொகுத்தாய்வு முறை
Industrialization த�ொழில் மயமாதல்
Industrial Policy resolution த�ொழிற்கொள்கை தீர்மானம்
Infant Mortality Rate (IMR) சிசு இறப்பு விகிதம் (1000 குழந்தைகளில் ஒரு வயதை முடிக்கும்
முன்புஇறக்கும் குழந்தைகளின் விகிதம்)
Innovation புத்தாக்கம், புதியன புனைதல்
Integral calculus த�ொகை நுண்கணிதம்
Interest rate வட்டிவீதம் (i)
Internal Economies of Scale அகப் ப�ொருளாதாரச் சிக்கனங்கள்
Investment முதலீடு
Invisible hand புலனாகா உந்துசக்தி
Involuntary unemployment வேலைக்குத் தயாராக இருந்தும் வேலை கிடைக்காத நிலை
Iso- quants சம அளவு உற்பத்திக் க�ோடுகள்
Labour உழைப்பு

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 Land Tenure நில உடைமை முறை
Land use pattern நிலத்தை பயன்படுத்தும் விதம்
Law of variable proportions மாறும் விகித விளைவு விதி
Laws of Returns to Scale விகித அளவு விளைவு விதி
Liberalization தாராள மயமாக்குதல்
Life Expectancy at Birth வாழ்நாள் எதிர்பார்ப்பு காலம்
Linear Equation நேர்க்கோட்டுச் சமன்பாடு
Liquidity preference நீர்மை விருப்பம்
Literacy Ratio ம�ொத்த மக்கள் த�ொகையில் எழுதப்படிக்க தெரிந்தவர்களின் விகிதம்
Long – run நீண்ட காலம்
Macro – Economics பேரினப் ப�ொருளியல் / பேரியல் ப�ொருளியில்
Mahalwari system குழு உரிமை முறை (இதில் கிராமக் குழுக்கள் நிலத்தை நிர்வாகம்
செய்து நிலத் தீர்வையை அரசுக்கு செலுத்தவேண்டும்)
Management மேலாண்மை
Marginal cost இறுதிநிலைச் செலவு
Marginal product இறுதிநிலை உற்பத்தி
Marginal Rate of substitution இறுதி நிலை பதிலீட்டு வீதம்
Marginal Rate of Technical Substitution இறுதிநிலை த�ொழில்நுட்பப் பதிலீட்டு வீதம்
Marginal utility இறுதி நிலைப் பயன்பாடு
Market அங்காடி / சந்தை
Material wealth பருப்பொருட் செல்வம்
Maternal Mortality Rate (MMR) மகப்பேறு இறப்பு விகிதம் (ஒரு லட்சம் தாய்மார்களில்
மகப்பேறுவின்போது இறக்கின்ற பெண்களின் எண்ணிக்கை)
Matrix / Matrices அணி / அணிகள்
Merchant Capital வணிக மூலதனம்
Micro, small and medium Enterprises குறு, சிறு மற்றும் நடுத்தர நிறுவனங்கள்
Micro-Economics நுண் ப�ொருளியியல் / நுண்ணினப் ப�ொருளியியல்/
Migration குடி பெயர்தல் / புலம் பெயர்தல்
Modern age நவீனயுகம்
Monetary Reforms பணச் சீர்திருத்தங்கள்
Money Cost பணச் செலவு
Monopolistic competition முற்றுரிமைப் ப�ோட்டி (ஒரு ப�ொருளை சிறிது வேறுபாடு செய்து
பலர் விற்பார்கள்)
Monopoly முற்றுரிமை (ஒரே ஒரு விற்பனையாளர்)
Morbidity Rate உடல் நலமின்மை விகிதம்
MRTP ACT முற்றுரிமை வணிகக் கட்டுப்பாட்டுச் சட்டம் ( Monopoly and
Restrictive Trade Practies ACT )
Multiplier பெருக்கி
National Income தேசிய வருமானம் (y)
Nationalization நாட்டுடைமையாக்குதல்
Need உயிர்பிழைக்க அடிப்படைத் தேவைகள்
Neo – classical புதிய மரபு வழி
Net sown Area நிகர விதைக்கப்பட்ட நிலம் பரப்பு, இது ம�ொத்தம் விதைக்கப்பட்ட
நிலப்பரப்புக்குச் சம்மாகவ�ோ குறைவாகவ�ோ இருக்கும்
NITI Aayog இந்தியாவை மாற்றுவதற்கான தேசிய அளவிலான நிலையத்திற்கான
திட்டம்
Nominal income/Money income பெயரளவு வருமானம்/பணவருமானம்
Non renewable Energy sources புதுப்பிக்க இயலாத சக்தி வளங்கள்
Normative Science நெறியுரை அறிவியல்

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 Oligopoly சில்லோர் முற்றுரிமை
Opportunity cost வாய்ப்புச் செலவு
Organisation அமைப்பு
Particular / partial equilibrium தனிச் சமநிலை / பகுதிச் சமநிலை
Per capita income தலைவீத வருமானம் (ம�ொத்த தேசிய வருமானத்தை ம�ொத்த மக்கள்
த�ொகையால் வகுக்க கிடைப்பது)
Perfect Competition நிறைவுப் ப�ோட்டி
Physical quality of life index வாழ்க்கைத் தரக் குறியீடு
Plan Holiday திட்ட விடுமுறை (1966 முதல் மூன்று ஆண்டுகளுக்கு ஐந்தாண்டுத்
திட்டங்கள் செயல்படுத்த இயலவில்லை)
Point of inflexion / point of inflection மாறும் விகிதம் மாறுகின்ற புள்ளி
Political Economy அரசியல் ப�ொருளாதாரம்
Positive Science இயல்புரை அறிவியல்
Poverty வறுமை
Price determination விலை நிர்ணயம் /விலை தீர்மானம்
Price discrimination விலைப்பேதம்
Price Elasticity of demand விலைத்தேவை நெகிழ்ச்சி
Price line விலைக்கோடு
Prime cost முதன்மைச் செலவு
Privatization தனியார் மயமாக்குதல்
Producer’s Equilibrium உற்பத்தியாளர் சமநிலை
Producer’s Surplus உற்பத்தியாளர் உபரி /உற்பத்தியாளர் எச்சம்
Production Possibility curve உற்பத்தி வாய்ப்பு வளைக�ோடு
Production Possibility Frontier உற்பத்தி வாய்ப்பு எல்லைக்கோடு
Production Possibility Schedule உற்பத்தி வாய்ப்பு பட்டியல்
Production உற்பத்தி
Public Economics ப�ொதுப் ப�ொருளியல்
Public Finance ப�ொது நிதி
Public sector enterprises ப�ொதுத்துறை நிறுவனங்கள்
Quasi – rent ப�ோலி வாரம்
Quotation மேற்கோள்
Rational பகுத்துணரவல்ல
Real Cost உண்மைச் செலவு
Real income உண்மை வருமானம் (பணவருமானத்தின்வாங்கும் சக்தி)
Rectangular Hyperbola செவ்வக அதிபர வளைவு
Redeemable Energy புதுப்பிக்க கூடிய சக்தி வளங்கள்
Regional development வட்டார மேம்பாடு
Rent வாரம்
Repo rate Repurchase Rate மைய வங்கியிடமிருந்து பிற வங்கிகள் பெறும் குறுகிய கால
கடனுக்கான வட்டி வீதம் (RR>RRR)
Reserve Requirements ஒதுக்கீட்டு விகித அளவுகள் (வங்கிகள் வைத்திருக்க வேண்டிய
வைப்புகள்)
Resources வளங்கள்
Revenue வருவாய்
Reverse Repo Rate (RRR) வங்கிகள் மைய வங்கியிடம் வைத்திருக்கும் குறுகிய கால
வைப்புகளுக்கு மைய வங்கி க�ொடுக்கின்ற வட்டி வீதம் (RR>RRR)
Risk bearing இடர் தாங்குதல்
Risk இடர்

279

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 Rolling Plan சுழல் திட்டம் (1978 - 79 ஆம் ஆண்டு மட்டும் இத்திட்டம்
நடைமுறையில் இருந்தது)
Ryotwari system உழுபவர் உரிமை முறை (இதில் நிலத்தை உழுபவரே நிலச்
ச�ொந்தக்காரராக இருப்பார்)
Savings சேமிப்பு (S)
Scale அளவுக�ோல்
Scarcity பற்றாக்குறை ; அளிப்பு <தேவை
Scope எல்லை
Secularism மதச்சார்பின்மை
Self – Help Groups சுய உதவிக் குழுக்கள் (ப�ொதுவாக 10 முதல் 20 பெண்களைக்
க�ொண்டவை)
Services பணிகள் / சேவைகள்
Sex ratio பாலின விகிதம் ( 1000 ஆண்களுக்கு எத்தனை பெண்கள் என்பது)
Shift in demand curve தேவை வளைக�ோடு இடப்பெயர்வு
Short –run குறுகிய காலம்
Skewed distribution சமமற்ற பரவல்
Slope சாய்வு
Social Cost சமூகச் செலவு
Social Infrastructure சமூகக் கட்டமைப்பு எ.கா. கல்வி மற்றும் மருத்துவ நிறுவனங்கள்
Social justice சமூக நீதி
Special Economic Zone சிறப்புப் ப�ொருளாதார மண்டலம்
Static equilibrium நிலையான சமநிலை
Statutory Liquidity Ratio(SLR) சட்ட ரீதியான நீர்மை வீதம்
Structural unemployment அமைப்பு சார் வேலையின்மை
Sunk cost அமிழ்த்தப்பட்ட செலவு, மீண்டும் திரும்பப் பெற முடியாத செலவு
Super Multiplier மிைகப் பெருக்கி
Supply அளிப்பு
Tangible த�ொட்டுச் செல்லும் / த�ொட்டுணரச் கூடிய
Tax வரி (T)
Theories க�ோட்பாடுகள்
Total cost ம�ொத்தச் செலவு
Total product ம�ொத்த உற்பத்தி
Trade /international trade வணிபம்
Uncertainty நிலையின்மை
Urbanisation நகர் மயமாதல்
Utility பயன்பாடு
Util அலகு
Values மதிப்பீடுகள் / விழுமியங்கள்
Value மதிப்பு
Variable cost மாறும் செலவு
Variable மாறி
Voluntary unemployment வேலை கிடைத்தும் வேலைக்கச் செல்லாமல் இருப்பது
Wants விருப்பங்கள்
Y intercept y அச்சை வெட்டும் இடம்

Zamindari system நிலக்கிழார் முறை (இதில் நிலக்கிழார் நிலத் தீர்வையை வசூலித்து

அரசுக்கு செலுத்தவேண்டும்)

280

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 Economics – XI
List of Authors and Reviewers

Reviewers
Dr. George V. Kallarackal
Dr. L.Venkatachalam
Former HOD, Economics Department
Professor, Madras Institute of Developmental Studies,
CMS College, Kottayam, Kerala
Chennai

Domain Experts
Dr. S. Iyyam Pillai Dr. A.G.Leonard SJ
Former Professor, Dept. of Economics Former Professor, Dept. of Economics
Bharathidasan University, Trichy Loyola College, Chennai

Subject Coordinator
J. Sornalatha
Post Graduate Assistant, Government Muslim Hr. Sec School.
Chennai-600002

Authors
Dr. J. Socrates Dr. K. Sadasivam
Head, Department of Economics Assistant Professor, School of Economics
Manonmaniam Sundaranar University Madurai Kamaraj University, Madurai-625 021
Tirunelveli
Dr. R. Bernadshaw
Dr. M. Chitra Former Professor, Dept. of Economics,
Assistant Professor, School of Economics NMSSVN College, Nagamalai, Madurai
Madurai Kamaraj University, Madurai
Dr. R. Albert Christopher Dhas
Dr. B.P. Chandramohan Associate Professor, Dept. of Economics
Associate Professor, Dept. of Economics, The American College, Madurai
Presidency College, Chennai
Dr. R.Vaheedha Banu
Dr. S. Theenathayalan Assistant Professor
Head, Department of Economics MSS WAKF Board College, Madurai
The Madura College, Madurai
Stephen Elangovan
K. Karnan Post Graduate Assistant
Post Graduate Assistant TVS Matric Higher Secondary School
Government Girls Higher Secondary School Madurai
Thirumangalam, Madurai
B. Shunmugam
K. Alamarselvan Post Graduate Assistant
Post Graduate Assistant Natarajan Dhamayanthi Higher Secondary School,
Government Boys Higher Secondary School, Bhuvanagiri, Cuddalore Nagapattinam
S. Bhuvana
Post Graduate Assistant
SRBAKD Dharma Raja Girls Higher Secondary School, Rajapalayam

Content Readers
Dr. A. Paramasivan Dr. A. Mariyappan
Professor of Economics, The MDT Hindu College, Tirunelveli Assistant Professor, Loyola College, Chennai

ICT Coordinator
D. Vasuraj
Art and Design Team BT Assistant, Pums, Kosapur, Puzhal Block,
Thiruvallur DT
Illustration S. Ganesh
R. Yuvaraj BT Assistant, Pums School, Kilariyam,
Gokulakrishnan Koradacherry Block, Thiruvallur DT

Art Teachers,
Government of Tamil Nadu. QR Code Management Team
Students R. Jaganathan
Government College of Fine Arts, Chennai & Kumbakonam. S.G.T. (SPOC), PUMS Ganesapuram - Polur, Thiruvannamalai Dist.
Layout N. Jagan
Udaya Info B.T. Asst., GBHSS Uthiramerur, Kanchipuram Dist.

In-House QC J.F. Paul Edwin Roy

Gopu Rasuvel B.T. Asst., PUMS Rakkipatti, Salem Dist.
Jerald Wilson
Tamilkumaran
This book has been printed on 80 GSM
Wrapper Design Elegant Maplitho paper.
Kathir Arumugam
Printed by offset at:
Co-ordination
Ramesh Munisamy
Typist
G. Anitha

281

Acknowledgement.indd 281 20-02-2020 12:16:12

 NOTES

282

Acknowledgement.indd 282 20-02-2020 12:16:12

 GOVERNMENT OF TAMIL NADU

HIGHER SECONDARY SECOND YEAR

ECONOMICS

A publication under Free Textbook Programme of Government of Tamil Nadu

Department of School Education

Untouchability is Inhuman and a Crime

12th_Economics_First 6 pages_Folder.indd 1 06-02-2020 17:36:54

 Government of Tamil Nadu

First Edition – 2019

Revised Edition – 2020
Published under New Syllabus

NOT FOR SALE

The wise
possess all

SCERT 2019

II

12th_Economics_First 6 pages_Folder.indd 2 06-02-2020 17:36:55

 HOW TO USE THE BOOK

Chapter content It presents a complete overview of the chapter

Introduction Summary of the presentation in every chapter

Objectives Goals to transform the class room processes into learner

centric with a list of bench marks

Think and Amazing facts and rhetorical questions to lead students

Do to economic inquiries

Boxes Additional inputs to the content is provided

Directions are provided to students to conduct

Activity activities in order to explore and enrich the concept.

To motivate the students to further explore and enrich the concept

ICT The use of ICT for improving the teaching – learning skills
is given

Give the values derived from functions which are graphed

Schedules in the diagrams

Concept Conceptual diagrams that depict relationships between concepts

Diagrams to enable students to learn the content schematically.

Figures To illustrate the situations.

Glossary Explanation of scientific terms

Model Question
Papers Evaluation

References List of related books for further details of the topic

Web links List of digital resources

III

12th_Economics_First 6 pages_Folder.indd 3 06-02-2020 17:36:55

 CAREER GUIDANCE
CAREER PROSPECTS IN ECONOMICS
The career prospects for economics graduates are many. Numerous fields are waiting for economic graduates both in public as well as private sectors. In the government
sector, one may try for Indian Economic Services, jobs in Reserve Bank of India, PSUs and other public sector banks. All these jobs have wonderful career options. These

12th_Economics_First 6 pages_Folder.indd 4
jobs give social prestige along with financial stability. Private sector also offers jobs for economic graduates in the fields like private banks, MNCs, BPOs, KPOs, Business
journals and newspapers. A good opportunity is also waiting for economic students in higher education. One can pursue Ph.D. in economics to enter into the field of
teaching in schools, colleges and universities and research in hundreds of Research Institutes and funding agencies – national & international.
One makes a successful career as a Corporate Lawyer after BA in economics followed by LLB. BA in economics and MBA placed one at a better position in the private
sector. Economic Journalism is another shining area for job perspective.

FAMOUS UNIVERSITIES AND COLLEGES OFFERING ECONOMICS

There are many institutes, colleges and universities that have economics in its BA, MA and Ph.D. level courses. Here are the lists of institutions offering economics.
One can easily see other information related with the respective universities/colleges/institutes with their given website.

Delhi School Sri Ram College University of Delhi, University of

of Economics of Commerce South Campus Agriculture Science

www.econdse.org www.srcc.edu www.south.du.ac.in www.uasbangalore.edu.in

IV
Jawaharlal Nehru St. Stephen University Ravenshaw
University, Delhi College, Delhi of Bombay University, Cuttack

www.jnu.ac.in www.ststephens.edu www.mu.ac.in www. ravenshawuniversity.ac.in

Gokhale Institute of
Madras School
IIT Kanpur BITS –Pilani Economics & Politics,
of Economics
Pune
www.jnu.ac.in www.mse.ac.in www.bits-pilani.ac.in www.gipe.ac.in

Indian Statistical
Presidency Symbiosis School of
IIT Madras Institute, Kolkata
College, Kolkata Economics
Bangalore
https://www.iitm.ac.in www.presiuniv.ac.in www. isical.ac.in www.sse.ac.in

Banaras University Centre for

IGIDR-Mumbai
Hindu University of Hyderabad Development Studies
Thiruvananthapuram
www.bhu.ac.in www.uohyd.ernet.in www.igidr.ac.in www.cds.edu

For world recognised institution in the field of economics, everybody wishes to join London School of Economics

06-02-2020 17:36:57
 Jobs in Economics Field
An array of employment opportunities is available in economics field. Meritorious candidates can get excellent job opportunities after successfully completing their BA or MA in
economics.
Government Sectors
Economics graduates can get prestigious jobs in the government sectors like

12th_Economics_First 6 pages_Folder.indd 5
• Indian Civil Services • Indian Economic Services • Reserve Bank of India • National Sample Survey
• Ministry of Economic Affairs • Planning Board • Planning Commission (State & Central)
• National Council for Applied Economic Research and • National Institute of Public Finance and Policy.
Other than Government Sectors
Job opportunities are also waiting in the private sectors, NGOs and International Aid Agencies. The firms like World Bank, Asian Development Bank, IMF, and other Development
Banks, Aid agencies, Financial Consultancy firms are hiring the economic graduates for their various positions. One can assume in these organisations as economist, economic
advisor, executive, analyst, consultant, researcher, financial analyst, business analyst, economic research analyst and stock market analyst. As far as salary is concerned, lots of
candidates are hired through campus placement. The average salary is Rs. 4 to 8 lakh per annum. But for the deserving candidates, the field opens plethora of options and
remuneration is also beyond expectation. The filed like accountancy, actuarial, banking, insurance also open many jobs opportunities.
Economics Employment Opportunities
The various fields are offering better job opportunity after passing BA or MA in economics. Some of the high demand sectors are given below where job prospects are huge.

CAREERS FOR AN ECONOMIST

V
Government
Banking and Finance Education and Communications Business
and Public Sector

Commodities Broker Claims Examiner Professor Market Research Analyst

Bank Management Trainee Foreign Trade analyst Technical Writer Retail Buyer

Financial Analyst Tax Auditor Journalist/Columnist Staff Training and Development Specialist

Economic Forecaster Public Administrator Teacher Insurance Underwriting Trainee

Investment Banker Legislative Assistant Higher Education, Administration Management Consultant

Loan Counsellor Regional/Urban Planner Educational Television Advisor Strategic Planner

Securities Analyst Financial Planner Information Analyst Business Administrator

06-02-2020 17:36:57
 Table of Contents
ECONOMICS
Page
Chapters Content Month
No
Chapter 1 Introduction to Macro Economics 1 June

Chapter 2 National Income 19 June

Chapter 3 Theories of Employment and Income 37 June

Chapter 4 Consumption and Investment Functions 52 July

Chapter 5 Monetary Economics 76 July

First Mid-Term 1 to 5 Chapters

Chapter 6 Banking 95 August

Chapter 7 International Economics 125 August

Chapter 8 International Economic Organisations 154 September

Quarterly 1 to 8 Chapters

Chapter 9 Fiscal Economics 176 October

Chapter 10 Environmental Economics 212 October

Chapter 11 Economics of Development and Planning 237 November

Second Mid-Term 9 to 11 Chapters

Introduction to Statistical Methods and
Chapter 12 257 November
Econometrics

E - book Assessment DIGI links

Lets use the QR code in the text books ! How ?
• Download the QR code scanner from the Google PlayStore/ Apple App Store into your smartphone
• Open the QR code scanner application
• Once the scanner button in the application is clicked, camera opens and then bring it closer to the QR code in the text book.
• Once the camera detects the QR code, a url appears in the screen.Click the url and goto the content page.

VI

12th_Economics_First 6 pages_Folder.indd 6 06-02-2020 17:36:58

 CHAPTER

1 Introduction to Macro Economics

“Macro economics is very much about tying together facts and theories”.
- Dorn Busch, Fischer and Startz

Learning Objectives

1 To enlighten the evolution, importance and basic concepts of

macroeconomics, and

2 To understand the functioning of an economy.

1.1
the words ‘micro’ meaning small and
Introduction ‘macro’ meaning large in the year 1933.
However, macroeconomics in its modern
The subject Economics is classified form, began with John Maynard Keynes
into two branches, namely, Micro and his book “The General Theory
Economics and Macro Economics. of Employment, Interest and Money”
Ragnar Frisch, a Norwegian economist published in 1936. Keynes offered an
and the co-recipient of the first Nobel explanation for fallout from the Great
Prize in Economic Sciences coined Depression, when goods remained unsold
and workers unemployed. Hence, Keynes
is regarded as the ‘Father of Modern
Macro Economics’.

1.2
Meaning of Macro Economics

The word ‘Macro’ is derived from

J.M.Keynes the Greek word ‘Makros’ meaning ‘large’.
Father of Modern Macro Economics Hence, Macro Economics is the study of

1 Introduction to Macro Economics

12-Economics-Chapter_1.indd 1 05-02-2020 11:42:22

 the economy as a whole. In other words, 1.3
macro economics deals with aggregates T
 here is a need to understand the
such as national income, employment and functioning of the economy at the
output. Macro Economics is also known aggregate level to evolve suitable
as ‘Income Theory’. strategies and to solve the basic
problems prevailing in an economy.
Study of the Economy
Understanding the future problems,
 
as a Whole
Na needs and challenges of an economy
ct ig

O tion
Pi e B

as a whole is important to evolve

e

ut
ur

pu al
Th

t precautionary measures.
Includes National,
Regional & Global
MACROECONOMICS Macro economics provides ample
 
Inflation

Economics
opportunities to use scientific
Study of investigation to understand the reality.
economy-wide
Un phenomena Macro economics helps to make
 
em meaningful comparison and analysis of
pl al
oy n economic indicators.
m ti o e
en
t Na com
In Macro economics helps for better
 
Contrasts with prediction about future and to formulate
Microeconomics suitable policies to avoid economic
crises.
The subject matters covered in 1.4
Macro Economics are the areas such as
employment, national income, inflation, Scope of Macro Economics
business cycle, poverty, inequality,
disparity, investment and saving, capital
formation, infrastructure development, The study of macro economics has
international trade, balance of trade and wide scope and it covers the major areas
balance of payments, exchange rate and as follows
economic growth.
 National Income: Measurement of
national income and its composition
Importance of Macro
 by sectors are the basic aspects of
Economics macroeconomic analysis. The trends in
National Income and its composition
The importance and the need provide a long term understanding of
for introducing a macro outlook of an the growth process of an economy.
economy are given below:
 Inflation: Inflation refers to steady
increase in general price level.
Introduction to Macro Economics 2

12-Economics-Chapter_1.indd 2 05-02-2020 11:42:22

 Estimating the general price level 1. 
There is a danger of excessive
by constructing various price index generalisation of the economy as a
numbers such as Wholesale Price whole.
Index, Consumer Price Index, etc, are
2. 
It assumes homogeneity among the
needed.
individual units.
 Business Cycle: Almost all economies
3. There is a fallacy of composition. What
face the problem of business
is good of an individual need not be
fluctuations and business cycle. The
good for nation and viceversa. And,
cyclical movements (boom, recession,
what is good for a country is not good
depression and recovery) in the
for another country and at another
economy need to be carefully studied
time.
based on aggregate economic variables.
4.  Many non - economic factors determine
 Poverty and Unemployment: The major
economic activities; but they do not
problems of most resource - rich nations
find place in the usual macroeconomic
are poverty and unemployment. This is
books.
one of the economic paradoxes. A clear
understanding about the magnitude of
poverty and unemployment facilitates
1.6
allocation of resources and initiating Economy and its Types
corrective measures.

 E conomic Growth: The growth and The term economy has been defined
development of an economy and by A. J. Brown as, “A system by which
the factors determining them could people earn their living.” J. R. Hicks
be understood only through macro defined as, “An economy is a cooperation
analysis. of producers and workers to make goods
and services that satisfy the wants of the
 E conomic Policies: Macro Economics consumers.”
is significant for evolving suitable In short, an economy is referred
economic policies. Economic policies to any system or area where economic
are necessary to solve the basic activities are carried out. Each economy
problems, to overcome the obstacles has its own character. Accordingly, the
and to achieve growth. functions or activities also vary. The
1.5 functioning of an economy by its activities
is explained in flow chart 1.
Limitations

Macro economics suffers from certain

limitations. They are:

3 Introduction to Macro Economics

12-Economics-Chapter_1.indd 3 05-02-2020 11:42:22

 Flow Chart: 1 Economies can be classified into different
Functioning of an Economy Based on types based on the
Activities 1. 
Status of Development: Developed,
Growth underdeveloped, undeveloped and
developing economies.
Production Activity Consumption Activity 2. 
System of Activities: Capitalistic,
Socialistic and Mixed Economies.
3. S cale of Activities: Small and Large
Exchange Activity
Economies.
4. 
Nature of Functioning: Static and
Supporting Economic and Non- Dynamic Economies.
Economic Activities of an Economy
5. Nature of Operation: Closed and Open
Economies.

External Activities (Activities of other Economies)

6. 
Nature of Advancement: Traditional
and Modern Economies.
7. L evel of National Income: Low Income,
In an economy, the fundamental Middle Income and High Income
economic activities are production and Economies.
consumption. These two activities are 1.7
supported by several other activities.
Economic Systems
The ultimate aim of these activities is to
achieve growth. The ‘exchange activity’
supports the production and consumption
Economic System refers to the manner
activities. These activities are influenced
in which individuals and institutions are
by several economic and non-economic
connected together to carry out economic
activities. The major economic activities
activities in a particular area. It is the
include transportation, banking,
methodology of doing economic activities
advertising, planning, government policy
to meet the needs of the society. There are
and others. The major non-economic
three major types of economic systems.
activities are environment, health,
They are:
education, entertainment, governance,
regulations etc. In addition to these 1. Capitalistic Economy (Capitalism),
supporting activities, external activities
from other economies such as import, 2. Socialistic Economy (Socialism)and
export, international relations, emigration, 3. Mixed Economy (Mixedism)
immigration, foreign investment, foreign
exchange earnings, etc. also influence the
entire functioning of the economy.

Introduction to Macro Economics 4

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 The means
Globalism
of production
The term coined by Manfred D in a capitalistic
Steger (2002) to denote the new market economy are
ideology of globalisation that connects privately owned.
nations together through international Manufacturers
Adam Smith
trade and aiming at global development. produce goods
This ideology is also termed as ‘Extended and services with profit motive. The private
Capitalism’. individual has the freedom to undertake
any occupation and develop any skill.
The USA, West Germany, Australia and
Capitalism and socialism are two Japan are the best examples for capitalistic
extreme and opposite approaches. In economies. However, they do undertake
capitalism, there is total freedom and large social welfare measures to safeguard
private ownership of means of production. the downtrodden people from the market
In socialism, there is no freedom for forces.
private and there is public ownership of
means of production. Mixedism denotes Features of Capitalistic Economy
the Co-existence of capitalism and 1. Private Ownership of Property and
socialism. The features, merits and Law of Inheritance: The basic feature of
demerits of various economic systems are capitalism is that all resources namely,
discussed below. land, capital, machines, mines etc.
are owned by private individuals. The
Socialism Capitalism owner has the right to own, keep, sell
Mi or use these resources according to his
xe
dism
will. The property can be transferred to
heirs after death.
2. Freedom of Choice and Enterprise:
Each individual is free to carry out any
occupation or trade at any place and
produce any commodity. Similarly,
consumers are free to buy any
commodity as per their choice.
3. Profit Motive: Profit is the driving
1.7.1 Capitalistic Economy (Capitalism)
force behind all economic activities
Adam Smith is the ‘Father of in a capitalistic economy. Each
Capitalism’. Capitalistic economy is also individual and organization produce
termed as a free economy (Laissez faire, in only those goods which ensure high
Latin) or market economy where the role profit. Advance technology, division of
of the government is minimum and market labour, and specialisation are followed.
determines the economic activities. The golden rule for a producer under
capitalism is ‘to maximize profit.’
5 Introduction to Macro Economics

12-Economics-Chapter_1.indd 5 05-02-2020 11:42:22

 4. Free Competition: There is free 5. C onsumers Sovereignty: All production
competition in both product and activities are aimed at satisfying the
factor market. The government or any consumers.
authority cannot prevent firms from 6. Higher Rates of Capital Formation:
buying or selling in the market. There Increase in saving and investment leads
is competition between buyers and to higher rates of capital formation.
sellers.
7. Development of New Technology: As
5. Price Mechanism: Price mechanism is profit is aimed at, producers invest on
the heart of any capitalistic economy. new technology and produce quality
All economic activities are regulated goods.
through price mechanism i.e, market
forces of demand and supply. Demerits of Capitalism
6. 
Role of Government: As the price 1. C oncentration of Wealth and Income:
mechanism regulates economic activity, Capitalism causes concentration of
the government has a limited role in a wealth and income in a few hands
capitalistic economy. The government and thereby increases inequalities of
provides basic services such as, defense, income.
public health, education, etc.
2. Wastage of Resources: Large amount
7. 
Inequalities of Income: A capitalist of resources are wasted on competitive
society is divided into two classes – advertising and duplication of products.
‘haves’ that is those who own property
and ‘have-nots’ who do not own 3. C lass Struggle: Capitalism leads to
property and work for their living. The class struggle as it divides the society
outcome of this situation is that the into capitalists and workers.
rich become richer and poor become 4. Business Cycle: Free market system
poorer. Here, economic inequality goes leads to frequent violent economic
on increasing. fluctuations and crises.

Merits of Capitalism 5. 
Production of non essential goods:
Even the harmful goods are produced if
1. Automatic Working: Without any there is possibility to make profit.
government intervention, the economy
works automatically. 1.7.2 
Socialistic Economy (Socialism)
2. 
Efficient Use of Resources: All
The Father of Socialism is Karl
resources are put into optimum use.
Marx. Socialism refers to a system of
3. Incentives for Hard work: Hard work total planning, public ownership and
is encouraged and entrepreneurs get state control on economic activities.
more profit for more efficiency. Socialism is defined as a way of organizing
4. E conomic Progress: Production and a society in which major industries are
productivity levels are very high in owned and controlled by the government,
capitalistic economies. A Socialistic economy is also known
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 as ‘Planned Economy’ or ‘Command 2. Central Planning: Planning is an
Economy’. integral part of a socialistic economy. In
this system, all decisions are undertaken
by the central planning authority.
3. Maximum Social Benefit: Social
welfare is the guiding principle behind
all economic activities. Investments are
planned in such a way that the benefits
are distributed to the society at large.
Karl Marx 4. Non-existence of Competition:
- Father of Socialism Under the socialist economic system
there is absence of competition in the
In a socialistic economy, all the resources
market. The state has full control over
are owned and operated by the government.
production and distribution of goods
Public welfare is the main motive behind
and services. The consumers will have
all economic activities. It aims at equality
a limited choice.
in the distribution of income and wealth
and equal opportunity for all. Russia, 5. Absence of Price Mechanism: The
China, Vietnam, Poland and Cuba are the pricing system works under the control
examples of socialist economies. But, now and regulation of the central planning
there are no absolutely socialist economies. authority.

Command Economy 6. Equality of Income: Another essential

feature of socialism is the removal and
What to How to For Whom reduction of economic inequalities.
Produce Produce to Produce Under socialism private property and
the law of inheritance do not exist.
7. Equality of Opportunity: Socialism
provides equal opportunity for all
through free health, education and
professional training.
8. Classless Society: Under socialism,
there is a classless society and so no
Completely determined and controlled by a class conflicts. In a true socialist society,
central authority everyone is equal as far as economic
Features of Socialism: status is concerned.
1. Public Ownership of Means of Merits of Socialism
Production: All resources are owned
by the government. It means that all the 1. Reduction in Inequalities: No one is
factors of production are nationalized allowed to own and use private property
and managed by the public authority. to exploit others.

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 2. Rational Allocation of Resources: Demerits of Socialism
The central planning authority
1. Red Tapism and Bureaucracy: As
allocates the resources in a planned
decision are taken by government
manner. Wastages are minimised and
agencies, approval of many officials
investments are made in a pre planned
and movement of files from one table
manner.
to other takes time and leads to red
3. Absence of Class Conflicts: As tapism.
inequalities are minimum, there is no
2. Absence of Incentive: The major
conflict between rich and poor class.
limitation of socialism is that this
Society functions in a harmonious
system does not provide any incentive
manner.
for efficiency. Therefore, productivity
4. End of Trade Cycles: Planning also suffers.
authority takes control over production
3. Limited Freedom of Choice:
and distribution of goods and services.
Consumers do not enjoy freedom of
Therefore, economic fluctuations can
choice over the consumption of goods
be avoided.
and services.
5. Promotes Social Welfare: Absence of
4. Concentration of Power: The State
exploitation, reduction in economic
takes all major decisions. The private
inequalities, avoidance of trade cycles
takes no initiative in making economic
and increase in productive efficiency
decisions. Hence, the State is more
help to promote social welfare.
powerful and misuse of power can also
take place.

1.7.3 Mixed Economy (Mixedism):

Pure Planned Pure Free Market

Economy Economy

Economic Systems
Mixed Economies Pure
Communism Socialist Capitalist
Learning Learning
Competition

Example
North China France United States
Countries:
Korea Venezuela Sweden Japan

In a mixed economy system both private It is a combination of both capitalism

and public sectors co-exist and work and socialism. It tends to eliminate the
together towards economic development. evils of both capitalism and socialism.

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 In these economies, resources are owned Merits of Mixed Economy
by individuals and the government.
1. 
R apid Economic Growth: The best
India, England, France and Brazil are the
advantage of mixed economy is that
examples of mixed economy.
it promotes rapid economic growth.
Features of Mixed Economy Thus, both public requirements and
private needs are taken care of.
1. O wnership of Property and Means of
Production: The means of production 2. Balanced Economic Growth: Mixedism
and properties are owned by both promotes balanced growth of the
private and public. Public and Private economy. It promotes balanced growth
have the right to purchase, use or between agriculture and industry,
transfer their resources. consumer goods and capital goods,
2. 
C oexistence of Public and Private rural and urban etc.
Sectors: In mixed economies, both
3. Proper Utilization of Resources: In a
private and public sectors coexist.
mixed economy, the government can
Private industries undertake activities
ensure proper utilization of resources.
primarily for profit. Public sector firms
The government controls most of the
are owned by the government with a
important activities directly and the
view to maximize social welfare.
private sector indirectly.
3. E conomic Planning: The central
planning authority prepares the 4. Economic Equality: The government
economic plans. National plans are uses progressive rates of taxation for
drawn up by the Government and levying income tax to bring about
both private and public sectors abide. economic equality.
In general, all sectors of the economy
function according to the objectives, 5. 
Special Advantages to the Society:
priorities and targets laid down in the The government safeguards the interest
plan. of the workers and weaker sections
by legislating on minimum wages,
4. S olution to Economic Problems: The
and rationing, establishing fair price
basic problems of what to produce, how
shops and formulating social welfare
to produce, for whom to produce and
measures.
how to distribute are solved through
the price mechanism as well as state Demerits of Mixed Economy
intervention.
1. 
L ack of Coordination: The greatest
6. Freedom and Control: Though private
drawback of mixedism is lack of
has freedom to own resources, produce
coordination between public sector
goods and services and distribute
and private sector. As both work with
the same, the overall control on the
divergent motives, it creates many
economic activities rests with the
coordination related problems.
government.

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 2. C ompetitive Attitude: It is expected discourages the private entrepreneurs
that both government and private in their business operations and
should work with a complementary innovative initiatives.
spirit towards the welfare of the society,
5. Widening Inequality: Ownership
but in reality they are competitive in
of resources, laws of inheritance and
their activities.
profit motive of people widens the gap
3. Inefficiency: Most of the public sector between rich and poor.
enterprises remain inefficient due to
lethargic bureaucracy, red tapism and Ultimately the inequality of
lack of motivation. capitalism and inefficiency of socialism
are found in mixed economies.
4. Fear of Nationalization: In a mixed
economy, the fear of nationalization
Comparison of Different Economic Systems

S.No. Features Capitalism Socialism Mixedism

Ownership of Means Private Public Private Ownership
1
of Production Ownership Ownership and Public Ownership
Social Welfare and
2 Economic Motive Profit Social Welfare
Profit Motive
Central Central Planning
Solution of Central Free Market
3 Planning System and Free
Problems System
System Market System
Interanal Complete
4 Government Role Limited Role
Regulation only Involvement
5 Income Distribution Unequal Equal Less unequal
Private Government Both Private and State
6 Nature of Enterprise
Enterprise Enterprise Enterprises
Complete Lack of
7 Economic Freedom Limited Freedom
Freedom Freedom
Inequality and
8 Major Problem Inequality Inefficiency
Ineffiency

1.8 1.8.1. Stock and Flow Variables

Concepts of Macro Economics Variables used in economic analysis

are classified as stock and flow. Both
The important concepts used in macro stock and flow variables may increase or
economics are presented below: decrease with time.

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  Stock refers to a quantity of a There are three models of circular
commodity measured at a point of time. flow of income, representing the major
In macro economics, money supply, economic systems.
unemployment level, foreign exchange
1. Two Sector Model: It is for a simple
reserves, capital etc are examples of
economy with households and firms.
stock variables.
2. Three Sector Model: It is for a mixed
 Flow variables are measured over and closed economy with households,
a period of time. National Income, firms and government.
imports, exports, consumption,
production, investment etc are examples 3. Four Sector Model: It is for an open
of flow variables. economy with households, firms,
government and rest of the world
 E conomic Models A model is a (External sector).
simplified representation of real
situation. Economists use models to
describe economic activities, their 1.9.1  C
 ircular Flow of Income in a
relationships and their behaviour. A Two-Sector Economy:
model is an explanation of how the
economy, or part of the economy, works. There are only two sectors namely,
Most economic models are built with household sector and firm sector.
mathematics, graphs and equations,
(i) Household Sector: The household
and attempt to explain relationships
sector is the sole buyer of goods and
between economic variables. The
services, and the sole supplier of
commonly used economic models are
factors of production, i.e., land, labour,
the supply-demand models and circular
capital and organisation. It spends its
flow models and Smith models.
entire income on the purchase of goods
1.9 and services produced by the business
Circular Flow sector. The household sector receives
of Income income from firm sector by providing
the factors of production owned by it.
The circular flow of income is a
(ii) Firms: The firm sector generates its
model of an economy showing connections
revenue by selling goods and services
between different sectors of an economy.
to the household sector. It hires the
It shows flows of income, goods and
factors of production, i.e., land, labour,
services and factors of production
capital and organisation, owned by the
between economic agents such as firms,
household sector. The firm sector sells
households, government and nations.
the entire output to households.
The circular flow analysis is the basis
of national accounts and macroeconomics.

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 In a two-sector economy, production
and sales are equal and there will be a
circular flow of income and goods. The
Goods and services outer circle represents real flow (factors
and goods) and the inner circle represents
Consumer expenditure the monetary flow (factor prices and
commodity prices). Real flow indicates
the factor services flow from household
sector to the business sector, and goods
and services flow from business sector to
the household. The basic identities of the
Households Firms
two-sector economy are as under:
Wages, rent, dividends
Y=C+I

Factors for production Where

Y is Income; C is Consumption; I is
investment

1.9.2. Circular Flow of Income in a Three-Sector Economy:

The Domestic Circular flow of Income & Spending

Purchases of goods and Service

Govt
Taxes Purchases
₹ Demand

Households Government Firms

Social
Incomes Transfers Taxes
₹

Wages, dividends, interest, profits and rent

In addition to household and firms, inclusion of the government sector makes

this model a three-sector model. The government levies taxes on households and firms,
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 purchases goods and services from firms, Under three sector model, national
and receive factors of production from income (Y) is obtained by adding
household sector. On the other hand, the Consumption expenditure (C), Investment
government also makes social transfers expenditure (I) and Government
such as pension, relief, subsidies to the expenditure (G).
households. Similarly, Government pays
the firms for the purchases of goods and Therefore:
services. The Flow Chart illustrates three- Y=C+I+G
sector economy model:

1.9.3 Circular Flow of Income in a Four-Sector Economy:

Trade Sector of the

Imports Export
The External

Rest of the
Economy

World

Purchases of goods and Service

Income Made up of Households
The Domestic Circular Flow of

₹ Taxes Demand
Government Firms

Govt
Purchases

Households Government Firms

Social Taxes
Transfers
Incomes ₹

Wages, dividends, interest, profits and rent

In a Four-sector economy, in addition The external sector comprises

to household, firms and government, a exports and imports. It is illustrated in the
fourth sector namely, external sector is Flow Chart.
included. In real life, only four-sector
economy exists. This model is composed In four-sector economy, expenditure for
of four sectors namely, the entire economy include domestic
expenditure (C+I+G) and net exports
(i) Households, (ii) Firms, (X– M). Therefore,
(iii) Government, (iv) External sector
Y = C + I + G + (X – M)

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 Summary
� S
 ocialism : A way of organizing a
Macroeconomics studies the society in which major economic
behavior and performance of an economy activities are owned and controlled
as a whole. It covers the functioning, by the government rather than by
performance and growth of an economy. individual people and companies
It examines the macro aspects such as � M
 ixedism : An ideology that mixes or
employment, national income, inflation, combines the principles of Capitalism
business cycle, poverty, inequality, (Private Role) and Socialism (Nation
disparity, investment and saving, capital Role) in an economy.
formation, infrastructure development,
� G
 lobalism : An economic system
banking, public finance, international
where the economic activities of a
trade, balance of trade and balance of
nation are inter connected and inter
payments, exchange rate and economic
dependent on each other nation.
growth. Economic models based
on economic variables are useful in � S
 tock : A quantity of a commodity that
understanding an economy. Circular is constant at a point of time(Static)
Flow Models provide a base to understand � F
 low : Variables measured over a
the functioning of a macro economy. period of time.(Dynamic)
� E
 conomic Model : It is an explanation
An economy could be classified on
of how the economy, or part of the
the basis of economic systems such as
economy, works.
capitalistic economy, socialistic economy
and mixed economy. However, nowadays � C
 ircular Flow : It shows flows of
it is difficult to find 100 percent capitalist income, goods and services and factors
system, socialistic system or perfectly of production between economic
mixed economy. agents such as firms, households,
government and nations.
Glossary

� M
 acroeconomics : The branch of
economics that studies the behavior
and performance of an economy as a
whole
� E
 conomic System : The manner in
which individuals and institutions
are connected together to carry out
economic activities in a particular area
� C
 apitalism : The system where the
means of production are privately
ownedand market determines the
economic activities.

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 MODEL QUESTIONS
Part-A
Multiple Choice Questions

1. The branches of the subject Economics 6. Indicate the contribution of

is J M Keynes to economics.
a) Wealth and welfare a) Wealth of Nations
b) production and consumption
b) General Theory
c) Demand and supply
d) micro and macro c) Capital
d) Public Finance
2. Who coined the word ‘Macro’?
7. A steady increase in general price level
a) Adam Smith is termed as_____________.
b) J M Keynes
c) Ragnar Frisch a) wholesale price index
d) Karl Marx b) Business Cycle
c) Inflation
3. Who is regarded as Father of Modern d) National Income
Macro Economics?
a) Adam Smith 8. 
Identify the necessity of Economic
policies.
b) J M Keynes
c) Ragnar Frisch a) to solve the basic problems
d) Karl Marx b) to overcome the obstacles
c) to achieve growth
4. 
Identify the other name for Macro
d) all the above
Economics.
9. 
Indicate the fundamental economic
a) Price Theory
activities of an economy.
b) Income Theory
c) Market Theory a) Production and Distribution
b) Production and Exchange
d) Micro Theory
c) Production and Consumption
5. Macro economics is a study of d) Production and Marketing
___________________.
10. An economy consists of
a) individuals a) consumption sector
b) firms b) Production sector
c) a nation c) Government sector
d) aggregates d) All the above

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 11. Identify the economic system where 16. 
An economic system where the
only private ownership of production economic activities of a nation are
exists. done both by the private and public
a) Capitalistic Economy together is termed as_____________.
b) Socialistic Economy a) Capitalistic Economy
c) Globalisic Economy b) Socialistic Economy
d) Mixed Economy c) Globalisic Economy
d) Mixed Economy
12. Economic system representing equality
in distribution is _________. 17. Quantity of a commodity accumulated
at a point of time is termed as
a) Capitalism ____________..
b) Globalism
c) Mixedism a)production
d) Socialism b) stock
c) variable
13. 
Who is referred as ‘Father of d) flow
Capitalism’?
18. Identify the flow variable.
a) Adam Smith
a) money supply
b) Karl Marx
b) assests
c) Thackeray
c) income
d) J M Keynes
d) foreign exchange reserves
14. The country following Capitalism is 19. Identify the sectors of a Two Sector
________________ . Model.
a) Russia a) Households and Firms
b) America b) Private and Public
c) India
c) Internal and External
d) China
d) Firms and Government
15. Identify The Father of Socialism. 20. 
The Circular Flow Model that
a) J M Keynes represents an open Economy.
b) Karl Marx a) Two Sector Model
c) Adam Smith b) Three Sector Model
d) Samuelson c) Four Sector Model
d) All the above
Answers
1 2 3 4 5 6 7 8 9 10
d c b b d b c d c d
11 12 13 14 15 16 17 18 19 20
a d a b b d b c a c
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 Part - B
Answer the following questions in one or two sentences
21. Define Macro Economics.
22. Define the term ‘Inflation’.
23. What is meant by an ‘Economy’?
24. Classify the economies based on status of development.
25. What do you mean by Capitalism?
26. Define ‘Economic Model’.
27. ‘Circular Flow of Income’ - Define.

Part - C
Answer the following questions in about a paragraph
28. State the importance of Macro Economics.
29. Describe the different types of economic systems.
30. Outline the major merits of capitalism.
31. Indicate the demerits of socialism.
32. Enumerate the features of mixed economy.
33. Distinguish between Capitalism and Globalism.
34. Briefly explain the two sector circular flow model.

Part - D
Answer the following questions in one page
35. Discuss the scope of Macro Economics.
36. Illustrate the functioning of an economy based on its activities.
37. Compare the features of capitalism and socialism.
38. Compare the feature among Capitalism, Secularism and Mixedism.

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 ACTIVITY
1. Internet Based Activity:
Each student may be asked allotted FOUR countries. The students may be
given the responsibility of collecting basic information about each country and
present them in chart papers. The list of geo, politic, socio-economic and other
information to be compiled may be listed by the course teacher. Students may
be asked to point out the economic system adopted in those countries. Internet
sources may be used for doing this activity.

2. Role Play Activity:

Students may be grouped in to Four groups, each one representing a sector
of the FOUR Sector Model. In specific, Household sector, Business Sector,
Government Sector and Externals sector. Each sector may decide on their
activities and understand how the flow of income and goods and services takes
place between sectors. The class teacher may initiate the activities and do the
moderator role.

References

Dhas A.C (2016): Economics, an Economy, and the Role of Information in Economic
Decisions, International Journal of Exclusive Global Research, Vol. 1, Issue 9
September.
Dornbusch, Fischer and Startz (2004): Macro Economics, Tata Mc Graw Hill
Education Private Limited, New Delhi.
Edward Shapiro (1998): Macro Economic Analysis, Galgotia Publications (P) Ltd.
New Delhi.
Gupta G.S. (2016): Macro Economics: Theory and Applications, Tata McGraw-Hill
Publishing Company, New Delhi.
Karl Marx (1920): Capital: A Critical Analysis of Capitalist Production, William
Glaisher Limited, London.
Lord Rollof Ipsden(1982): The Mixed Economy, Macmillan Press, London.
Manfred B.Steger (2002) : Globalism: The New Market Ideology, Rowan and Littlefield
Publishers, USA.
Maria John Kennedy M(2013): Macro Economic Theory, PHI Learning Private Ltd,
New Delhi.
Paul A Samuelson and William D.Nordhuaus (2012): Macro Economics, Tata Mc
Graw Hill Education Private Limited, New Delhi.

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 CHAPTER

2 National Income

“The concept of national income is an indispensable preparation for

tackling the great issues of unemployment, inflation and growth”.
- Samuelson

Learning Objectives

1 To understand the meaning of national income and some basic concepts of

national income.

2 To know the methods of measuring national income.

2.1 2.2
Introduction Meaning of National Income
National Income provides a
comprehensive measure of the economic In common parlance, National
activities of a nation. It denotes the Income means the total money value of all
country’s purchasing power. The growth final goods and services produced in a
of an economy is measured by the rate country during a particular period of time
at which its real national income grows (one year).
over time. National income thus serves
as an instrument of economic planning.
f
Further, national income is one of Value o vices
& S er
the most significant macroeconomic
G o o ds
variables. Thus, a clear understanding of ce d
y Pr o d u
the meaning, concepts, measurement and C ou ntr
r
uses of national income is essential. In a Yea

e
Nobel laureate Simon Kuznets National Incom
first introduced the concept of national
income.

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 2.3 2.4.5. Personal Income

Definitions 2.4.6. Disposable Income

2.4.7. Per capita Income
“The labour and capital of a 2.4.8. Real Income
country acting on its natural resources 2.4.9 GDP deflator
produce annually a certain net aggregate
of commodities, material and immaterial 2.4.1. Gross Domestic Product (GDP)
including services of all kinds. This is the
true net annual income or revenue of the GDP is the total market value of final
country or national dividend”. goods and services produced within the
-Alfred Marshall. country during a year. This is calculated
at market prices and is known as GDP at
GDP and its detractors.
market prices.
The welfare of a
nation can scarcely GDP by expenditure method at
be inferred from market prices = C + I + G + (X – M)
a measurement of
national income
Where C – consumption goods;
as defined by the
GDP... goals for I – Investment goods;
more growth should G – Government purchases;
Simon Kuznets, specify of what and X – Exports; M – Imports
(Creator of GDP) 1932 for what. (X – M) is net export which can be
“The net output of the commodities positive or negative.
and services flowing during the year
from the country’s productive system a) Net Domestic Product (NDP)
into the hands of the ultimate consumers
NDP is the value of net output of
or into net addition to the country’s stock
the economy during the year. Some of the
of capital goods”.
country’s capital equipment wears out or
- Simon Kuznets. becomes outdated each year during the
2.4 production process. Thus
Basic concepts of national
income Net Domestic
= GDP - Depreciation.
Product
The following are some of the
concepts used in measuring national 2.4.2 Gross National Product (GNP)
income.
2.4.1. GDP GNP is the total measure of the flow
2.4.2. GNP of final goods and services at market
2.4.3. NNP value resulting from current production
2.4.4. NNP at factor cost in a country during a year, including net

National Income 20

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 income from abroad. GNP includes five during the year. NNP is obtained by
types of final goods and services : deducting the value of depreciation, or
replacement allowance of the capital assets
(1) 
value of final consumer goods and from the GNP. It is expressed as,
services produced in a year to satisfy the
immediate wants of the people which NNP = GNP – depreciation allowance.
is referred to as consumption (C);
(depreciation is also called as Capital
(2) gross private domestic investment in Consumption Allowance)
capital goods consisting of fixed capital
formation, residential construction
and inventories of finished and 2.4.4 NNP at Factor cost
unfinished goods which is called as NNP refers to the market value of
gross investment (I) ; output. Whereas NNP at factor cost is the
(3) 
goods and services produced or total of income payment made to factors
purchased by the government which is of production. Thus from the money value
denoted by (G) ; and of NNP at market price, we deduct the
amount of indirect taxes and add subsidies
(4) 
net exports of goods and services,
to arrive at the net national income at
i.e., the difference between value of
factor cost.
exports and imports of goods and
services, known as (X-M) ; Net factor NNP at factor cost = NNP at Market
incomes from abroad which refers to prices – Indirect taxes + Subsidies.
the difference between factor incomes
(wage, interest, profits ) received from
2.4.5 Personal Income
abroad by normal residents of India
Personal income is the total income
and factor incomes paid to the foreign
received by the individuals of a country
residents for factor services rendered
from all sources before payment of direct
by them in the domestic territory in
taxes in a year. Personal income is never
India (R-P);
equal to the national income, because the
(5) GNP at market prices means the gross former includes the transfer payments
value of final goods and services whereas they are not included in national
produced annually in a country income. Personal income is derived
plus net factor income from abroad from national income by deducting
(C + I + G + (X-M) + (R-P)). undistributed corporate profit, and
GNP at Market Prices = GDP at Market employees’ contributions to social security
Prices + Net Factor income from Abroad. schemes and adding transfer payment.

Personal Income = National Income

2.4.3 Net National Product (NNP)
– (Social Security Contribution and
(at Market price)
undistributed corporate profits) +
Net National Product refers to the Transfer payments
value of the net output of the economy
21 National Income

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 P1 – Price index during current year;
2.4.6 Disposable Income
P0 – Price index during base year
Disposable Income is also known as
Disposable personal income. It is the
individuals income after the payment of 2.4.9 GDP deflator
income tax. This is the amount available
GDP deflator is an index of price
for households for consumption.
changes of goods and services included in
Disposable Income = Personal income – Direct Tax.
GDP. It is a price index which is calculated
As the entire disposable income is not spent on by dividing the nominal GDP in a given
consumption,
year by the real GDP for the same year
Disposal income = consumption + saving.
and multiplying it by 100.
2.4.7 Per Capita Income Nominal GDP
GDP deflator = x 100
The average income of a person of a Real GDP
country in a particular year is called Per
Capita Income. Per capita income is 2.5
obtained by dividing national income by
Methods of Measuring
population.
National Income
All goods and
services produced in the
National Income country must be counted
Per Capita income =
Population and converted against
money value during a
year. Thus, whatever is
produced is either used for consumption
or for saving. Thus, national output can
be computed at any of three levels, viz.,
2.4.8 Real Income production, income and expenditure.
Nominal income is national income Accordingly, there are three methods that
expressed in terms of a general price level are used to measure national income.
of a particular year in other words, real 1. Production or value added method
income is the buying power of nominal 2. Income method or factor earning method
income. National income is the final
3. Expenditure method
value of goods and services produced and
expressed in terms of money at current And if these methods are done
prices. But it does not indicate the real correctly, the following equation must
state of the economy. The real income is hold
derived as follows:
Output = Income = Expenditure
Real Income at National Income at
=
constant price current price ÷ P1 / P0

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 GDP - By Sum of Spending, Factor Incomes or Output

GDP GDP GDP

(Expenditure) (Factor Incomes) (Value of Output)

 Consumption  I
ncome from people  V
alue added from each
 Government spending in jobs and in self of the main economic
 Investment spending employment (e.g. wages sectors
and salaries)  Th
 ese sectors are
 C
hange in value of
stocks  P
rofits of private sector  rimary
P
 Exports business  Secondary

 −Imports  R
ent income from the  Manufacturing

 = GDP (known as ownership of land  Quaternary

aggregate demand)

This is because the three methods are the estimate of GNP or the sum of values
circular in nature. It begins as production, added should be taken.
through recruitments of factors of
production, generating income and going In India, the gross value of the farm
as incomes to factors of production. output is obtained as follows :

(i) 
Total production of 64 agriculture
2.5.1 Product Method commodities is estimated. The output
of each crop is measured by multiplying
Product method measures the the area sown by the average yield per
output of the country. It is also called hectare.
inventory method. Under this method,
(ii) The total output of each commodity is
the gross value of output from different
valued at market prices.
sectors like agriculture, industry, trade
and commerce, etc., is obtained for the (iii) The aggregate value of total output
entire economy during a year. The value of these 64 commodities is taken to
obtained is actually the GNP at market measure the gross value of agricultural
prices. Care must be taken to avoid double output.
counting.
(iv) The net value of the agricultural output
The value of the final product is is measured by making deductions
derived by the summation of all the for the cost of seed, manures and
values added in the productive process. fertilisers, market charges, repairs and
To avoid double counting, either the value depreciation from the gross value.
of the final output should be taken into

23 National Income

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 Similarly, the gross values of the
2.5.2. Income Method
output of animal husbandry, forestry,
(Factor Earning Method)
fishery, mining and factory establishments
are obtained by multiplying their This method approaches national
estimates of total production with market income from the distribution side. Under
prices. Net value of the output in these this method, national income is calculated
sectors is derived by making deductions by adding up all the incomes generated in
for cost of materials used in the process of the course of producing national product.
production and depreciation allowances,
etc. from gross value of output. Steps involved

Net value of each sector measured in 1. 

The enterprises are classified into
this way indicates the net contribution of various industrial groups.
the sector to the national income.
2. 
Factor incomes are grouped under
Precautions labour income, capital income and
mixed income.
The product method is followed in i) 
L abour income - Wages and
the underdeveloped countries, but it is salaries, fringe benefits, employer’s
less reliable because the margin of error in contribution to social security.
this method is large. In India, this method
ii) 
Capital income – Profit, interest,
is applied to agriculture, mining and
dividend and royalty
manufacturing, including handicrafts.
iii) 
Mixed income – Farming,
1. 
Double counting is to be avoided sole proprietorship and other
under value added method. Any professions.
commodity which is either raw material
3. 
National income is calculated as
or intermediate good for the final
domestic factor income plus net factor
production should not be included. For
incomes from abroad. In short,
example, value of cotton enters value
of yarn as cost, and value of yarn in Y = w + r + i + π + (R-P)
cloth and that of cloth in garments. At
every stage value added only should be w = wages, r = rent, i = interest, π = profits,
calculated. R = Exports and P = Imports
2. 
The value of output used for self
This method is adopted for estimating
consumption should be counted while
the contributions of the remaining
measuring national income.
sectors, viz., small enterprises, banking
3. In the case of durable goods, sale and and insurance, commerce and transport,
purchase of second hand goods (for professions, liberal arts and domestic
example pre owned cars) should not be service, public authorities, house property
included. and foreign sector transaction.

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 Data on income from abroad (the 2.5.3. The Expenditure Method
rest of the world sector or foreign sector) (Outlay method)
are obtained from the account of the Under this method, the total
balance of payments of the country. expenditure incurred by the society in
a particular year is added together. To
Precautions
calculate the expenditure of a society,
While estimating national income it includes personal consumption
through income method, the following expenditure, net domestic investment,
precautions should be taken. government expenditure on consumption
as well as capital goods and net exports.
Items not to be included Symbolically,

1. Transfer payments are not to be included

GNP = C + I + G + (X-M)
in estimation of national income as
these payments are not received for any
C - Private consumption expenditure
services provided in the current year
I - Private Investment Expenditure
such as pension, social insurance etc.
G - Government expenditure
2. The receipts from the sale of second
hand goods should not be treated as X-M = Net exports
part of national income as they do not
create new flow of goods or services in Precautions
the current year.
1. S econd hand goods: The expenditure
3. 
Windfall gains such as lotteries are made on second hand goods should not
also not to be included as they do not be included.
represent receipts from any current
2. 
Purchase of shares and bonds :
productive activity.
Expenditures on purchase of old shares
4. 
C orporate profit tax should not be and bonds in the secondary market
separately included as it has been should not be included.
already included as a part of company
3. 
Transfer payments : Expenditures
profit.
towards payment incurred by the
Items to be included government like old age pension should
not be included.
1. Imputed value of rent for self occupied
houses or offices is to be included. 4. 
E xpenditure on intermediate goods
: Expenditure on seeds and fertilizers
2. 
Imputed value of services provided by farmers, cotton and yarn by textile
by owners of production units (family industries are not to be included to
labour) is to be included. avoid double counting. That is only
expenditure on final products are to be
included.
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 Factor cost (FC)

There are a number of inputs that are included into a production process when producing
goods and services. These inputs are commonly known as factors of production and
include things such as land, labour, capital and entrepreneurship.

Producers of goods and services incur a cost for using these factors of production. These
costs are ultimately added onto the price of the product.

The factor cost refer to the cost of production that is incurred by a firm when producing
goods and services.

Examples of such production costs include the cost of renting machines, purchasing
machinery and land, paying salaries and wages, cost of obtaining capital, and the profit
margins that are added by the entrepreneur.

The factor cost does not include the taxes that are paid to the government since taxes are
not directly involved in the production process and, therefore, are not part of the direct
production cost.

However, subsidies received are included in the factor cost as subsidies are direct inputs
into the production.

Market price (MP)

Once goods and services are produced they are sold in a market place at a set market
price.
The market price is the price that consumers will pay for the product when they purchase
it from the sellers.

Taxes charged by the government will be added onto the factor price while subsides
provided will be reduced from the factor price to arrive at the market price.

Taxes are added on because taxes are costs that increase the price, and subsidies are
reduced because subsidies are already included in the factor cost, and cannot be double
counted when market price is calculated.
Thus, MP = FC + Indirect Taxes - Subsidies ...... Equation (1)

Or, FC = MP - Indirect Taxes + Subsidies ........... Equation (2)

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 National Income (NNPFC) = Gross Value Added by all the production Enterprises within
the Domestic Territory of the Country – Depreciation –
Net Indirect Taxes + Net Factor Income from Abroad
[Where, Net Indirect Taxes = Indirect tax – Subsidies]
[Gross Value Added = Value of Output – Intermediate Consumption]
Value of Output = Sales + Change in Stock
Where, Change in Stock = Closing Stock – Opening Stock
Note: I f entire out put is sold within the year, then value of output will be equal to sales
itself.
or
Value of Output = Price x Quantity Sold
GDPMP = P
 rivate Final Consumption + Government Final Consumption Expenditure
+ Gross Domestic Capital Formation + Net Exports (Exports – Imports)

2.6 pertaining to a country’s gross income,

Importance of National Income output, saving and consumption from
Analysis different sources should be available for
economic planning.
National income is of great 4. 
To build economic models both in
importance for the economy of a country. short - run and long - run.
Nowadays the national income is regarded
as accounts of the economy, which are 5. 
To make international comparison,
known as social accounts. It enables us inter - regional comparison and
inter - temporal comparison of growth
1. To know the relative importance of the
of the economy during different periods.
various sectors of the economy and
their contribution towards national 6. To know a country’s per capita income
income; from the calculation of national which reflects the economic welfare of
income, we could find how income is the country (Provided income is equally
produced, how it is distributed, how distributed)
much is spent, saved or taxed.
7. To know the distribution of income for
2. To formulate the national policies such various factors of production in the
as monetary policy, fiscal policy and country.
other policies; the proper measures can
be adopted to bring the economy to the 8. 
To arrive at many macro economic
right path with the help of collecting variables namely, Tax – GDP ratio,
national income data. Current Account Deficit - GDP ratio,
Fiscal Deficit - GDP ratio, Debt - GDP
3. 
To formulate planning and evaluate ratio etc.
plan progress; it is essential that the data

27 National Income

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 2.7 During a year, Interest on national
Difficulties in debt is also considered transfer payments
Measuring National because it is paid by the government to
Income individuals and firms on their past savings
without any productive work.
In India, a special conceptual
problem is posed by the existence of a
2.7.2 Difficulties in assessing
large, unorganised and non-monetised
depreciation allowance
subsistence sector where the barter
system still prevails for transacting goods The deduction of depreciation
and services. Here, a proper valuation of allowances, accidental damages, repair
output is very difficult. and replacement charges from the national
income is not an easy task. It requires
high degree of judgment to assess the
depreciation allowance and other charges.

Difficulties 2.7.3 Unpaid services

A housewife renders a number of
useful services like preparation of meals,
serving, tailoring, mending, washing,
cleaning, bringing up children, etc. She
is not paid for them and her services are
Transfer payments
Difficulties in Measuring National

not directly included in national income.

Difficulties in assessing depreciation Such services performed by paid servants
allowance
are included in national income. The
Unpaid services
reason for the exclusion of her services
Income

Income from illegal activities from national income is that the love and
Production for self-consumption and affection of a housewife in performing
changing price her domestic work cannot be measured
Capital Gains in monetary terms. Similarly, there are a
number of goods and services which are
Statistical problems
difficult to be assessed in money terms for
the reason stated above, such as rendering
2.7.1 Transfer payments
services to their friends, painting, singing,
Government makes payments in dancing, etc.
the form of pensions, unemployment
allowance, subsidies, etc. These are 2.7.4 Income from illegal activities
government expenditure. But they are not
included in the national income. Because Income earned through illegal
they are paid without adding anything to activities like gambling, smuggling, illicit
the production processes. extraction of liquor, etc., is not included

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 in national income. Such activities have equally important in estimating national
value and satisfy the wants of the people income.
but they are not considered as productive
from the point of view of society. The following are the some of the
statistical problems:

2.7.5 Production for self-consumption 1. 

Accurate and reliable data are not
and changing price adequate, as farm output in the
subsistence sector is not completely
Farmers keep a large portion of food
informed. In animal husbandry, there
and other goods produced on the farm for
are no authentic production data
self consumption. The problem is whether
available.
that part of the produce which is not sold
in the market can be included in national 2. Different languages, customs, etc., also
income or not. create problems in computing estimates.
National income by product method 3. People in India are indifferent to the
is measured by the value of final goods official inquiries. They are in most cases
and services at current market prices. But non-cooperative also.
prices do not remain stable. They rise or
fall. To solve this problem, economists 4. Most of the statistical staff are untrained
calculate the real national income at a and inefficient.
constant price level by the consumer price
index. Therefore, national income estimates
in our country are not very accurate or
2.7.6 Capital Gains adequate. There is at least 10 per cent
The problem also arises with margin of error, i.e., national income is
regard to capital gains. Capital gains arise overestimated or underestimated by at
when a capital asset such as a house, other least 10 per cent. That is why the GDP
property, stocks or shares, etc. is sold at estimates for India varies from 2 trillion
higher price than was paid for it at the time US dollar to 5 trillion US dollar.
of purchase. Capital gains are excluded 2.8
from national income. National Income and Social
Accounting
2.7.7 Statistical problems
National income is also being
There are statistical problems, measured by the social accounting method.
too. Great care is required to avoid Under this method, the transactions
double counting. Statistical data may among various sectors such as firms,
not be perfectly reliable, when they are households, government, etc., are recorded
compiled from numerous sources. Skill and their interrelationships traced. The
and efficiency of the statistical staff and social accounting framework is useful
cooperation of people at large are also for economists as well as policy makers,
29 National Income

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 because it represents the major economic  “
The Government sector” refers to
flows and statistical relationships among the economic transactions of public
various sectors of the economic system. It bodies at all levels, centre, state and
becomes possible to forecast the trends of local. In their work concerning social
economy more accurately. accounting, Edey and Peacock have
defined government as a collective
2.8.1 Social Accounting and Sector ‘person’ that purchases goods and
services from firms. These purchases
Under this method, the economy may be financed through taxation,
is divided into several sectors. A sector public borrowings, or any other fiscal
is a group of individuals or institutions means. The main function of the
having common interrelated economic government is to provide social goods
transactions. The economy is divided into like defence, public health, education,
the following sectors etc. This means satisfying the
collective wants of society. However,
(i) Firms,
public enterprises like Post Offices
(ii) Households, and railways are separated from the
(iii) Government, Government sector and included as
“Firms”.
(iv) Rest of the world and
(v) Capital sector.  “Rest of the world sector” relates to
international economic transactions
 “Firms” undertake productive of the country. It contains income,
activities. Thus, they are all export and import transactions,
organizations which employ the external loan transaction, and allied
factors of production to produce overseas investment income and
goods and services. payments.

 “Households” are consuming  “C apital sector” refers to saving and

entities and represent the factors of investment activities. It includes the
production, who receive payment for transactions of banks, insurance
services rendered by them to firms. corporations, financial houses, and
Households consume the goods and other agencies of the money market.
services that are produced by the These are not included under “Firms”.
firms. These agencies merely provide
financial assistance to the firms’
Thus, firms make payment to activities.
households for their services. Households
spend money incomes they received on While assessing sectoral contribution
the goods and services produced by the to GDP, the economy is divided into three
firms. This is a circular flow of money namely Primary, Secondary and Tertiary
between these two groups. sectors.

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 2.8.2 National Income and Welfare 2.8.3 National Income & Erosion of
national Wealth
National Income is considered as
an indicator of the economic wellbeing For achieving higher GDP, larger
of a country. The economic progress of natural resources are being depleted
countries is measured in terms of their or damaged. This means reduction of
GDP per capita and their annual growth potential for future growth. Hence, it is
rate. A country with a higher per capita suggested that while assessing national
income is supposed to enjoy greater income, loss of natural resources should
economic welfare with a higher standard be subtracted from national income.
of living.
2.8.4 National income in terms of US$
But the rise in GDP or per capita
income need not always promote When Indian national income is
economic welfare. The per capita income expressed in terms of US$, the former
as an index of economic welfare suffers looks very low. If Purchasing Power Parity
from limitations which are stated below: (PPP) method is adopted India looks
1. 
The economic welfare depends upon better.
the composition of goods and services
2.8.5 Social and Environmental Cost
provided. The greater the proportion of
capital goods over consumer goods, the While producing economic goods,
improvement in economic welfare will many environmental and social bads are
be lesser. Similarly the production of also generated. Hence, they also must be
luxuries is meant for rich classes only. considered while enumerating National
2. Higher GDP with greater environmental income.
hazards such as air, water and soil
pollution will be little economic welfare. Summary

3. The production of war goods will show The national income of a country
the increase in national output but not describes the economic performance or
welfare. production performance of a country.
Economists, planners, government,
4. An increase in per capita income may businessmen and international agencies
be due to employment of women and (IMF, World Bank, etc.,) use national
children or forcing workers to work income data and analyses them for
for long hours. But it will not promote various purposes. National income data
economic welfare. help in measuring changes in the standard
Therefore the Physical Quality of of living over time and also enable us to
Life Index (PQLI) is considered a better compare standard of living of different
indicator of economic welfare. It includes countries. Level of development of a
standard of living, life expectancy at birth country is also measured by using national
and literacy. income figures.

31 National Income

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 � D
 isposable income : It is the sum of the
Glossary
consumption and saving of individuals
� G
 NP : Total money value of final goods after the payment of income tax
and services produced in a country
� P
 er capita income : Annual average
during a particular year (one year)
income of a person
including depreciation and net exports
� S
 ocial Accounts : The accounts of
� N
 NP : Total money value of final goods
national income considering the social
and services produced in a country
cost generated by economic activities.
during a particular year (one year)
excluding depreciation including net � U
 npaid services : Rendering useful
exports services like preparation of meals,
washing, leaning, bringing up children,
� N
 NP at Factor cost : The total of
services to their friends and relatives
income payment made to factors of
without payment
production
� C
 apital sector : It includes saving and
� P
 ersonal Income : Total income
investment activities.
received by the individuals of a country
before payment of direct taxes � T
 ransfer payments : Government
makes payments in the form of
pensions unemployment allowance,
subsides, etc.

MODEL QUESTIONS
Part – A
Multiple choice questions

1. Net National product at factor cost is 3. National income is measured by using

also known as ……….. methods.

(a) National Income (a) Two

(b) Domestic Income (b) Three
(c) Per capita Income (c) Five
(d) Salary. (d) Four

2. Primary sector is ………………….. 4. 

Income method is measured by
summing up of all forms of ……………
(a) Industry
(b) Trade (a) Revenue
(c) Agriculture (b) Taxes
(d) Construction. (c) expenditure
(d) Income

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 5. Which is the largest figure? 11. NNP stands for ……….
(a) Disposable income (a) Net National Product
(b) Personal Income (b) National Net product
(c) NNP (c) National Net Provident
(d) GNP (d) Net National Provident

6. Expenditure method is used to estimate 12. ……… is deducted from gross value
national income in ………….. to get the net value.
(a) Construction sector (a) Income
(b) Agricultural Sector (b) Depreciation
(c) Service sector (c) Expenditure
(d) Banking sector (d) Value of final goods

7. Tertiary sector is also called as ………. 13. The financial year in India is ……
sector
(a) April 1 to March 31
(a) Service (b) March 1 to April 30
(b) Income (c) March 1 to March 16
(c) Industrial (d) January 1 to December 31
(d) Production
14. When net factor income from abroad
8. National income is a measure of the is deducted from NNP, the net value
……… performance of an economy. is …….
(a) Industrial (a) Gross National Product
(b) Agricultural (b) Disposable Income
(c) Economic (c) Net Domestic Product
(d) Consumption (d) Personal Income

9. Per capita income is obtained by dividing 15. The value of NNP at production point
the National income by ………… is called ……
(a) Production (a) NNP at factor cost
(b) Population of a country (b) NNP at market cost
(c) Expenditure (c) GNP at factor cost
(d) GNP (d) Per capita income

10. GNP = ………. + Net factor income 16. The average income of the country is
from abroad. ….
(a) NNP (a) Personal Income
(b) NDP (b) Per capita income
(c) GDP (c) Inflation Rate
(d) Personal income (d) Disposal Income
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 17. The value of national income adjusted 19. PQLI is the indicator of ………………
for inflation is called ….
(a) Economic growth
(a) Inflation Rate (b) Economic welfare
(b) Disposal Income (c) Economic progress
(c) GNP (d) Economic development
(d) Real national income
20. 
The largest proportion of national
18. Which is a flow concept ? income comes from …….
(a) Number of shirts (a) Private sector
(b) Total wealth (b) Local sector
(c) Monthly income (c) Public sector
(d) Money supply (d) None of the above

Answers

1 2 3 4 5 6 7 8 9 10
a c b d d a a c b c
11 12 13 14 15 16 17 18 19 20
a b a c a b d c b a

Part – B
Answer the following questions in one or two sentences.
21. Define National Income.
22. Write the formula for calculating GNP.
23. What is the difference between NNP and NDP?
24. Trace the relationship between GNP and NNP.
25. What do you mean by the term ‘Personal Income’?
26. Define GDP deflator.
27. Why is self consumption difficult in measuring national income?

Part – C
Answer the following questions in one Paragraph.
28. Write a short note on per capita income.
29. Differentiate between personal and disposable income.
30. Explain briefly NNP at factor cost.
31. Give short note on Expenditure method.

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 32. What is the solution to the problem of double counting in the estimation of
national income?
33. Write briefly about national income and welfare.
34. List out the uses of national income.

Part - D
Answer the following questions in about a page.
35. Explain the importance of national income.
36. Discuss the various methods of estimating the national income of a country.
37. What are the difficulties involved in the measurement of national income?
38. Discuss the importance of social accounting in economic analysis.

ACTIVITY
Compare GDP different countries since 2001

References

1. Jhingan M.L. Macro Economic Theory, Vrinda Publication LTD.

2. Keshava.S.R. Economics, New Age Internatonal Publishers, 2010
3. Mitani D.M. Macroeconomics, Himalaya Publishing House,
4. www.articlelibrary.com

35 National Income

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 ICT CORNER
National Income

This activity enables the students

to calculate the National Income.

Steps 1:
• Open the Browser and type the URL given (or) Scan the QR Code. Work sheet
named “Factor Cost and Market price” will open

Steps 2:
• You can change your values by typing in the boxes given in Left hand side.
Right hand side all the values are calculated and shown. Check the output
values. For detailed formula scroll down to next page.

Step1 Step2

Pictures are indicatives only*

URL:
https://ggbm.at/dx7bamzw
(or) scan the QR Code

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 CHAPTER

3 Theories of Employment
and Income

“Unemployed people suffer the demoralization, frustration and loss of

self respect that come from enforced idleness”.
– Wonnacott. P and Wonnacott. R

Learning Objectives

1 To understand the meaning of full employment and unemployment and its types.

2 To learn the classical theory of employment.

3 To know the importance of Keynes’ theory of income and employment.

3.1 3.2
Introduction Meaning of Full Employment

The economic history has shown Full employment refers to a situation

many countries facing economic problems. in which every able bodied person who
Out of these problems, unemployment is is willing to work at the prevailing wage
the most vexing. Both classical economists rate, is employed. In other words full
and Keynes have explained the relationship employment means that persons who are
between employment and income. The willing to work and able to work must have
classical economists had great faith in employment or a job; Keynes defines full
the law of markets articulated by J.B. Say, employment as the absence of involuntary
the French economist. J. M. Keynes is unemployment.
one of the greatest and most influential Lerner defines full employment as
economists of the mid 20th century. “that level of employment at which any
further increase in spending would result

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 in an inflationary spiral of wages and in urban areas. Due to urbanization, a
prices”. large number of people move from rural
Every economy in the world aims areas to urban areas. This migration from
at attaining the level of full employment rural to urban areas increases the size of
equilibrium where all its available labour force in urban areas and adds to
resources are fully and efficiently employed the already unemployed labour force.
to achieve maximum level of output. But Types of unemployment :
in reality, the concept of full employment
generally refers to full employment of In developing countries like India,
labour force of a country. the nature of unemployment is different
from that of developed countries. In
developed countries, the unemployment
3.3
is purely temporary or cyclical or
Unemployment and its types frictional. But in the developing countries,
it is largely structural unemployment
Unemployment is problem faced which is due to slow rate of capital
when there are people, who are willing to formation.
work and able to work but cannot find The following are the types of
suitable jobs. unemployment.
While formulating policies to solve
the problem of unemployment in India for
Cyclical Unemployment
Types of unemployment

instance, we need to distinguish between Seasonal Unemployment

the nature of unemployment in rural
Frictional Unemployment
Educated Unemployment
Technical Unemployment
Structural Unemployment
Disguised Unemployment

1. Cyclical Unemployment
areas and in urban areas in India. India’s This unemployment exists during
rural economy has both unemployment the downturn phase of trade cycle in
and underemployment. The major the economy. In a business cycle during
feature of rural unemployment is the the period of recession and depression,
existence of unemployment in the form income and output fall leading to
of disguised unemployment and seasonal widespread unemployment. It is caused by
unemployment. In India, frictional,
structural and open unemployment exist
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 deficiency of effective demand. Cyclical and contributes to technological
unemployment can be cured by public unemployment. Now a days, invention
investment or expansionary monetary and innovations lead to the adoption
policy. of new techniques there by the existing
workers are retrenched. Labour saving
2. Seasonal Unemployment devices are responsible for technological
This type of unemployment occurs unemployment.
during certain seasons of the year. In
agriculture and agro based industries like 6. Structural Unemployment
sugar,production activities are carried out Structural unemployment is due
only in some seasons. These industries to drastic change in the structure of the
offer employment only during that season society. Lack of demand for the product or
in a year. Therefore people may remain shift in demand to other products cause
unemployed during the off season. this type of unemployment. For example
Seasonal unemployment happens from rise in demand for mobile phones has
demand side also; for example ice cream adversely affected the demand for
industry, holiday resorts etc. cameras, tape recorders etc. So this kind
of unemployment results from massive
3. Frictional Unemployment
and deep rooted changes in economic
(Temporary Unemployment)
structure.
Frictional unemployment arises due
to imbalance between supply of labour 7. Disguised Unemployment
and demand for labour. This is because
of immobility of labour, lack of necessary
skills, break down of machinery, shortage
of raw materials etc. The persons who
lose jobs and in search of jobs are also
included under frictional unemployment.

4. Educated Unemployment
Sometimes educated people are
underemployed or unemployed when
qualification does not match the job. Faulty Disguised unemployment occurs
education system, lack of employable when more people are there than what is
skills, mass student turnout and preference actually required. Even if some workers
for white collar jobs are highly responsible are withdrawn, production does not
for educated unemployment in India. suffer. This type of unemployment is
found in agriculture. A person is said
5. Technical Unemployment to be disguisedly by unemployed if his
contribution to output is less than what
Modern technology being capital
he can produce by working for normal
intensive requires less labourers
39 Theories of Employment and Income

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 hours per day. In this situation, marginal David Ricardo. J.B. Say enunciated the
productivity of labour is zero or less or proposition that “Supply creates its own
negative. demand”. Hence there cannot be general
3.4 over production or the problem of
unemployment in the economy.
Classical Theory of Employment
According to Say, “When goods are
produced by firms in the economy, they
There was no single theory which
pay reward to the factors of production.
could be labeled as classical theory of
The households after receiving rewards of
employment. The classical theory of
the factors of production spend the
employment is composed of different
amount on the purchase of goods and
views of classical economists on the
services produced by them. Therefore,
issue of income and employment in the
each product produced in the economy
economy. Adam smith wrote the book “An
creates demand equal to its value in the
Enquiry into the Nature and Causes of
market.
the Wealth of Nations’ in 1776. Since the
publication of this book, classical theory
was developed by David Ricardo, J.S.Mill,
J.B.Say and A.C.Pigou.
Classical economists assumed that
the economy operates at the level of full
employment without inflation in the long
period. They also assumed that wages
and prices of goods were flexible and
the competitive market existed in the
economy (laissez-faire economy).

3.4.1 Say’s Law of Market

ly of good and service

Supp s
J.B.Say
Output Income

Dem
and for ices
good and serv
Say’s law of markets is the core of the
classical theory of employment. J.B.Say In short, this classical theory explains
(1776 – 1832) was a French Economist that “A person receives his income from
and an industrialist. He was influenced production which is spent on the purchase
by the writings of Adam Smith and of goods and services produced by others.
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 For the economy as a whole, therefore, 12. Interest rate flexibility leads is saving
total production equals total income”. – Investment equality
Implications of Say’s Law
Ex ante and Expost in Says’ Law 1. There is no possibility for over
The statement that supply creates own production or unemployment.
demand or equivalently that the aggregate
investment equals the aggregate saving
2. If there exist unutilized resources
always holds good in the ex post sense in the economy, it is profitable to
since it is simply an accounting identity. employ them up to the point of full
Say’s law of markets, however, states that employment. This is true under the
these two are equal in ex ante sense, i.e., condition that factors are willing to
the total quantity which people produce
accept rewards on a par with their
i.e., aggregate supply must be equal to the
toal quantity which they plan to buy i.e., productivity.
aggregate demand. 3. As automatic price mechanism
operates in the economy, there is no
Assumptions of the Say’s law of market need for government intervention.
The Say’s Law of market is based on the (However, J.M. Keynes emphasized
following assumptions: the role of the State)
1. No single buyer or seller of commodity 4. Interest flexibility brings about equality
or an input can affect price. between saving and investment.
2. Full employment. 5. Money performs only the medium of
3. People are motivated by self interest exchange function in the economy, as
and self – interest determines people will not hold idle money.
economic decisions.
4. The laissez faire policy is essential for an Criticisms of Say’s Law
automatic and self adjusting process of The following are the criticisms against
full employment equilibrium. Market Say’s law:
forces determine everything right.
1. According to Keynes, supply does not
5. There will be a perfect competition
create its demand. It is not applicable
in labour and product market.
where demand does not increase as
6. There is wage-price flexibility. much as production increases.
7. Money acts only as a medium of
2. Automatic adjustment process
exchange.
will not remove unemployment.
8. Long - run analysis. Unemployment can be removed by
9. There is no possibility for over increase in the rate of investment.
production or unemployment.
3. Money is not neutral. Individuals hold
10. Unutilized resources used until
money for unforeseen contingencies
reaches full employment.
while businessmen keep cash reserve
11. No Government intervention automatic for future activities.
Price adjustment mechanism operated.
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 4. Say’s law is based on the proposition of employment but also the concept of full
that supply creates its own demand employment as well as the possibility of
and there is no over production. underemployment.
Keynes said that over production is Keynes theory of employment was
possible. based on the view of the short run.
5. Keynes regards full employment as a According to him, the factors of production
special case because there is under - such as capital goods, supply of labour,
employment in capitalist economies. technology and efficiency of labour
remain unchanged while determining the
6. The need for state intervention arises level of employment.
in the case of general over production
and mass unemployment. John Maynard Keynes was one of the
most influential economists of the 20th
century. He was born in Cambridge in1883.
3.5 In addition to his work as an economist he
Keynes’ Theory of held position as civil servant a director of
Employment and the Bank of England, and leader of British
Income delegation of negotiators at the Bretton
Woods conference at points in his career.
Economic theory based on his idea is known
as Keynesian economics, and remain highly
influential today, particularly in the field of
macroeconomics.
John
Maynard Keynes 3.6
Effective Demand

The starting point of Keynes theory

of employment and income is the principle
Keynes’ book, “The General Theory
of effective demand. Effective demand
of Employment, Interest and Money”
denotes money actually spent by the
published in 1936 is a highly significant
people on products of industry. The
work that marked a turning point in the
money which entrepreneurs receive is
development of modern economic theory.
paid in the form of rent, wages, interest
The theory of Keynes was against and profit. Therefore effective demand
the belief of classical economists that the equals national income.
market forces in capitalist economy adjust
themselves to attain equilibrium. Keynes
not only criticized classical economists
but also advocated his own theory of
employment.
Keynes’ theory was a general
theory as it tried to explain all types of
situations, i.e. not only equilibrium level
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 An increase in the aggregate effective to the concept of liquidity preference.
demand would increase the level of Liquidity preference is based on three
employment. A decline in total effective motives namely transaction motive,
demand would lead to unemployment. precautionary motive and speculative
Therefore, total employment of a country motive. MEC depends on two factors
can be determined with the help of total namely Prospective yield of capital asset
demand of a country. and supply price of capital.
According to the Keynes theory of (For more details see Chapter 4)
employment, “Effective demand signifies
the money spent on consumption of
3.6.1 Aggregate Demand Function (ADF)
goods and services and on investment.
The total expenditure is equal to the In the Keynesian model, output is
national income, which is equivalent to determined mainly by aggregate demand.
the national output”. The relationship The aggregate demand is the amount of
between employment and output of money which entrepreneurs expect to
an economy depends upon the level of get by selling the output produced by the
effective demand which is determined number of labourers employed. Therefore,
by the forces of aggregate supply and it is the expected income or revenue from
aggregate demand. the sale of output at different levels of
employment.
ED = Y = C + I = Output = Employment Aggregate demand has the following four
components:
Effective demand determines the
level of employment in the economy. 1. Consumption demand
When effective demand increases, 2. Investment demand
employment will increase. When effective 3. Government expenditure and
demand decreases, the level employment
will decline. The effective demand will 4. Net Export ( export – import )
be determined by two determinants The desired or planned demand
namely consumption and investment (spending) is the amount that households,
expenditures. The consumption function firms, the governments and the foreign
depends upon income of the people purchasers would like to spend on
and marginal propensity to consume. domestic output. In other words, desired
According to Keynes, if income increases, demand in the economy is the sum total of
consumption will also increase but by less desired private consumption expenditure,
than the increase in income. desired investment expenditure, desired
The rate of interest and marginal government spending and desired net
efficiency of capital determine the exports (difference between exports and
investment levels. Rate of interest imports). Thus, the desired spending is
depends on money supply and liquidity called aggregate spending (demand), and
preference. Keynes has given importance can be expressed as:

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 AD = C + I + G + (X – M) to produce goods. Thus, production
involves cost. If revenue from the sale
of output produced exceeds the cost of
y production at a given level of employment
AD and output, the entrepreneur would be
Aggregate Demand

encouraged to employ more labour and

other inputs to produce more.
Aggregate supply price is the total
amount of money that all entrepreneurs
in an economy expect to receive from the
x sale of output produced by given number
0 Employment of labourers employed. The term ‘price’
Figure.3.1 refers to the amount of money received
from the sale of output (sales proceeds).
Figure 3.1. explains that aggregate Hence, there are different aggregate prices
demand price increases or decreases with for different levels of employment.
an increase or decrease in the volume
of employment. Aggregate demand The components of aggregate supply are :
curve increases at an increasing rate 1. 
Aggregate (desired) consumption
in the beginning and then increases at expenditure (C)
a decreasing rate. This shows that as
income increases owing to increase in 2. Aggregate (desired) private savings (S)
employment, expenditure of the economy
3. 
Net tax payments (T) (Total
increases at a decreasing rate.
tax payment to be received by
the government minus transfer
3.6.2 Aggregate Supply Function (ASF) payments, subsidy and interest
payments to be incurred by the
Aggregate supply function is government) and
an increasing function of the level of
4. Personal (desired) transfer payments
employment. Aggregate supply refers to
to the foreigners (Rf)(eg. Donations
the value of total output of goods and
to international relief efforts)
services produced in an economy in a
year. In other words, aggregate supply is Aggregate Supply = C + S + T + Rf =
equal to the value of national product, i.e., Aggregate income generated in the
national income. economy
In other words, the aggregate supply
The following figure 3.2 shows the
refers to the required amount of labourers
shape of the two aggregate supply curves
and materials to produce the necessary
drawn for the assumption of fixed money
output. Employers hire labourers,
wages and variable wages.
purchase various inputs and raw materials

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 AGGREGATE SUPPLY CURVE
3.6.3 Equilibrium between ADF and ASF
y
Z1 Under the Keynes
theory of employment, a
Expected Proceeds

simple two sector

economy consisting of the
z household sector and the
business sector is taken to understand the
equilibrium between ADF and ASF. All
Employment the decisions concerning consumption
expenditure are taken by the individual
0 Figure.3.2 Nf x
households, while the business firms take
decisions concerning investment. It is also
Z curve is linear where money wages assumed that consumption function is
remains fixed; Z1 curve is non - linear since linear and planned investment is
wage rate increases with employment. autonomous.
When full employment level of Nf is y AS
reached it is impossible to increase output E AD
by employing more men. So aggregate
supply curve becomes inelastic (Vertical
Proceed and Cast

straight line). M1

The slope of the aggregate supply

curve depends on the relation between the
employment and productivity. The capital R1
stock is often fixed and hence the law of
diminishing marginal returns takes place 0 N1 Employment N0 Nf x
as more workers are employed. Based Figure.3.3
upon this relation, the aggregate supply
There are two approaches to
curve can be expected to slope upwards.
determination of the equilibrium level of
In reality the aggregate supply curve
income in Keynesian theory. These are :
will be like Z1 in figure 3.2. Therefore,
the aggregate supply depends on the 1. Aggregate demand – Aggregate supply
relationship between price and wages. approach
If prices are high and wages low, the 2. Saving – Investment approach
producers will try to employ labourers. If
In this chapter, out of these two,
prices are low and wages high, investment
aggregate demand and aggregate supply
will be curtailed, output will fall and there
approach is alone explained to understand
will be a reduction in the productive
the determination of equilibrium level of
capacity. Thus aggregate supply is an
income and employment.
important factor in determining the level
of economic activity.
45 Theories of Employment and Income

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 The concept of effective demand is aggregate supply curve indicating loss to the
more clearly shown in the figure 3.3 producers. Hence they will never employ
more than ONo labour. Thus effective
In the figure, the aggregate demand demand concept becomes a crucial point
and aggregate supply reach equilibrium in determining the equilibrium level of
at point E. The employment level is No at output in the capitalist economy or a free
that point. market economy in the Keynesian system.

At ON1 employment, the aggregate It is important to note that the

supply is N1 R1. But they are able to equilibrium level of employment need
produce M1 N1. The expected level of not be the full employment level (N1)
profit is M1 R1. To attain this level of from the Figure 3.3, it is understood that
profit, entrepreneurs will employ more the difference between No – Nf is the level
labourers. The tendency to employ more of unemployment. Thus the concept of
labour will stop once they reach point E. effective demand becomes significant
At all levels of employment beyond, ONo, in explaining the under employment
the aggregate demand curve is below the equilibrium.
3.7
Comparison of Classicism and Keynesianism

Sl.No Keynesianism Classicism

1. Short-run equilibrium Long-run equilibrium

2. Saving is a vice Saving is a social virtue.

The function of money is a medium
The function of money is to act as a
3. of exchange on the one side and a
medium of exchange
store of value on the other side.
Macro approach to national
4. Micro foundation to macro problems
problems

5. State intervention is advocated. Champions of Laissez-fair policy

Applicable to all situations – full

Applicable only to the full employment
6. employment and less than full
situation.
employment.
Capitalism has inherent
7. Capitalism is well and good.
contradictions
Budgeting should be adjusted to the
8. Balanced budget
requirements of economy.
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 The equality between saving and The equality between saving and
9. investment is advanced through investment is achieved through changes
changes in income. of rate of interest.

Rate of interest is determined by the Rate of interest is determined by saving

10.
demand for and supply of money. and investment.

11. Rate of interest is a flow. Rate of interest is a stock.

12. Demand creates its own supply. Supply creates its own demand.

Rate of interest is a reward for

13. Rate of interest is a reward for saving.
parting with liquidity.

After learning so much about the � U

 nder employment : Resources
theories of employment and income, it is (eg. Labour) are not fully utilized in
pertinent to look at what is employment production
multiplier.
� E
 ffective demand : The amount of
Summary money which entrepreneurs expect to
Keynes challenged the classical get by the output product.
economic theory regarding the merits of � A
 ggregate demand : The amount that
state intervention in markets and led to households, firms, the governments
widespread shift in both economic theory and the foreign purchasers would like
and government policies worldwide in the to spend on domestic output.
post World War II period. � A
 ggregate supply : The value of total
output of goods and services produced
Glossary in an economy in a year.
� M
 arginal Propensity to Consume :
� F
 ull employment : Persons who are The additional consumption due to an
willing to work and able to work must additional unit of income.
have employment or a job � M
 arginal Efficiency of Capital : The
� U
 nemployment : when there are expected rate of return over costs of a
people, who are willing to work and new capital good.
able to work but cannot find suitable � M
 oney supply : The total stock of
jobs. money circulating in an economy.
� D
 isguised unemployment : It is found
in which when more people are doing
work than actually required.

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 MODEL QUESTIONS
PART A
I. Multiple choice questions 6. According to Keynes, which type of
1. Every able bodied person who is willing unemployment prevails in capitalist
to work at the prevailing wage rate is economy ?
employed called as ………. (a) Full employment
(a) Full employment (b) Voluntary unemployment
(b) Under employment (c) Involuntary unemployment
(c) Unemployment (d) Under employment
(d) Employment opportunity 7. 
The core of the classical theory of
employment is …………
2. Structural unemployment is a feature in
a ……….. (a) Law of Diminishing Return
(a) Static society (b) Law of Demand
(b) Socialist society (c) Law of Markets
(c) Dynamic society (d) Law of Consumption
(d) Mixed economy 8. 
Keynes attributes unemployment to
…………..
3. 
In disguised unemployment, the
marginal productivity of labour is ….. (a) A lack of effective supply
(a) Zero (b) A lock of effective demand
(b) One (c) A lack of both
(c) Two (d) None of the above
(d) Positive 9. 
… ……. Flexibility brings equality
between saving and investment.
4. The main concention of the Classical
Economic Theory is …….. (a) Demand
(a) Under employment (b) Supply
(b) Economy is always in the state of (c) Capital
equilibrium d) Interest
(c) Demand creates its supply
10. …………… theory is a turning point in
(d) Imperfect competition
the development of modern economic
5. J .B. Say is a ……………………. theory.

(a) Neo Classical Economist (a) Keynes’

(b) Classical Economist (b) Say’s
(c) Modern Economist (c) Classical
(d) New Economist (d) Employment
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 11. 
T he basic concept used in Keynes 16. Classical theory advocates ……
Theory of Employment and Income (a) Balanced budget
is…………….
(b) Unbalanced budget
(a) Aggregate demand (c) Surplus budget
(b)Aggregate supply (d) Deficit budget
(c) Effective demand
17. Keynes theory emphasized on ……
(d) Marginal Propensity Consume
equilibrium.
12. The component of aggregate demand (a) Very short run
is ………….
(b) Short run
(a) Personal demand (c) Very long run
(b) Government expenditure (d) Long run
(c) Only export
18. According to classical theory, rate of
(d) Only import
interest is a reward for ……
13. Aggregate supply is equal to …………. (a) Investment
(a) C + I + G (b) Demand
(b) C + S + G + (x-m) (c) Capital
(c) C + S + T + (x-m) (d) Saving
(d) C + S + T + Rf
19. In Keynes theory , the demand for and
14. 
Keynes theory pursues to replace supply of money are determined by ….
laissez faire by ………… (a) Rate of interest
(a) No government intervention (b) Effective demand
(b) Maximum intervention (c) Aggregate demand
(c) 
State intervention in certain (d) Aggregate supply
situation
20. 
Say’s law stressed the operation of
(d) Private sector intervention
…………. in the economy.
15. In Keynes theory of employment and (a) Induced price mechanism
income, ………….. is the basic cause
(b) Automatic price mechanism
of economic depression.
(c) Induced demand
(a) Less production
(d) Induced investment
(b) More demand
(c) Inelastic supply
(d) Less aggregate demand in relation
to productive capacity.

49 Theories of Employment and Income

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 Answers
1 2 3 4 5 6 7 8 9 10
a c a b b d c b d a
11 12 13 14 15 16 17 18 19 20
c b d c d a b d a b

Part - B
Answer the following questions in one or two sentences.
21. Define full employment.
22. What is the main feature of rural unemployment ?
23. Give short note on frictional unemployment.
24. Give reasons for labour retrenchment at present situation.
25. List out the assumptions of Say’s law.
26. What is effective demand ?
27. What are the components of aggregate supply ?

PART – C
Answer the following questions in a paragraph.
28. Write the following in short
(i) Seasonal unemployment
(ii) Frictional unemployment
(iii) Educated unemployment
29. According to classical theory of employment, how wage reduction solve the
problem of unemployment diagramatically explain.
30. Write short note on the implications of Say’s law.
31. Explain Keynes’ theory in the form of flow chart.
32.What do you mean by aggregate demand ? Mention its components.
33. Explain about aggregate supply with the help of diagram.
34. Write any five differences between classism and Keynesianism.

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 PART - D

Answer the following questions in about page.

35. Describe the types of unemployment.
36. Critically explain Say’s law of market.
37. Narrate the equilibrium between ADF and ASF with diagram.
38. Explain the differences between classical theory and Keynes theory.

ACTIVITY
List out the persons in your village or ward who are fully
unemployed, partially unemployed and underemployed.

References

1. Jhingan. M. L. ‘ Macroeconomic Theory’, Vrinda Publication LTD.

2. Keshava. S.R. ‘Economics’ , New Age International Publishers, 2010.
3. M
 aria John Kennedy. M. ‘Macroeconomic Theory’ PHI Learning Private Limited,
New Delhi, 2011.
4. Mithani.D. M, ‘Macroeconomics’ Himalaya Publishing House.
5. Seth. M. L, ‘Macroeconomics’ , Lakshmi Narai Agarwal, Agra, 2012.
6. www.articlelibrary.com
7. www.economicdiscussion.com

51 Theories of Employment and Income

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 CHAPTER

4 Consumption And Investment

Functions

The theory of multiplier and the theory of accelerator are the two
sides of the theory of fluctuations just as the theory of demand and the
theory of supply are the two sides of the theory of value. The full theory
must be that which shows both sides in operation.
– J.R.Hicks.

Learning Objectives

1 To study the basic concepts in consumption and investment functions.

2 To impart knowledge on the working of Multiplier, Accelerator and Super

Multiplier.

4.1
Introduction

In the second chapter we have The multiplier refers to the change in

seen the concept of national income, national income resulting from change
its measurement, importance and in investment. The value of multiplier
difficulties. The present chapter deals itself depends on consumption function
with consumption function and the or marginal propensity to consume. The
investment function which play a vital consumption function is the relationship
role in influencing national income. between consumption expenditure and
the national income. The unspent portion
The primary macroeconomic of national income is called saving which
objective is acceleration of growth of becomes investment and thereby capital.
national income. We have already seen The relationship between consumption
that national income comprises of expenditure and the capital expenditure
consumption goods (C) and investment is explained by the principle of
(I) goods. There is close correlation accelerator. All these variables are closely
between investment and national income. interconnected.
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 In this chapter one can learn the based on the ceteris paribus (other things
consumption function, psychological law being same) assumption, as only income
of consumption, investment function, consumption relationship is considered
multiplier, accelerator and super and all possible influences on consumption
multiplier. are held constant.
4.2
In fact, consumption function is
Consumption Function a schedule of the various amounts of
consumption expenditure corresponding
to different levels of income. A hypothetical
4.2.1 Meaning of Consumption
consumption schedule is given in Table 1.
Function
Table : 1 Income - Consumption
INCOME SPENDING
Schedule (₹Crores)

Income Consumption Savings

Y C S
CONSUMPTION 0 20 -20
FUNCTION 60 70 -10
The consumption function or 120 120 0
propensity to consume refers to income 180 170 10
consumption relationship. It is a
240 220 20
“functional relationship between two
aggregates viz., total consumption and 300 270 30
gross national income.” 360 320 40

Symbolically, the relationship is If we take C = 100 + 0.8y, then MPC = 0.8

represented as
Here, if Y = 0, C = 100; if Y = 100, C = 180;
C= f (Y)
if Y = 200, C = 260;
Where, ∆c
if Y = 300, C = 340 (MPC = =0.8 )
∆y
C = Consumption In mathematical terms
Y = Income
C= a + b Y or C = 20 + 0.8Y
f = Function
Where a>0 and b<1
Thus the consumption function
indicates a functional relationship between C= Consumption
С and Y, where С is the dependent variable
and Y is the independent variable, i.e., С a= constant or intercept = 20
is determined by Y. This relationship is
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 Y= income consumption but also the amount saved.
This is because the propensity to save is
b= MPC (Marginal prosperity to merely the propensity not to consume.
∆c
consume) = 0.8 = The 45° line may therefore be regarded
∆y
The given table shows that as a zero-saving line, and the shape and
consumption is an increasing function of position of the C curve indicate the
income because consumption expenditure division of income between consumption
increases with increase in income. Here it and saving.
is shown that when income is zero, people
spend out of their past savings on 4.2.2 Technical Attributes of the
consumption because they must eat in Consumption Function
order to live (Autonomous Consumption).

y c=y PROPENSITY TO
CONSUME
Consumption

c Average Marginal

Marginal Propensity to Consume

Average Propensity to Consume
170
S
120
B
20
45o
75%

25%
Total Income
0 120 180 x Income Increase
Figure.4.1 Income : 40,000 : 10,000
Amount Increase
Here, when y = 120, C = 120 (Point B is Spent : Spent :
the diagram) 30,000 2,500

When y = 180, C = 170, S = 10 (Point S is (i) The Average Propensity to

the diagram) Consume= c
y
If Y increases to 360, C = 320, S = 40 (ii) The Marginal Propensity to
∆c
In the diagram, income is measured Consume =
∆y
horizontally and consumption is
measured vertically. In 45 line at all levels, (iii) The Average Propensity to
income and consumption are equal. It is a s
Save= y
linear consumption function based on the
assumption that consumption changes by (iv) The Marginal Propensity to
the same amount as does income. ∆s
Save = ∆y
Thus the consumption function
measures not only the amount spent on

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 (1) The Average Propensity to Consume: APS is the quotient obtained by
dividing the total saving by the total
The average propensity to consume income. In other words, it is the ratio of
is the ratio of consumption expenditure to total savings to total income. It can be
any particular level of income.” expressed algebraically in the form of
Algebraically it may be expressed as equation as under
under:
S
APS =
C Y
APC =
Y
Where,
Where,
S= Saving
C= Consumption
Y=Income
Y = Income
(4) 
The Marginal Propensity to Save
(2) The Marginal Propensity to Consume:
(MPS) :
The marginal propensity to consume
Marginal Propensity to Save is the
may be defined as the ratio of the change
ratio of change in saving to a change in
in the consumption to the change in
income.
income. Algebraically it may be expressed
as under: MPS is obtained by dividing change
in savings by change in income. It can be
∆C expressed algebraically as
MPC =
∆Y

∆S
Where, MPS =
∆Y
ΔC= Change in Consumption
ΔS = Change in Saving
ΔY = Change in Income
ΔY= Change in Income
MPC is positive but less than unity
Since MPC+MPS=1
MPS=1-MPC and MPC = 1 - MPS
∆C
0< <1
∆Y Generally the average ie APC is
expressed in percentage and the MPC in
(3) The Average Propensity to Save (APS) : fraction.

The average propensity to save is the

ratio of saving to income.

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 Table: 2 Calculation of APC, MPC, APS and MPS

Income Consumption APC % APS % MPC MPS

Y C C/Y S/Y ΔC/ΔY ΔS/ΔY
120 120 (120/120)100 = 100 (0/120)0 - -
50/60 =
180 170 (170/180)100 = 94 (10/180)100 0.17
0.83

Assumptions:
4.2.3 Keynes’s Psychological Law of
Consumption:
Keynes’s Law is based on the
Keynes propounded the fundamental
following assumptions:
Psychological Law of Consumption which
forms the basis of the consumption 1. Ceteris paribus (constant extraneous
function. He stated that “The fundamental variables):
psychological law upon which we are
entitled to depend with great confidence The other variables such as income
both prior from our knowledge of human distribution, tastes, habits, social customs,
nature and from the detailed facts of price movements, population growth, etc.
experience, is that men are disposed as a do not change and consumption depends
rule and on the average to increase their on income alone.
consumption as their income increases
but not by as much as the increase in their 2. Existence of Normal Conditions:
income.” The law implies that there is a
The law holds good under normal
tendency on the part of the people to
conditions. If, however, the economy is
spend on consumption less than the full
faced with abnormal and extraordinary
increment of income.
circumstances like war, revolution or
hyperinflation, the law will not operate.
Income Consumption People may spend the whole of increased
income on consumption.

3. Existence of a Laissez-faire Capitalist

Consumption increases Economy:
Income but not equal and to
Increases income rises The law operates in a rich capitalist
economy where there is no government
intervention. People should be free to
spend increased income. In the case
of regulation of private enterprise and
consumption expenditures by the State,
the law breaks down.
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 Propositions of the Law: Proposition (2):
This law has three propositions: The increased income of ₹ 60
(1) W
 hen income increases, consumption crores in each case is divided in some
expenditure also increases but by a proportion between consumption and
smaller amount. The reason is that saving respectively. (i.e., ₹ 50crores and
as income increases, our wants are ₹ 10 crores).
satisfied side by side, so that the need
to spend more on consumer goods Proposition (3):
diminishes. So, the consumption As income increases consumption
expenditure increases with increase in as well as saving increase. Neither
income but less than proportionately. consumption nor saving has fallen.
(2) T
 he increased income will be
Diagrammatically, the three
divided in some proportion between
propositions are explained in Figure 4.2.
consumption expenditure and
Here, income is measured horizontally
saving. This follows from the first
and consumption and saving are measured
proposition because when the whole
on the vertical axis. С is the consumption
of increased income is not spent on
function curve and 45° line represents
consumption, the remaining is saved.
income consumption equality.
In this way, consumption and saving
move together.
(3) Increase in income always leads to y c=y
an increase in both consumption 240 y
5 /6
and saving. This means that increased 220 2 0+
income is unlikely to lead to fall 180 c=
170
in either consumption or saving. 120
Thus with increased income both
consumption and saving increase.
450
0
Table 3. The three propositions of the 120 180 240 x
law Figure.4.2
Income Consumption Savings
Proposition (1):
Y C S=Y-C
120 120 0
When income increases from 120 to
180 170 10
180 consumption also increases from 120
240 220 20
to 170 but the increase in consumption
Proposition (1): is less than the increase in income, 10 is
Income increases by ₹ 60 crores and saved.
the increase in consumption is by ₹ 50
crores.
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 Proposition (2): 3. The motive of calculation: The desire
to enjoy interest and appreciation.
When income increases to 180 and
240, it is divided in some proportion 4. 
The motive of improvement: The
between consumption by 170 and 220 and desire to enjoy for improving standard
saving by 10 and 20 respectively. of living.

Proposition (3): 5. The motive of financial independence.

Increases in income to 180 and 240 6. The motive of enterprise (desire to do

lead to increased consumption 170 and forward trading).
220 and increased saving 20 and 10 than
before. It is clear from the widening area 7. The motive of pride.(desire to bequeath
below the С curve and the saving gap a fortune)
between 45° line and С curve.
8. The motive of avarice.(purely miserly
4.2.4  Determinants of Consumption instinct)
function: Subjective and Objective
Factors Keynes sums up the motives as
Precaution, Foresight, Calculation,
J.M Keynes has divided factors Improvement, Independence, Enterprise,
influencing the consumption function Pride and Avarice.
into two namely: Subjective factors and
Objective factors The Government, institutions and
business corporations and firms may also
A) Subjective Factors consume mainly because of the following
four motives:
Subjective factors are the internal
factors related to psychological feelings. 1. The motive of enterprise: The desire
Major subjective factors influencing to obtain resources to carry out further
consumption function are given below. capital investment without incurring
debt.
Keynes lists eight motives which lead
individuals to refrain from spending, they 2. The motive of liquidity: The desire
are: to secure liquid resources to meet
emergencies, and difficulties.
1. The motive of precaution: To build
up a reserve against unforeseen 3. 
The motive of improvement: The
contingencies. Eg. Accidents, sickness desire to secure a rising income and to
demonstrate successful management.
2. The motive of foresight: The desire to
provide for anticipated future needs. 4. 
The motive of financial prudence:
Eg. Old age The desire to ensure adequate financial

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 provision against depreciation and 4) Interest rate
obsolescence and to discharge debt.
Rate of interest plays an important
According to Keynes, the subjective role in determining the consumption
factors do not change in the short run function. Higher rate of interest will
and hence consumption function remains encourage people to save more money and
stable in the short period. reduces consumption.

B) Objective Factors 5) Fiscal Policy

Objective factors are the external When government reduces the

factors which are real and measurable. tax the disposable income rises and the
These factors can be easily changed in propensity to consume of community
the long run. Major objective factors increases. The progressive tax system
influencing consumption function are: increases the propensity to consume of the
people by altering the income distribution
1) Income Distribution in favour of poor.
If there is large disparity between rich
6) Consumer credit
and poor, the consumption is low because
the rich people have low propensity to The availability of consumer credit
consume and high propensity to save. The at easy installments will encourage
community with more equal distribution households to buy consumer durables
of income tends to have high propensity to like automobiles, fridge, computer. This
consume. This view has been corroborated pushes up consumption.
by V.K.R.V. Rao.
7) Demographic factors
2) Price level
Ceteris paribus, the larger the size of
Price level plays an important role in the family, the grater is the consumption.
determining the consumption function. Besides size of family, stage in family life
When the price falls, real income goes up; cycle, place of residence and occupation
people will consume more and propensity affect the consumption function. Families
to save of the society increases. with children of college education stage
3) Wage level spend more than those of primary
education and urban families spend more
Wage level plays an important role than rural families.
in determining the consumption function
and there is positive relationship between 8) Duesenberry hypothesis
wage and consumption. Consumption
expenditure increases with the rise in Duesenberry has made two
wages. Similar is the effect with regard to observations regarding the factors
windfall gains. affecting consumption.

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 a) The consumption expenditure 4.3.1. Meaning of investment
depends not only on his
current income but also The term investment means
past income and standard purchase of stocks and shares, debentures,
of living. As the individuals government bonds and equities. According
are accustomed to a to Keynes, it is only financial investment
particular standard of and not real investment. This type of
living, they continue to investment does result in an addition to
spend the same amount Duesenberry the stock of real capital of the nation.
on consumption even though the current
income is reduced. In the views of Keynes, Investment
includes expenditure on capital
b) Consumption is influenced by investment.
demonstration effect. The consumption
standards of low income groups are 4.3.2. Types of investment
influenced by the consumption standards
of high income groups. In other words, Autonomous Investment and Induced
the poor people want to imitate the Investment
consumption pattern of rich. This results
in spending beyond their income level. Autonomous Investment
9) Windfall Gains or losses ● Investment that is not dependent
on the national income
Unexpected changes in the stock
● 
Mainly done with the welfare
market leading to gains or losses tend to
motive and not for making profits
shift the consumption function upward or
downward. ● Examples : Construction of road,
4.3 bridges, School, Charitable houses
● Not affected by rise in raw materials
Investment Function or wages of workers
● Essential to development of nation
The investment function refers to
and out of depression
investment -interest rate relationship.
There is a functional and inverse
relationship between rate of interest and i)Autonomous investment: Autonomous
investment. The investment function investment is the expenditure on capital
slopes downward. formation, which is independent of the
change in income, rate of interest or rate
I = f (r) of profit.
I= Investment (Dependent variable)
r=R  ate of interest (Independent
variable)
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 This investment is independent ii) Induced investment: Induced
of economic activity. Autonomous investment is the expenditure on fixed
investment is income-inelastic, the assets and stocks which are required
volume of autonomous investment is the when level of income and demand in
same at all levels. an economy goes up.

The autonomous investment curve is Induced investment is profit

horizontal, parallel to X axis. motivated. It is related to the changes of
national income. The relationship between
Autonomous Investment the national income and induced
y
investment is positive; decreases in
national income leads to decrease in
induced investment and vice versa.
Investment

I I’
Induced investment is income elastic. It is
positively sloped as shown here.

Induced Investment
0 Income x
y
Figure.4.3
Id
In the times of economic
Investment

depression, the governments try to

boost the autonomous investment.
Thus, autonomous investment is one of
the key concepts in welfare economics.
0
GNP x
Generally, Government makes Figure.4.4
autonomous investment because of the
welfare consideration.
Sl. Autonomous Induced
No Investment Investment
1 Independent Planned
2 Income inelastic Income elastic
3 Welfare motive Profit Motive

4.3.3 Determinants of Investment Function

The classical economists believed that investment depended exclusively on rate of

interest. In reality investment decision depends on a number of factors. They are as follows:

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 1. Rate of interest
4.3.4.  Relationship
2. Level of uncertainty between rate
of interest and
3. Political environment
Investment:
4. Rate of growth of population An explanation of how the rate of
5. Stock of capital goods interest influences the level of investment
in the economy. Typically, higher interest
6. Necessity of new products rates reduce investment, because higher
7. Level of income of investors rates increase the cost of borrowing and
require investment to have a higher rate of
8. Inventions and innovations return to be profitable.
9. Consumer demand Interest rates and investment
10. Policy of the state Interest Rate %
11. Availability of capital y
12. Liquid assets of the investors

However, Keynes contended that 8%

business expectations and profits are more 5%
important in deciding investment. He also
pointed out that investment depends on
MEC (Marginal Efficiency of Capital)
and rate of interest. 0 80 100 x
Amount (Volume)
i. Private investment is an increase in the Figure.4.5
of Investment
capital stock such as buying a factory or
machine. As the real cost of borrowing rises,
fewer investment projects are profitable.
ii. 
The marginal efficiency of capital If interest rates rise from 5% to
(MEC) states the rate of return on an 8 %, then we get a fall in the amount of
investment project. Specifically, it investment from ₹ 100 cr to ₹ 80 cr.
refers to the annual percentage yield
(output) earned by the last additional If interest rates are increased then it
unit of capital. will tend to discourage investment because
investment has a higher opportunity cost.
iii. 
If the marginal efficiency of capital 1. With higher rates, it is more expensive
is 5% and interest rates is 4%, then to borrow money from a bank.
it is worth borrowing at 4% to get an 2. Saving money in a bank gives a higher
expected increase in output of 5%. rate of return. Therefore, using savings to
finance investment has an opportunity
cost of lower interest payments.
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 If interest rates rise, firms will need a) Short - Run Factors
to gain a better rate of return to justify the
cost of borrowing using savings. (i) Demand for the product: If the market
for a particular good is expected to
4.3.5. Marginal Efficiency of Capital. grow and its costs are likely to fall, the
rate of return from investment will be
MEC was first introduced by high. If entrepreneurs expect a fall in
J.M Keynes in 1936 as an important demand for goods and a rise in cost,
determinant of autonomous investment. the investment will decline.
The MEC is the expected profitability (ii) L iquid assets: If the entrepreneurs
of an additional capital asset. It may be are holding large volume of working
defined as the highest rate of return over capital, they can take advantage of the
cost expected from the additional unit of investment opportunities that come in
capital asset. their way. The MEC will be high.
Meaning of Marginal Efficiency (iii) Sudden changes in income: The MEC
of Capital (MEC) is the rate of discount is also influenced by sudden changes
which makes the discounted present value in income of the entrepreneurs. If the
of expected income stream equal to the business community gets windfall
cost of capital. profits, or tax concession the MEC
will be high and hence investment in
MEC depends on two factors: the country will go up. On the other
hand, MEC falls with the decrease in
1. 
The prospective yield from a capital income.
asset.
(iv) Current rate of investment: Another
2. T
 he supply price of a capital asset. factor which influences MEC is
the current rate of investment in a
Factors Affecting MEC: particular industry. If in a particular
industry, much investment has already
Three factors that are taken into taken place and the rate of investment
consideration while making any currently going on in that industry
investment decision
is also very large, then the marginal
l T
he cost of the capital asset efficiency of capital will be low.
l T
he expected rate of return
MEC

from during its lifetime (v) Waves of optimism and pessimism:

l T
he market rate of interest The marginal efficiency of capital is
also affected by waves of optimism
and pessimism in the business cycle.
The marginal efficiency of capital is If businessmen are optimistic about
influenced by short - run as well as long- future, the MEC will be likely to be
run factors. These factors are discussed in high. During periods of pessimism the
brief: MEC is under estimated and so will be
low.
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 b)Long - Run Factors improvements encourage investment
in various projects and increase
The long run factors which influence marginal efficiency of capital.
the marginal efficiency of capital are as
follows: (iii) Monetary and Fiscal policies: Cheap
money policy and liberal tax policy
(i) 
R ate of growth of population: pave the way for greater profit margin
Marginal efficiency of capital is also and so MEC is likely to be high.
influenced by the rate of growth of (iv) Political environment: Political
population. If population is growing stability, smooth administration,
at a rapid speed, it is usually believed maintenance of law and order help to
that the demand of various types of improve MEC.
goods will increase. So a rapid rise in
(v) Resource availability: Cheap and
the growth of population will increase
abundant supply of natural resources,
the marginal efficiency of capital and a
efficient labour and stock of capital
slowing down in its rate of growth will
enhance the MEC.
discourage investment and thus reduce
marginal efficiency of capital. 4.3.6. Marginal Efficiency of Investment

(ii) Technological progress: If investment MEI is the expected rate of return

and technological development take on investment as additional units of
place in the industry, the prospects investment are made under specified
of increase in the net yield brightens conditions and over a period of time. When
up. For example, the development of cost of borrowing is high, businesses are
automobiles in the 20th century has less motivated to borrow money and make
greatly stimulated the rubber industry, investment on different projects because
the steel and oil industry etc. So we can high cost of borrowing reduces profit
say that inventions and technological margin of the business firms;
Marginal Efficiency of Capital(MEC) Marginal Efficiency of Investment(MEI)
1) It is based on a given supply price for 1) It is based on the induced change in the
capital. price due to change in the demand for
capital.
2) It represents the rate of return on all 2) It shows the rate of return on just those
successive units of capital without units of capital over and above the existing
regard to existing capital. capital stock.
3) The capital stock is taken on the X axis 3) The amount of investment is taken on the
of diagram. X - axis of diagram.
4) It is a “stock” concept. 4) It is a “flow” concept.
5) 
It determines the optimum capital 5) It determines the net investment of the
stock in an economy at each level of economy at each interest rate given the
interest rate. capital stock.
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 4.4 4.4.2.  Marginal propensity
to consume and
Multiplier
multiplier.

The concept of multiplier was first The propensity to

developed by R.F. Khan in terms of consume refers to the portion of income
employment. J.M Keynes redefined it as spent on consumption. The MPC
investment multiplier. refers to the relation between change
in consumption (C) and change in
The multiplier is defined as the ratio income(Y).
of the change in national income to change
Symbolically MPC = ∆C/∆Y
in investment. If ∆I stands for increase in
investment and ∆Y stands for resultant The value of multiplier depends on
increase in income, the multiplier MPC
K =∆Y/∆I. Since ∆Y results from ∆I, the
Multiplier (K) = 1/1-MPC
multiplier is called investment multiplier.
The multiplier is the reciprocal of one
4.4.1 Assumptions of Multiplier:
minus marginal propensity to consume.
Keynes’s theory of the multiplier Since marginal propensity to save is
works under certain assumptions which 1 - MPC. (MPC+MPS =1). Multiplier
limit the operation of the multiplier. They is 1/ MPS. The multiplier is therefore
are as follows: defined as reciprocal of MPS. Multiplier is
inversely related to MPS and directly with
1. 
There is change in autonomous MPC.
investment.
Numerically if MPC is 0.75, MPS is
2. There is no induced investment 0.25 and k is 4.
3. The marginal propensity to consume is Using formula k = 1/1- MPC
constant.
1/1-0.75 =1/0.25 =4
4. C onsumption is a function of current
income. c=y
Consumption and investment

5. There are no time lags in the multiplier y D c + 110

process. 1050 C c + 100
6. 
C onsumer goods are available in 1000 B c + 100+ 0.8y
response to effective demand for them. 500
A
200
7. There is a closed economy unaffected
100
by foreign influences.
45o GNP
8. There are no changes in prices. 0 500 1000 1050 x
9. There is less than full employment level Figure.4.6
in the economy.
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 Table 4. The original national income is 500.
(C = 100 + 0.8y = 100 + 0.8(500) = 500)
Taking the following values, we can
explain the functioning of multiplier When I is 100, y = 1000, C = 900;
S = 100 = I
MPC MPS K
The new aggregate demand curve is
0.00 1.00 1
C+I’ = 100 + 0.8y + 100 +10
0.10 0.90 1.11 210
0.50 0.50 2.00 Y= = 1050
0.2
0.75 0.25 4.00 C = 940; S = 110 = I
0.90 0.10 10.00
1.00 0.00 α 4.4.3. Working of Multiplier

C = 100 + 0.8 y; I = 100 Suppose the Government undertakes

investment expenditure equal to �100
I = 10 crore on some public works, by way of
Y=C+I wages, price of materials etc. Thus income
of labourers and suppliers of materials
= 100 + 0.8y + 100
increases by �100 crore. Suppose the MPC
0.2y = 200 is 0.8 that is 80 %. A sum of �80 crores is
Y = 1000 spent on consumption (A sum of �20
Crores is saved). As a result, suppliers of
Here, C = 100 + 0.8y = 100 + (1000) = 900;
goods get an income of �80 crores. They
S = 100 = I inturn spend �64 crores (80% of �80 cr).
After I is raised by 10, now I = 110, In this manner consumption expenditure
and increase in income act in a chain like
Y = 100 + 0.8y + 110
manner.
0.2y = 210
Positive Multiplier and Negative
Y = 210 = 1050 Multiplier Effects
0.2

Here C = 100=0.8(1050) = 940; S = 110 = I Positive Negative

Diagrammatic Explanation. Multiplier Multiplier
When an intial When an intial
At 45° line y = C+ S
increases in an increases in an
It implies the variables in axis and injection (or a injection (or
axis are equal. decrease in a an increase in a
 he MPC is assumed to be at 0.8
T leakage ) leads leakage ) leads
(C = 100 + 0.8y) to a greater to a greater
final increase final decrease
The aggregate demand (C+I) curve
in real GDP. in real GDP.
intersects 45° line at point E.
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 The final result is∆Y = 100+100×4/5+100 Under static multiplier the change in
×[4/5]2+100×[4/5]3 or, investment and the resulting change
∆Y = 1 00 + 100 x 0.8 + 100 x (0.8)2 + 100 in income are simultaneous.There is
x (0.8)3 no time lag. There is also no change in
MPC as the economy moves from one
= 100 + 80 + 64 + 51.2...
equilibrium position to another.
= 500
ii. D
 ynamic multiplier is also known
that is 100×1/1-4/5
as ‘sequence multiplier’. In real life,
100×1/1/5 income level does not increase instantly
100×5 = �500 crores with investment. In fact, there is a time
lag between increase in income and
For instance if C = 100 + 0.8Y, I = 100,
consumption expenditure.
Then Y = 100 + 0.8Y + 100
0.2Y = 200 4.4.5. Leakages of multiplier
Y = 200/0.2 = 1000→Point B The multiplier assumes that those
If I is increased to 110, then who earn income are likely to spend a
0.2Y =210 proportion of their additional income
on consumption. But in practice, people
Y = 210/0.2 = 1050→Point D tend to spend their additional income on
For �10 increase in I, Y has increased by other items. Such expenses are known as
�50. leakages.
This is due to multiplier effect. Payment towards past debts.
At point A, Y = C = 500 If a portion of the additional income
C = 100 + 0.8 (500) = 500; S=0 is used for repayment of old loan, the
At point B, Y = 1000 MPC is reduced and as a result the value
C = 100 + 0.8 (1000) = 900; S = 100 = I of multiplier is cut.
At point D, Y = 1050 Purchase of existing wealth
C = 100 + 0.8 (1050) = 940; S = 110 = I If income is used in purchase of
When I is increased by 10, Y increases by existing wealth such as land, building and
50. shares money is circulated among people
and never enters into the consumption
 his is multiplier effect (K = 5)
T
stream. As a result the value of multiplier
K = 1 =5
0.2 is affected.
4.4.4 Classification of Multiplier: Import of goods and services

1. Static and dynamic multiplier Income spent on imports of goods or

services flows out of the country and has
i. Static multiplier is otherwise known little chance to return to income stream
as simultaneous multiplier, timeless in the country. Thus imports reduce the
multiplier, and logical multiplier. value of multiplier.
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 Non availability of consumer goods 4.5
The multiplier theory assumes The Accelerator Principle
instantaneous supply of consumer
goods following demand. But there is
The origin of accelerator principle
often a time lag. During this gap (D>S)
can be traced back in the writings
inflation is likely to rise. This reduces the
of Aftalion (1909), Hawtrey (1913)
consumption expenditure and thereby
and Bickerdike(1914). However, the
multiplier value.
systematic development of the simple
Full employment situation accelerator model was made by J.M.Clark,
in 1917. It was further developed by Hicks,
Under conditions of full employment, Samuelson and Harrod in relation to the
resources are almost fully employed. So, business cycles.
additional investment will lead to inflation
only, rather than generation of additional 4.5.1. Meaning
real income.
A given increase in the demand for
4.4.6. Uses of multiplier consumption goods in the economy
generally leads to an accelerated demand
1. Multiplier highlights the importance of for machineries (investment goods).
investment in income and employment Accelerator is the numerical value of the
theory. relation between an increase in
consumption and the resulting increase in
2. The process throws light on the different investment.
stages of trade cycle.
Accelerator Effects
3. It also helps in bringing the equality
Increase in Films get Films invest
between S and I. consumer close to fill to meet rising
demand capacity demand
4. 
It helps in formulating Government
policies.
ΔI
Accelerator (β)=
5. It helps to reduce unemployment and ΔC
achieve full employment.
ΔI = Change in investment outlays
(Say 100)
KINDS OF MULTIPLIER
1. Tax multiplier ΔC = Change in consumption
demand (Say 50)
2. Employment multiplier
3. Foreign Trade multiplier The accelerator expresses the ratio of
the net change in investment to change in
4. Investment Multiplier
consumption.

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 constant flow of 1000 consumer goods.
4.5.2. Definition
This might be called replacement demand.
“The accelerator coefficient is the
Suppose that demand for consumer
ratio between induced investment and an
goods rises by 10 percent (ie from 1000
initial change in consumption.”
to 1100). This results in increase in
demand for 10 more machines. So that
Assuming the expenditure of
total demand for machines is 20. (10 for
₹50crores on consumption goods, if
replacement and 10 for meeting increased
industries lead to an investment of ₹ 100
demand). It may be noted here a 10
crores in investment goods industries, we
percent increase in demand for consumer
can say that the accelerator is 2.
goods causes a 100 percent increase in
100 demand for machines (from 10 to 20). So
Accelerator = =2
50 we can conclude even a mild change in
4.5.3. Assumptions demand for consumer goods will lead to
wide change in investment.
1. Absence of excess capacity in consumer
goods industries. Diagrammatic illustration:

Operation of Accelerator.
2. Constant capital - output ratio
S
3. Increase in demand is assumed to be y I1
permanent I
Saving and Investment

E3
I4 I4
4. 
Supply of funds and other inputs is
E2
quite elastic I3 I3
E1
5. Capital goods are perfectly divisible in I2 I2
any required size.
I
S
4.5.4.  Operation of the 0 Y1 Y2 Y3 Income x
Acceleration Principle
Figure.4.7
Let us consider a simple example. SS is the saving curve. II is the
The operation of the accelerator may be investment curve. At point E1, the
illustrated as follows. economy is in equilibrium with OY1
income. Saving and investment are equal
Let us suppose that in order to
at OI2. Now, investment is increased from
produce 1000 consumer goods, 100
OI2 to OI4. This increases income from
machines are required. Also suppose that
OY1 to OY3, the equilibrium point being
working life of a machine is 10 years. This
E3. If the increase in investment by I2 I4
means that every year 10 machines have
is purely exogenous, then the increase in
to be replaced in order to maintain the
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 income by Y1 Y3 would have been due to
4.6.1. Leverage Effect
the multiplier effect. But in this diagram
it is assumed that exogenous investment The combined effect of the
is only by I2 I3 and induced investment is multiplier and the accelerator is also
by I3 I4. Therefore, increase in income by called the leverage effect which may lead
Y1 Y2 is due to the multiplier effect and the the economy to very high or low level of
increase in income by Y2 Y3 is due to the income propagation.
accelerator effect.
Symbolically
4.5.5. Limitations
Y= C + IA + IP
1. 
The assumption of constant capital- Y = Aggregate income.
output ratio is unrealistic.
C = Consumption expenditure
2. Resources are available only before full
IA= autonomous investment
employment.
IP= induced private investment
3. 
Excess capacity in capital goods
industries is assumed. Summary
4. 
Accelerator will work only if the
The chapter consumption function
increased demand is permanent.
and investment function can be
5. Accelerator will work only when credit summarised under three heads.
is available easily.
The consumption function deals
6. If there is unused or excess capacity
with relationship between national income
in the consumer goods industry, the
and consumption expenditure Viz APC,
accelerator principle would not work.
MPC and APS, MPS. The subjective and
4.6 objective factors determine consumption
Super Multiplier: function.
(k and β interaction)
The investment function includes
The super multiplier is greater than autonomous investment and the induced
simple multiplier which includes only investment, the functional relationship
autonomous investment and no induced between interest rate and the investment,
investment, while super multiplier the role of MEC and rate of interest in
includes induced investment. determining the investment.

In order to measure the total effect The multiplier is directly related to

of initial investment on income, Hicks has MPC and inversely related to MPS. The
combined the k and β mathematically and accelerator principle explains the effect of
given it the name of the Super Multiplier. changing consumption expenditure upon
The super multiplier is worked out by volume of investment. The interaction of
combining both induced consumption multiplier and accelerator is called super
and induced investment. multiplier.
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 Glossary Subjective Factors : Internal factors
n 
related to Psychological feeling
Consumption function : the relationship
n 
between consumption and income Objective Factors : External factors
n 
which are real and measurable.
Autonomous Consumption :
n 
Autonomous consumption is the Demonstration effect : the tendency to
n 
minimum level of consumption or imitate superior consumption pattern.
spending that must take place even if a n I
nduced investment : Additional
consumer has no disposable income, investment demand that results from an
such as spending for basic necessities. increase in domestic product (GDP)
Autonomous Investment : Additional
n  Multiplier : ratio of change in income to
n 
investment that is independent of income change in investment. ΔY/ΔI
Average Propensity to Consume (APC):
n  Accelerator : ratio of change in induced
n 
Ratio of the consumption expenditure to investment to change in consumption.
income. C/Y (or) Technical relationship between
Marginal Propensity to Consume
n  change in capital stock and change in
(MPC) : Ratio of change in consumption level of output.
to change in income. ΔC/ΔY n S
 uper Multiplier : The combined effect of
Average Propensity to Save (APS):
n  interaction of multiplier and accelerator.
Ratio of the saving to income. S/Y
Marginal Propensity to Save (MPS):
n 
Ratio of change in saving to change in
income. ΔS/ΔY

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 MODEL QUESTIONS

Part-A
Multiple Choice Questions

1. T
 he average propensity to consume is 5. If the Keynesian consumption function
measured by is C=10+0.8 Y then, and disposable
income is �100, what is the average
a) C/Y
propensity to consume?
b) CxY
c) Y/C a) ₹ 0.8
d) C+Y b) ₹ 800
c) ₹ 810
2. An increase in the marginal propensity d) ₹0.9
to consume will:
6. As national income increases
a) 
Lead to consumption function
becoming steeper a) 
The APC falls and gets nearer in
b) 
Shift the consumption function value to the MPC.
upwards
b) The APC increases and diverges in
c) 
Shift the consumption function
value from the MPC.
downwards
d) Shift savings function upwards c) The APC stays constant

3. If the Keynesian consumption function d) The APC always approaches infinity.
is C=10+0.8 Y then, if disposable
income is Rs 1000, what is amount of 7. As increase in consumption at any given
total consumption? level of income is likely to lead
a) ₹ 0.8 a) Higher aggregate demand
b) ₹ 800 b) An increase in exports
c) ₹ 810 c)A fall in taxation revenue
d) ₹ 0.81 d) A decrease in import spending

4. If the Keynesian consumption function 8. Lower interest rates are likely to :
is C=10+0.8Y then, when disposable
a) Decrease in consumption
income is Rs 100, what is the marginal
propensity to consume? b) increase cost of borrowing
c) Encourage saving
a) ₹ 0.8
d) increase borrowing and spending
b) ₹ 800
c) ₹ 810
d) ₹ 0.81

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 9. The MPC is equal to : 14. 
The multiplier tells us how much
__________ changes after a shift in
a) Total spending / total consumption
_____
b) Total consumption/total income
c) Change in consumption /change in a) Consumption , income
income b) investment, output
d) none of the above. c) savings, investment
d) output, aggregate demand
10. 
The relationship between total
spending on consumption and the total 15. The multiplier is calculated as
income is the ___________________
a) 1/(1-MPC)
a) Consumption function b) 1/MPS
b) Savings function c) 1/MPC
c) Investment function d) a and b
d) aggregate demand function
16. It the MPC is 0.5, the multiplier is
11. 
The sum of the MPC and MPS is ____________
_______
a) 2
a)1 b)1/2
b) 2 c) 0.2
c) 0.1 d) 20
d) 1.1
17. In an open economy import _________
12. 
As income increases, consumption the value of the multiplier
will _________
a) Reduces
a)fall b) increase
b) not change c) does not change
c) fluctuate d) changes
d) increase
18. According to Keynes, investment is a
13. 
When investment is assumed function of the MEC and _____
autonomous the slope of the AD
a) Demand
schedule is determined by the _____
b) Supply
a) marginal propensity to invest c) Income
b) disposable income d) Rate of interest
c) marginal propensity to consume
d) average propensity to consume

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 19. The term super multiplier was first 20. The term MEC was introduced by
used by
a) Adam Smith
a) J.R.Hicks b) J.M. Keynes
b) R.G.D. Allen c) Ricardo
c) Kahn d) Malthus
d) Keynes
Answers
1 2 3 4 5 6 7 8 9 10

a a c a d a a d c a

11 12 13 14 15 16 17 18 19 20

a d c d d a a d a b

Part-B
Answer the following questions in one or two sentences.
21. What is consumption function?
22. What do you mean by propensity to consume?
23. Define average propensity to consume (APC).
24. Define marginal propensity to consume (MPC).
25. What do you mean by propensity to save?
26. Define average propensity to save (APS).
27. Define Marginal Propensity to Save (MPS).
28. Define Multiplier.
29. Define Accelerator.

Part C
Answer the following questions in one paragraph
30. State the propositions of Keynes’s Psychological Law of Consumption
31. Differentiate autonomous and induced investment.
32. E
 xplain any three subjective and objective factors influencing the
consumption function.
33. Mention the differences between accelerator and multiplier effect

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 34. State the concept of super multiplier.
35. Specify the limitations of the multiplier.

Part D
Answer the following questions in a page
36. Explain Keynes psychological law of consumption function with diagram.
37. Briefly explain the subjective and objective factors of consumption function?
38. Illustrate the working of Multiplier.
39. Explain the operation of the Accelerator.
40. What are the differences between MEC and MEI

ACTIVITY
How do you calculate MPC from consumption function?

References

Asis Banerjee &DebashisMazumdar - Principles of Economics – ABS publishing

House.

Edward Shapiro – Macro Economic Analysis – Galgotia publication Pvt. Ltd.

Maria John Kennedy.M. - Macro Economic Theory (2013) - PHI learning Pvt. Ltd.

Siddiqui.S.A. &Siddiqui.A.S. – Introductory Macroeconomics – Laxmipublication

Pvt. Ltd.

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 CHAPTER

5 Monetary Economics

Inflation is taxation without legislation.

-Milton Friedman

Learning Objectives

1 To understand the evolution of money, types, functions, meaning of inflation,

types, causes, effects of inflation and measures to control.

2 To know the various phases of trade cycle.

5.1 services and repayment of debts and that

serves as a medium of exchange. A
Introduction medium of exchange is anything that is
widely accepted as a means of payments.
Monetary Economics is a branch
In recent years, the importance of credit
of economics that provides a framework
has increased in all the countries of the
for analyzing money and its functions as
world. Credit instruments are used on an
a medium of exchange, store of value and
extensive scale. The use of cheques, bills
unit of account. It examines the effects of
of exchange, etc. has gone up. It should
monetary systems including regulation
however, be remembered that money is
of money and associated financial
the basis of credit.
institutions.
5.2
Money

5.2.1 Meaning

Money is anything that is generally

accepted as payment for goods and

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 5.2.2 Definitions The history of Barter system starts
way back in 6000 BC
Many economists developed definition n Barter system was introduced by
for money. Among these, definitions of Mesopotamia tribes.
Walker and Crowther are given below: n Phoenicians adopted bartering of
goods with various other cities across
“ Money is, what money does”
oceans.
- Walker. n Babyloninan’s also developed an
“Money can be anything that is improved barter system, where goods
generally acceptable as a means of exchange were exchanged for goods.
and at the same time acts as a measure and
Metallic Standard
a store of value”.
–Crowther

5.2.3 Evolution of Money

Barter System
The introduction of money as a
medium of exchange was one of the
greatest inventions of mankind. Before After the barter system and
money was invented, exchange took commodity money system, modern money
place by Barter, that is, commodities systems evolved. Among these, metallic
and services were directly exchanged for standard is the premier one. Under
other commodities and services. Under metallic standard, some kind of metal
the barter system, buyers and sellers of either gold or silver is used to determine
commodities had to face a number of the standard value of the money and
difficulties. Surplus goods were exchanged currency. Standard coins made out of the
for money which in turn was exchanged metal are the principal coins used under
for other needed goods. Goods like furs, the metallic standard. These standard
skins, salt, rice, wheat, utensils, weapons, coins are full bodied or full weighted legal
etc. were commonly used as money. Such tender. Their face value is equal to their
exchange of goods for goods was known intrinsic metal value.
as “Barter Exchange” or “Barter System”.
Gold Standard

BARTER SYSTEM

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 Gold Standard is a system in which not convertible into any metal. Its value
the value of the monetary unit or the is determined independent of the value
standard currency is directly linked with of gold or any other commodity. The
gold. The monetary unit is defined in paper standard is also known as managed
terms of a certain weight of gold. The currency standard. The quantity of money
purchasing power of a unit of money is in circulation is controlled by the monetary
maintained equal to the value of a fixed authority to maintain price stability.
weight of gold.
Plastic Money
Silver Standard

The silver standard is a monetary The latest type of money is plastic

system in which the standard economic money. Plastic money is one of the most
unit of account is a fixed weight of evolved forms of financial products.
silver. The silver standard is a monetary Plastic money is an alternative to the cash
arrangement in which a country’s or the standard “money”. Plastic money
Government allows conversion of its is a term that is used predominantly in
currency into fixed amount of silver. reference to the hard plastic cards used
every day in place of actual bank notes.
Paper Currency Standard Plastic money can come in many different
forms such as Cash cards, Credit cards,
Debit cards, Pre-paid Cash cards, Store
cards, Forex cards and Smart cards. They
aim at removing the need for carrying
cash to make transactions.

Crypto Currency

The paper currency standard refers

to the monetary system in which the paper
currency notes issued by the Treasury
or the Central Bank or both circulate as
unlimited legal tender. Paper currency is

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 A digital currency in which Personal Wealth that is beyond restriction
encryption techniques are used to regulate and confiscation.
the generation of units of currency and
verify the transfer of funds, operating
5.2.4 Functions of Money
independently of a Central Bank.
Decentralised crypto currencies The main functions of money can be
such as Bitcoin now provide an outlet for classified into four categories:

Functions of Money

Primary Functions Secondary Functions Contingent Functions Other functions

1.Primary Functions: ii) Money as a measure of value: The

second important function of money is
that it measures the value of goods and
services. In other words, the prices of
all goods and services are expressed in
Medium of Store of Value terms of money. Money is thus looked
exchange upon as a collective measure of value.
Since all the values are expressed in
terms of money, it is easier to determine
the rate of exchange between various
types of goods in the community.

Measure of value Standard of 2.Secondary Functions

deferred payments
i) Money as a Store of value: Savings
i) Money as a medium of exchange: This done in terms of commodities were
is considered as the basic function of not permanent. But, with the invention
money. Money has the quality of general of money, this difficulty has now
acceptability, and all exchanges take disappeared and savings are now done
place in terms of money. On account of in terms of money. Money also serves as
the use of money, the transaction has an excellent store of wealth, as it can be
now come to be divided into two parts. easily converted into other marketable
First, money is obtained through sale of assets, such as, land, machinery, plant
goods or services. This is known as sale. etc.
Later, money is obtained to buy goods
and services. This is known as purchase. ii) Money as a Standard of Deferred
Thus, in the modern exchange system Payments: Borrowing and lending were
money acts as the intermediary in sales difficult problems under the barter
and purchases. system. In the absence of money, the

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 borrowed amount could be returned commodities in such a manner as to
only in terms of goods and services. equalize marginal utilities accruing
But the modern money-economy has from them. Now in equalizing these
greatly facilitated the borrowing and marginal utilities, money plays an
lending processes. In other words, important role, because the prices
money now acts as the standard of of all commodities are expressed in
deferred payments. money. Money also helps to equalize
marginal productivities of various
iii) M
 oney as a Means of Transferring factors of production.
Purchasing Power: The field of
exchange also went on extending with iv) 
Money Increases Productivity of
growing economic development. The Capital: Money is the most liquid
exchange of goods is now extended form of capital. In other words, capital
to distant lands. It is therefore, felt in the form of money can be put to any
necessary to transfer purchasing power use. It is on account of this liquidity of
from one place to another. money that capital can be transferred
from the less productive to the more
3.Contingent Functions productive uses.

i) Basis of the Credit System: Money is 4.Other Functions

the basis of the Credit System. Business
i) Money helps to maintain Repayment
transactions are either in cash or on
Capacity: Money possesses the quality
credit. For example, a depositor can
of general acceptability. To maintain its
make use of cheques only when there
repayment capacity, every firm has to
are sufficient funds in his account. The
keep assets in the form of liquid cash.
commercial bankscreate credit on the
The firm ensures its repayment capacity
basis of adequate cash reserves. But,
with money. Likewise, banks, insurance
money is at the back of all credit.
companies and even governments have
ii) 
Money facilitates distribution to keep some liquid money (i.e., cash)to
of National Income: The task of maintain their repayment capacity.
distribution of national income was ii) 
Money represents Generalized
exceedingly complex under the barter Purchasing Power: Purchasing power
system. But the invention of money kept in terms of money can be put to
has now facilitated the distribution any use. It is not necessary that money
of income as rent, wage, interest and should be used only for the purpose for
profit. which it has been served.
iii) 
Money gives liquidity to Capital:
iii) Money helps to Equalize Marginal
Money is the most liquid form of
Utilities and Marginal Productivities:
capital. It can be put to any use.
Consumer can obtain maximum utility
only if he incurs expenditure on various

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 5.3 M4 = M
 3 + Total deposits with Post offices.

Supply of Money M1 and M2 are known as narrow money

M3 and M4 are known as broad money
Money supply means the total The gradations are in decreasing
amount of money in an economy. It order of liquidity.
refers to the amount of money which is
in circulation in an economy at any given Currency Symbol
time. Money supply plays a crucial role
in the determination of price level and The new symbol designed by
interest rates. Money supply viewed at a D.Udaya Kumar, a post graduate of
given point of time is a stock and over a IIT Bombay was finally selected by
period of time it is a flow. the Union cabinet on 15th July, 2010.
The new symbol, is an amalgamation
Meaning of Money Supply of Devanagri ‘Ra’ and the Roman ‘R’
without the stem. The symbol of India
rupee came into use on 15thJuly,2010.
After America, Britain, Japan, Europe
Union. India is the 5th country to accept
a unique currency symbol.
Determinants of Money Supply

In India, currency notes are issued by 1. 

Currency Deposit Ratio (CDR); It is
the Reserve Bank of India (RBI) and coins the ratio of money held by the public
are issued by the Ministry of Finance, in currency to that they hold in bank
Government of India (GOI). Besides deposits.
these, the balance is savings, or current
account deposits, held by the public in 2. Reserve deposit Ratio (RDR); Reserve
commercial banks is also considered Money consists of two things (a) vault
money. The currency notes are also called cash in banks and (b) deposits of
fiat money and legal tenders. commercial banks with RBI.

Money supply is a stock variable. 3. 

Cash Reserve Ratio (CRR); It is the
RBI publishes information for four fraction of the deposits the banks must
alternative measures of Money supply, keep with RBI.
namely M1,M2,M3 and M4.
4. Statutory Liquidity Ratio (SLR); It is the
M1 = Currency, coins and demand deposits fraction of the total demand and time
M2 = M
 1 + Savings deposits with post deposits of the commercial banks in the
office savings banks form of specified liquid assests.

M3 = M
 2 + Time deposits of all commercial
and cooperative banks
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 5.4 Fisher points out that in a country
during any given period of time, the total
Quantity Theories

quantity of money (MV) will be equal to
of Money
the total value of all goods and services
Quantity theories bought and sold (PT).
of money explain the MV = PT
relationship between
quantity of money and Supply of Money = Demand for Money
value of money. Here, we
This equation is referred to as “Cash
are given two approaches
Transaction Equation”.
of Quantity Theory of
Irving Fisher It is expressed as P = MV / T
Money, viz. Fisher’s
Transaction Approach and Cambridge which implies that the quantity of money
Cash Balance Approach. determines the price level and the price
level in its turn varies directly with the
(a) Fisher’s Quantity quantity of money, provided ‘V’ and ‘T’
Theory of Money: remain constant.
The quantity theory
of money is a very The above equation considers only
old theory. It was first currency money. But, in a modern
propounded in 1588 economy, bank’s demand deposits or
by an Italian economist, Davanzatti. credit money and its velocity play a vital
But, the credit for popularizing this part in business. Therefore, Fisher
theory in recent years rightly belongs to extended his original equation of exchange
the well-known American economist, to include bank deposits M1 and its
Irving Fisher who published his book, velocity V1. The revised equation was:
‘The Purchasing Power of Money” in
1911.He gave it a quantitative form PT = MV + M1V1
in terms of his famous “Equation of
P = MV + M1V1
Exchange”.
T

The general form of equation given

by Fisher is From the revised equation, it is evident,
that the price level is determined by
MV = PT
(a) the quantity of money in circulation ‘M’
Where M = Money Supply/quantity (b) the velocity of circulation of money ‘V’
of Money (c) the volume of bank credit money M1
V = Velocity of Money (d) the velocity of circulation of credit
money V1 and the volume of trade (T)
P = Price level
T = Volume of Transaction.

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 Diagrammatic Illustration money is OI / P. But with the doubling of
the quantity of money to OM2 , the value
y P=f (M)
of money becomes one-half of what it was
P4 before, (OI / P2). But, with the quantity
of money increasing by four-fold to OM4,
Price Level

the value of money is reduced by OI /

P2 (A)
P4. This inverse relationship between the
P quantity of money and the value of money
is shown by downward sloping curve
0 IO / P = f(M).
M M2 M4 x
b) 
Cambridge Approach (Cash Balances
y Approach)

I/P i) Marshall’s Equation

Value of Money

(B)
The Marshall equation is expressed as:
I/P2 M = KPY
I/P4 Where
I/P=f (M)
0 M M2 M4 M is the quantity of money
x
Quantity of Money  is the aggregate real income of the
Y
Figure 5.1 community
P is Purchasing Power of money
Figure (A) shows the effect of changes
in the quantity of money on the price K represents the fraction of the real
level. When the quantity of money is OM, income which the public desires to hold in
the price level is OP. When the quantity of the form of money.
money is doubled to OM2 , the price level Thus, the price level P = M/KY or the
is also doubled to OP2 . Further, when the value of money (The reciprocal of price
quantity of money is increased four-fold level) is 1/P = KY/M
to OM4 , the price level also increases by
four times to OP4 . This relationship is The value of money in terms of this
expressed by the curve OP = f (M) from equation can be found out by dividing the
the origin at 450. total quantity of goods which the public
desires to holdout of the total income by
Figure (B), shows the inverse relation the total supply of money.
between the quantity of money and the
value of money, where the value of money According to Marshall’s equation,
is taken on the vertical axis. When the the value of money is influenced not only
quantity of money is OM, the value of by changes in M, but also by changes in K.

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 ii) Keynes’ Equation In this extended equation also,
Keynes assumes that, k, k' and r are
Keynes equation is expressed as:
constant. In this situation, price level (P)
n = pk (or) p=n/k is changed directly and proportionately
changing in money volume (n).
Where
5.5
n is the total supply of money
Inflation
p
 is the general price level of
consumption goods Both inflation and deflations are
 is the total quantity of consumption
k evils of economy. So, understanding of
units the people decide to keep in the these is essential.
form of cash,
5.5.1 Meaning of Inflation
Keynes indicates that K is a real
balance, because it is measured in terms Inflation is a consistent and
of consumer goods. appreciable rise in the general price level.
According to Keynes, peoples’ In other words, inflation is the rate at
desire to hold money is unaltered by which the general level of prices for goods
monetary authority. So, price level and and services is rising and consequently
value of money can be stabilized through the purchasing power of currency is
regulating quantity of money (n) by the falling.
monetary authority.

Later, Keynes extended his equation

in the following form:
n = p (k + rk') or p = n/(k + rk')
Where,
n = total money supply
p = price level of consumer goods
k
 = peoples' desire to hold money in Definitions
hand (in terms of consumer goods) “ Too much of Money chasing too few
in the total income of them goods”
- Coulbourn
r = cash reserve ratio
“A state of abnormal decrease in the
 ' = community’s total money deposit
k quantity of purchasing power”
in banks, in terms of consumers
- Gregorye
goods.

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 iv) Galloping inflation: Galloping
5.5.2 Types of Inflation
inflation or hyper inflation points out
to unmanageably high inflation rates
On the basis of speed
that run into two or three digits. By
y high inflation the percentage of the
100 same is almost 20% to 100% from an
90
D
overall perspective.
Percentage of price - Rise

80
70
C The first hyper inflation of the 21st
60
n

50 century Zimbabwe’s annual inflation

t io

on B
ati
fla

40 fl rate surged to an unprecendented 3714

In

In
ing
er

on A
flati
p

30 n n percent at the end of April 2007.

Hy

Ru lking In
20 Wa ation
e pi n g Infl
10 Cre
0 1 2 3 4 5 6 7 8 9 10 x Demand-Pull Vs Cost-Push inflation
Year
Figure 5.2 i) Demand-Pull Inflation: Demand and
supply play a crucial role in deciding the
(i) Creeping inflation (ii) Walking inflation levels in the society at all points
inflation (iii) Running inflation and (iv) of time. For instance, if the demand is
Galloping inflation or Hyper inflation. high for a product and supply is low, the
price of the products increases.
The four types of inflation are
indicated in Figure-5.2.
Demand Pull Inflation
i) Creeping Inflation: Creeping inflation Too much of money chasing too few goods
is slow-moving and very mild. The rise
in prices will not be perceptible but
spread over a long period. This type of
inflation is in no way dangerous to the
economy. This is also known as mild
inflation or moderate inflation.
ii) Cost-Push Inflation: When the cost
ii) Walking Inflation: When prices rise of raw materials and other inputs rises
moderately and the annual inflation inflation results. Increase in wages paid
rate is a single digit ( 3% - 9%), it is to labour also leads to inflation.
called walking or trolling inflation.
Wage-Price Spiral
iii) Running Inflation: When prices rise
rapidly like the running of a horse at a Wage-price spiral is used to explain
rate of speed of 10% - 20% per annum, the cause and effect relationship between
it is called running inflation. rising wages and rising prices or inflation.

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 Other types of inflation (on the basis of aggregate demand. The higher the
inducement) growth rate of the nominal money
supply, the higher is the rate of inflation.
i) Currency inflation: The excess supply
of money in circulation causes rise in ii) Increase in Disposable Income: When
price level. the disposable income of the people
increases, it raises their demand for
ii) Credit inflation: When banks are goods and services. Disposable income
liberal in lending credit, the money may increase with the rise in national
supply increases and thereby rising income or reduction in taxes or
prices. reduction in the saving of the people.

iii) Deficit induced inflation: The deficit iii) 

Increase in Public Expenditure:
budget is generally financed through Government activities have been
printing of currency by the Central expanding due to developmental activities
Bank. As a result, prices rise. and social welfare programmes. This is
also a cause for price rise.
iv) Profit induced inflation: When the
firms aim at higher profit, they fix the iv) 
Increase in Consumer Spending:
price with higher margin. So prices go The demand for goods and services
up. increases when they are given credit
to buy goods on hire-purchase and
v) 
S carcity induced inflation: Scarcity installment basis.
of goods happens either due to fall in
production (eg. farm goods) or due to v) C heap Money Policy: Cheap money
hoarding and black marketing. This policy or the policy of credit expansion
also pushes up the price. (This has also leads to increase in the money
happened is Venezula in the year 2018) supply which raises the demand for
goods and services in the economy.
vi) 
Tax induced inflation: Increase in
indirect taxes like excise duty, custom vi) Deficit Financing: In order to meet its
duty and sales tax may lead to rise in mounting expenses, the government
price (eg. petrol and diesel). This is resorts to deficit financing by
also called taxflation. borrowing from the public and even
by printing more notes. This raises
5.5.3 Causes of Inflation aggregate demand in relation to
aggregate supply, thereby leading to
The main causes of inflation in India inflationary rise in prices.
are as follows:
vii) Black Assests, Activities and Money:
i) Increase in Money Supply: Inflation The existence of black money and
is caused by an increase in the supply black assests due to corruption, tax
of money which leads to increase in evasion etc., increase the aggregate
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 demand. People spend such money, ii) When the value of money undergoes
lavishly. Black marketing and considerable depreciation, this may
hoarding reduces the supply of goods. even drain out the foreign capital
These trends tend to raise the price already invested in the country.
level further.
iii) With reduced capital accumulation,
viii) 
Repayment of Public Debt: the investment will suffer a serious
Whenever the government repays set-back which may have an adverse
its past internal debt tothe public, it effect on the volume of production
leads to increase in the money supply in the country. This may discourage
with the public. This tends to raise entrepreneurs and business men from
the aggregate demand for goods and taking business risk.
services.
iv) 
Inflation also leads to hoarding of
ix) Increase in Exports: When exports are essential goods both by the traders as
encouraged, domestic supply of goods well as the consumers and thus leading
decline. So prices rise. to still higher inflation rate.

v) 
Inflation encourages investment in
5.5.4 Effects of Inflation speculative activities rather than
productive purposes.
The effects of inflation can be classified
into two heads: 2. Effects on Distribution

(1) Effects on Production and i) 

Debtors and Creditors: During
inflation, debtors are the gainers while
(2) Effects on Distribution.
the creditors are losers. The reason is
1. Effects on Production: that the debtors had borrowed when
the purchasing power of money was
When the inflation is very moderate, high and now repay the loans when the
it acts as an incentive to traders and purchasing power of money is low due
producers. This is particularly prior to full to rising prices.
employment when resources are not fully
utilized. The profit due to rising prices ii) Fixed-income Groups: The fixed
encourages and induces business class to income groups are the worst hit during
increase their investments in production, inflation because their incomes being
leading to generation of employment and fixed do not bear any relationship with
income. the rising cost of living. Examples are
wage, salary, pension, interest, rent etc.
i) However, hyper-inflation results in a
serious depreciation of the value of iii) Entrepreneurs: Inflation is the boon
money and it discourages savings on to the entrepreneurs whether they are
the part of the public. manufacturers, traders, merchants
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 or businessmen, because it serves as 3. Other Measures: These measures can
a tonic for business enterprise. They be divided broadly into short-term and
experience windfall gains as the prices long-term measures.
of their inventories (stocks) suddenly
go up. i) Short-term measures can be in regard
to public distribution of scarce essential
iv. Investors: The investors, who generally commodities through fair price
invest in fixed interest yielding bonds shops (Rationing). In India whenever
and securities have much to lose during shortage of basic goods has been felt,
inflation. On the contrary those who the government has resorted to import
invest in shares stand to gain by rich so that inflation may not get triggered.
dividends and appreciation in value of
shares. ii) L ong-term measures will require
accelerating economic growth
especially of the wage goods which
5.5.5 Measures to Control Inflation
have a direct bearing on the general
Keynes and Milton Friedman price and the cost of living. Some
together suggested three measures to restrictions on present consumption
prevent and control of inflation. may help in improving saving and
investment which may be necessary
( 1) Monetary measures, for accelerating the rate of economic
(2) Fiscal measures (J.M. Keynes) and growth in the long run.
(3) Other measures.
5.6
1. Monetary Measures: These measures  eaning of Deflation,
M
are adopted by the Central Bank of Disinflation and Stagflation
the country. They are (i) Increase
in Bankrate (ii) Sale of Government Deflation: The essential feature of
Securities in the Open Market (iii) deflation is falling prices, reduced money
Higher Cash Reserve Ratio (CRR) supply and unemployment. Though
and Statutory Liquidity Ratio (SLR) falling prices are desirable at the time
(iv) Consumer Credit Control and of inflation, such a fall should not lead
(v) Higher margin requirements (vi) to the fall in the level of production and
Higher Repo Rate and Reverse Repo employment. But if prices fall from the
Rate. level of full employment both income and
employment will be adversely affected.
2. Fiscal Measures: Fiscal policy is now
recognized as an important instrument Disinflation: Disinflation is the slowing
to tackle an inflationary situation. down the rate of inflation by controlling
The major anti-inflationary fiscal the amount of credit (bank loan, hire
measures are the following: Reduction purchase) available to consumers without
of Government Expenditure, Public causing more unemployment. Disinflation
Borrowing and Enhancing taxation. may be defined as the process of reversing
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 inflation without creating unemployment Phases of Trade Cycle
or reducing output in the economy.
The Economic Cycle
Stagflation: Stagflation is a combination y Boom
of stagnant economic growth, high Boom Prosperity
unemployment and high inflation. Prosperity Trend

Level of real output

5.7 th
Grow

y
ver
Re
ce
Trade Cycle

co
ssi

y
ver
Re on

Re
ce

co
ssi
on

Re
Depression
The economic activity in a capitalist Depression
economy will have its periodic ups and
downs. The study of these ups and downs 0 Time x
Figure 5.3
is called the study of Business cycle or
Trade cycle or Industrial Fluctuation. i) Boom or Prosperity Phase: The full
employment and the movement of the
5.7.1 Meaning of Trade Cycle economy beyond full employment is
characterized as boom period. During
A Trade cycle refers to oscillations this period, there is hectic activity in
in aggregate economic activity particularly economy. Money wages rise, profits
in employment, output, income, etc. It increase and interest rates go up. The
is due to the inherent contraction and demand for bank credit increases and
expansion of the elements which energize there is all-round optimism.
the economic activities of the nation. The
fluctuations are periodical, differing in ii) Recession: The turning point from
intensity and changing in its coverage. boom condition is called recession.
This happens at higher rate, than what
Definition was earlier. Generally, the failure of a
“A trade cycle is composed of company or bank bursts the boom and
periods of good trade characterised by brings a phase of recession. Investments
rising prices and low unemployment are drastically reduced, production
percentages altering with periods of bad comes down and income and profits
trade characterised by falling prices and decline. There is panic in the stock
high unemployment percentages”. market and business activities show
signs of dullness. Liquidity preference
- J.M. Keynes
of the people rises and money market
becomes tight.
5.7.2 Phases of Trade Cycle
iii) Depression: During depression the
The four different phases of trade cycle
level of economic activity becomes
is referred to as (i) Boom (ii) Recession
extremely low. Firms incur losses and
(iii) Depression and (iv) Recovery. These
closure of business becomes a common
are illustrated in the Figure 5.3.
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 feature and the ultimate result is
Glossary
unemployment. Interest prices, profits
and wages are low. The agricultural n B
arter : The exchange of one good for
class and wage earners would be another without the use of money.
worst hit. Banking institutions will
be reluctant to advance loans to n M
oney : An asset that is generally
businessmen. Depression is the worst acceptable as a medium of exchange
phase of the business cycle. Extreme
n S
upply of Money : It refers to the
point of depression is called as “trough”,
amount of money which is in circulation
because it is a deep point in business
in an economy at any given time
cycle. Any person fell down in deeps
could not come out from that without n I
nflation : An increase in average level
other’s help. Similarly, an economy of prices
fell down in trough could not come
out from this without external help. n D
eflation : A fall in average level of
Keynes advocated that autonomous prices, the opposite of inflation
investment of the government alone
n D
isinflation : Process of reversing
can help the economy to come out
inflation without generating adverse
from the depression.
effects.
iv. Recovery: After a period of depression,
n S
tagflation : The co-existence of a high
recovery sets in. This is the turning
rate of unemployment and inflation.
point from depression to revival
(derived from stag(nation) and (in)
towards upswing. It begins with the
flation).
revival of demand for capital goods.
Autonomous investments boost the n T
rade Cycle : The more or less regular
activity. The demand slowly picks upward and downward movement
up and in due course the activity is of economic activity over a period of
directed towards the upswing with years.
more production, profit, income, wages
and employment. Recovery may be n R
ecovery : An increase in business
initiated by innovation or investment activities after the lowest point, (i.e.
or by government expenditure depression.)
(autonomous investment).
n N
arrow money : M1 and M2 are
Summary is narrow money as they includes
currency plus demand deposits in
Currency is created by the RBI and banks and other deposits.
Union Government. Bank deposits are
created by Commercial Banks and Co-
operative Banks. The demand for money
is determined by a number of factors such
as income, price level, interest rate etc.
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 MODEL QUESTIONS
Part-A

Multiple Choice Questions

 he RBI Headquarters is located at

1. T 6. MV stands for
(a) Delhi (a) demand for money
(b) Chennai (b) supply of legal tender money
(c) Mumbai (c) Supply of bank money
(d) Bengaluru (d) Total supply of money

2. Money is 7. Inflation means

(a) acceptable only when it has intrinsic (a) Prices are rising
value (b) Prices are falling
(b) constant in purchasing power (c) Value of money is increasing
(c) the most liquid of all assets (d) Prices are remaining the same
(d) needed for allocation of resources
8. __________ inflation results in a serious
3. Paper currency system is managed by depreciation of the value of money.
the
(a) Creeping
(a) Central Monetary authority (b) Walking
(b) State Government (c) running
(c) Central Government (d) Hyper
(d) Banks
9. 
__________ inflation occurs when
4. The basic distinction between M1 and general prices of commodities increases
M2 is with regard to . due to increase in production costs
such as wages and raw materials.
(a) post office total deposits
(b) 
saving deposits with post office
(a) Cost-push
savings bank
(b) demand pull
(c) Terms deposits of banks
(c) running
(d) currency
(d) galloping
5. 
Irving Fisher’s Quantity Theory of
10. During inflation, who are the gainers?
Money was popularized in
(a) Debtors
(a) 1908
(b) Creditors
(b) 1910
(c) Wage and salary earners
(c) 1911
(d) Government
(d) 1914.

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 11. ____________ is a decrease in the rate 16. Debit card is an example of
of inflation.
(a) currency
(a) Disinflation (b) paper currency
(b) Deflation (c) plastic money
(c) Stagflation (d) money
(d) Depression
17.Fisher’s Quantity Theory of money
12. 
Stagflation combines the rate of is based on the essential function of
inflation with money as
(a) Stagnation (a) measure of value
(b) employment (b5) store of value
(c) output (c) medium of exchange
(d) price (d) standard of deferred payment

13. The study of alternating fluctuations 18. V in MV = PT equation stands for

in business activity is referred to in
(a) Volume of trade
Economics as
(b) Velocity of circulation of money
(a) Boom (c) Volume of transaction
(b) Recession (d) Volume of bank and credit money
(c) Recovery
(d) Trade cycle 19. When prices rise slowly, we call it
(a) galloping inflation
14. 
During depression the level of
economic activity becomes extremely (b) mild inflation
(c) hyper inflation
(a) high
(d) deflation
(b) bad
(c) low 20. ___________ inflation is in no way
(d) good dangerous to the economy.

15.“Money can be anything that is (a) walking

generally acceptable as a means of (b) running
exchange and that thesame time acts (c) creeping
as a measure and a store of value”, This (d) galloping
definition was given by
(a) Crowther
(b) A.C.Pigou
(c) F.A.Walker
(d) Francis Bacon
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 Answers

1 2 3 4 5 6 7 8 9 10
c c a b c b a d a a
11 12 13 14 15 16 17 18 19 20
a a d c a c c b b c

Part – B
Answer the following questions in one or two sentences.

21. Define Money.

22. What is barter?
23. What is commodity money?
24. What is gold standard?
25. What is plastic money? Give example.
26. Define inflation.
27. What is Stagflation?

Part – C

Answer the following questions in one paragraph.

28. Write a note on metallic money.

29. What is money supply?
30. What are the determinants of money supply?
31. Write the types of inflation.
32. Explain Demand-pull and Cost push inflation.
33. State Cambridge equations of value of money.
34. Explain disinflation.

Part – D

Answer the following questions in about a page

35. Illustrate Fisher’s Quantity theory of money.

36. Explain the functions of money.
37. What are the causes and effects of inflation on the economy?
38. Describe the phases of Trade cycle.

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 ACTIVITY
1. Ask the students to visit anyone of the public sector or private
sector nationalized banks to know the types of savings such
as current account deposits, savings deposits, fixed deposits,
interest rate and facilities.
2. Make the students to collect ancient period coins, currency
notes and also Indian and foreign countries coins and currency
notes.

References

1. Ahuja, H L, (2010),”Modern Economics”, 15th Revised Edition, S. Chand & Company

Ltd., New Delhi.

2. Gaurav Datt & Ashwani Mahajan (2018), “Indian Economy”, S.Chand and Company
Limited, New Delhi – 110055

3. 
Gupta R.D. (1984), “Keynes Post – Keynesian Economics”, Kalyani Publishers,
Ludhiana – 8.

4. Jhingan M.L. (2008), “Monetary Economics”, Vrinda Publication (P) Ltd., Delhi-32.

5. Sankaran S. (2018), “Macro Economics”, Margham Publications, Chennai – 17.

6. Seth M.L. (2012), “Monetary Economics”, Lakshmi Narayani Agarwal Publication,

Agra.

7. Sudesh kumar 92009), Dictionary of Economics, Sahni Publications, New Delhi – 7.

8. Sundaram K.P.M. (2011), “Money, Banking,Trade and Finance”. Sultan Chand & Sons
Publishers, New Delhi – 2.N

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 CHAPTER

6 Banking

“Commercial Banks are the institutions that make short term loans to
business and in the process create Money’.’
- Culbertson

Learning Objectives

1 To know about the functions of central bank and commercial banks.

2 To understand the Non-Banking Financial Institutions and their functions.

6.1 6.2
Introduction Historical Development

Finance is the life blood of all The Ricks Banks of Sweden, which
economic activities such as trade, had sprung from a private bank established
commerce, agriculture and industry. in 1656 is the oldest central bank in the
A bank is generally understood as an world. It acquired the sole right of note
institution which provides fundamental issue in 1897. But the fundamentals of the
financial services such as accepting art of banking have been developed by the
deposits and lending loans. Banking sector Bank of England (1864) as the first bank
acts as the backbone of modern business of issues.
world. The banking system significantly
contributes for the development of any A large number of central banks
country. Due to the importance in the were established between 1921 and 1954
financial stability of a country, banks are in compliance with the resolution passed
highly regulated in most countries. by the International Finance Conference
held at Brussels in 1920. The South African

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 Reserve Bank (1921), the Central Bank of India (1935), the Central Bank of Ceylon
China (1928), The Reserve Bank of (1950) and the Bank of Israel (1954) were
New Zealand (1934), The Reserve Bank of established.

History Of Indian BANKS

 The first bank of India was Bank of Hindustan (1770) {Under British Rule}
 The Banking system in India was controlled and dominated by the Presidency
Banks.
There were three Presidency Banks:

{ }
1. Bank of Bengal (1809)
They were called
2. Bank of Bombay (1840) Presidential Banks
3. Bank of Madras (1843)

All Merged (1921) Change into (1955)

IMPERIAL BANK OF INDIA SBI

6.3 6.3.1 Functions of Commercial Banks:

Commercial banks Commercial banks are institutions

that conduct business with profit motive
Commercial bank refers to a bank, by accepting public deposits and lending
or a division of a large bank, which more loans for various investment purposes.
specifically deals with deposit and loan
services provided to corporations or large/ The functions of commercial banks are
middle-sized business - as opposed to broadly classified into primary functions
individual members of the public/small and secondary functions, which are
business. They do not provide, long-term shown in the picture
credit, as liquidity of assets is to be
maintained. Functions of
Commercial Banks

Primary Secondary Other

functions Functions Functions

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 tio ry
Fu mary

Fu onda
ns

ns
tio

Sec
nc

nc
i
Pr

po g

loa ng

Ser ency

Ser tility

fun of

eat t
Cr redi
De ptin
sits

ns

es

es

ds

ion
ci

er
vic

vic
van

nsf
al U
Ag

C
ce
Ac

Tra
Ad

ner
Ge
Functions of Commercial Banks 2. Advancing Loans

(a) Primary Functions: It refers to granting loans to

individuals and businesses. Commercial
1. Accepting Deposits banks grant loans in the form of overdraft,
cash credit, and discounting bills of
It implies that commercial banks are exchange.
mainly dependent on public deposits.
(b) Secondary Functions
There are two types of deposits, which
are discussed as follows The secondary functions can be
classified under three heads, namely,
(i) Demand Deposits agency functions, general utility functions,
It refers to deposits that can be and other functions.
withdrawn by individuals without any
prior notice to the bank. In other words, 1. Agency Functions: It implies that
the owners of these deposits are allowed commercial banks act as agents of
to withdraw money anytime by writing a customers by performing various
withdrawal slip or a cheque at the bank functions.
counter or from ATM centres using debit
(i) Collecting Cheques
card.
Banks collect cheques and bills of
(ii) Time Deposits exchange on the behalf of their customers
It refers to deposits that are made through clearing house facilities provided
for certain committed period of time. by the central bank.
Banks pay higher interest on time deposits.
(ii) Collecting Income
These deposits can be withdrawn only
after a specific time period by providing a Commercial banks collect dividends,
written notice to the bank. pension, salaries, rents, and interests on
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 investments on behalf of their customers. 3. Transferring Funds
A credit voucher is sent to customers for
It refers to transferring of funds from
information when any income is collected
one bank to another. Funds are transferred
by the bank.
by means of draft, telephonic transfer, and
(iii) Paying Expenses electronic transfer.

Commercial banks make the 4. Letter of Credit

payments of various obligations of Commercial banks issue letters of
customers, such as telephone bills, credit to their customers to certify their
insurance premium, school fees, and rents. creditworthiness.
Similar to credit voucher, a debit voucher
is sent to customers for information when (i) Underwriting Securities
expenses are paid by the bank.
Commercial banks also undertake
(2) G eneral Utility Functions: It implies the task of underwriting securities. As
that commercial banks provide public has full faith in the creditworthiness
some utility services to customers by of banks, public do not hesitate in buying
performing various functions. the securities underwritten by banks.

(ii) Electronic Banking

(i) Providing Locker Facilities
It includes services, such as debit
Commercial banks provide locker
cards, credit cards, and Internet banking.
facilities to its customers for safe custody
of jewellery, shares, debentures, and other (C) Other Functions:
valuable items. This minimizes the risk of
loss due to theft at homes. Banks are not (i) Money Supply
responsible for the items in the lockers. It refers to one of the important
(ii) Issuing Traveler’s Cheques functions of commercial banks that help
in increasing money supply. For instance,
Banks issue traveler’s cheques to a bank lends �5 lakh to an individual and
individuals for traveling outside the opens a demand deposit in the name of
country. Traveler’s cheques are the safe that individual. Bank makes a credit entry
and easy way to protect money while of �5 lakh in that account. This leads
traveling. to creation of demand deposits in that
account. The point to be noted here is that
(iii) Dealing in Foreign Exchange there is no payment in cash. Thus, without
Commercial banks help in providing printing additional money, the supply of
foreign exchange to businessmen dealing money is increased.
in exports and imports. However,
(ii) Credit Creation
commercial banks need to take the
permission of the Central Bank for dealing Credit Creation means the
in foreign exchange. multiplication of loans and advances.
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 Commercial banks receive deposits from book debt in his name called a deposit, it
the public and use these deposits to give is known as a “primary deposit’. But when
loans. However, loans offered are many such a deposit is created, without there
times more than the deposits received by being any prior payment of equivalent
banks. This function of banks is known as cash to the bank, it is called a ‘derived
‘Credit Creation’. deposit’.

(iii) Collection of Statistics: Primary Deposits

Banks collect and publish statistics  It is out of these primary deposits that
relating to trade, commerce and industry. the bank makes loans and advances to
Hence, they advice customers and the its customers.
public authorities on financial matters.  The initiative is taken by the customers
themselves. In this case, the role of
6.3.2. Mechanism / Technique of Credit the bank is passive.
Creation by Commercial Banks S o these deposits are also called
 
Bank credit refers to bank loans and “Passive deposits”.
advances. Money is said to be created when
the banks, through their lending activities, Credit Creation literally means the
make a net addition to the total supply of multiplication of loans and advances.
money in the economy. Likewise, money Every loan creates its own deposits.
is said to be destroyed when the loans are Central Bank insists the banks to maintain
repaid by the borrowers to the banks and a ratio between the total deposits they
consequently the credit already created by create and the cash in their possession.
the banks is wiped out in the process. For the purpose of understanding,
it is assumed that all banks are obliged
Banks have the power to expand
to keep the ratio between cash and its
or contract demand deposits and they
deposits at a minimum of 20 percent.
exercise this power through granting more
or less loans and advances and acquiring 1. 
The banks do not keep any excess
other assets. This power of commercial reserves, in other words, it would
bank to create deposits through expanding exhaust possible avenues of income
their loans and advances is known as earning activities like giving loans
credit creation. etc. up to the maximum extent after
attaining the minimum cash reserves.
Primary / Passive Deposit and Derived /
2. There are no drains in the supply of
Active Deposit
money i,e., the public do not suddenly
The modern banks create deposits in want to hold more ideal currency or
two ways. They are primary deposit and withdraw from the time deposits.
derived deposit. When a customer gives Under the above assumptions, when
cash to the bank and the bank creates a a customer deposits a sum of ₹1000 in a
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 bank, the bank creates a deposit of ₹ 1000 people scattered over a wide area through
in his favor. Bank deposits (Bank Money) their network of branches all over the
have increased by ₹1000. But, at this stage, country and make it available for
there is no increase in the total supply of productive purposes.
money with the public, because the above 1. Capital Formation
extra bank money of ₹1000 is offset by the
2. Creation of Credit
cash of ₹1000 deposited in the bank.

Role of Commercial
3. Channelizing the funds
The bank has now additional cash of 4. Encouraging Rights Type of Industries

Banks
₹1000 in its custody. Since it is required 5. Banks Monetize Debt
to keep only a cash reserve of 20 per
6. Finance to Government
cent, this means that ₹ 800 is excess cash
7. Employment Generation
reserve with it. According to the above
assumption, the bank should lend out 8. Bank Promote Entrepreneurship

this ₹ 800 to the public. Suppose, it does Now-a-days, banks offer very
so, and the debtor deposits the money in attractive schemes to induce the people to
his own account with another bank B, save their money with them and bring the
Bank is creating a deposit of ₹ 800. Bank savings mobilized to the organized money
B then has also excess cash reserve of market. If the banks do not perform this
₹ 640(800-160). It could, in its turn, lend function, savings either remains idle or
out ₹ 640. This ₹ 640 will, in its turn find used in creating other assets,(eg.gold)
its way with, say Bank C; it will create a which are low in scale of plan priorities.
deposit of ₹ 640and so on.
2. Creation of Credit
The total deposits will now grow into Banks create credit for the purpose
₹ 1000+800+640+…….till ultimately the of providing more funds for development
excess cash reserve peters out. It can be projects. Credit creation leads to increased
shown that when that stage is reached the production, employment, sales and prices
total of the above will be ₹ 5000. and thereby they bring about faster
Money Multiplier = 1/20% economic development.
=1/20/100=1/20x100=5
3. Channelizing the Funds towards
Credit creation is 1000x5 = ₹ 5000.
Productive Investment
6.3.3. Role of Commercial Banks in Banks invest the savings mobilized
Economic Development of a by them for productive purposes. Capital
Country formation is not the only function of
commercial banks. Pooled savings
1. Capital Formation
should be allocated to various sectors of
Banks play an important role in the economy with a view to increase the
capital formation, which is essential for productivity. Then only it can be said to
the economic development of a country. have performed an important role in the
They mobilize the small savings of the economic development.
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 4. Encouraging Right Type of Industries government of India in the year 2018-19,
this is 99% the RBI's surplus.
Many banks help in the development
of the right type of industries by extending 7. Employment Generation
loan to right type of persons. In this way,
they help not only for industrialization After the nationalization of big
of the country but also for the economic banks, banking industry has grown to a
development of the country. They grant great extent. Bank’s branches are opened
loans and advances to manufacturers frequently, which leads to the creation of
whose products are in great demand. new employment opportunities.
The manufacturers in turn increase their
products by introducing new methods of 8. Banks Promote Entrepreneurship
production and assist in raising the national In recent days, banks have assumed
income of the country. Sometimes, sub- the role of developing entrepreneurship
prime lending is also clone. That is how particularly in developing countries like
there was an economic crisis in the year India by inducing new entrepreneurs
2007-08 in the US. to take up the well-formulated projects
and provision of counseling services like
5. Banks Monetize Debt technical and managerial guidance.
Commercial banks transform the
loan to be repaid after a certain period Banks provide 100% credit for
into cash, which can be immediately used worthwhile projects, which is also
for business activities. Manufacturers and technically feasible and economically
wholesale traders cannot increase their viable. Thus commercial banks help for
sales without selling goods on credit basis. the development of entrepreneurship in
But credit sales may lead to locking up of the country.
capital. As a result, production may also
be reduced. As banks are lending money 6.4
by discounting bills of exchange, business Non-Banking Financial
concerns are able to carryout the economic Institution (NBFI)
activities without any interruption.
A non-banking financial institution
6. Finance to Government (NBFI) or non-bank financial company
(NBFC) is a financial institution that does
Government is acting as the not have a full banking license or is not
promoter of industries in underdeveloped supervised by the central bank.
countries for which finance is needed
for it. Banks provide long-term credit to The NBFIs do not carry on pure
Government by investing their funds in banking business, but they will carry on
Government securities and short-term other financial transactions. They receive
finance by purchasing Treasury Bills. deposits and give loans. They mobilize
RBI has given � 68,000 crores to the people’s savings and use the funds to

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 finance expenditure on investment rupee. It commenced its operations on 1
activities. In short, they are institutions April 1935 in accordance with the Reserve
which undertake borrowing and lending. Bank of India Act, 1934. The original
They operate in both the money and the share capital was divided into shares of
capital markets. �100 each fully paid, which were initially
owned entirely by private shareholders.
Following India’s independence on 15
August 1947, the RBI was nationalised on
1 January 1949.

NBFIs can be broadly classified into

two categories. Viz.., (1) Stock Exchange;
and (2) Other Financial institutions.
Under the latter category comes Finance
Companies, Finance Corporations,
ChitFunds, Building Societies, Issue 1. Monetary Authority: It controls
Houses, Investment Trusts and Unit Trusts the supply of money in the economy
and Insurance Companies. to stabilize exchange rate, maintain
6.5 healthy balance of payment, attain
financial stability, control inflation,
Central Bank strengthen banking system.

A central bank, reserve bank, or 2. The issuer of currency: The objective

monetary authority is an institution that is to maintain the currency and credit
manages a state’s currency, money supply, system of the country. It is the sole
and interest rates. Central banks also authority to issue currency. It also takes
usually oversee the commercial banking action to control the circulation of fake
system of their respective countries. currency.

3. The issuer of Banking License: As per

6.5.1 Functions of Central Bank (Reserve Sec 22 of Banking Regulation Act, every
Bank of India) bank has to obtain a banking license
The Reserve Bank of India (RBI) is from RBI to conduct banking business
India’s central banking institution, which in India.
controls the monetary policy of the Indian

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 RESERVE BANK OF INDIA
History: Administration: Functions:

Formed on April 1, 1935

  It is the Central Bank/
  Issues currency
 
in accordance with the RBI Regulator for all bank in Banker to the government
 
Act, 1934 India
{It collects receipts of funds
Nationalized on January 1,
  Also called “Lender of
  and makes payments on
1949 (Fully owned by GOI) Last Resort” behalf of the government}
Headquarter moved from
  Governors and 4 Deputy
  Regulator of Indian
 
Calcutta to Mumbai in 1937 Governors along with a Banking system
Osborne Smith was the first
  central board of directors Custodian of Forex
 
Governor of RBI appointed by the GOI.
C ontroller of credit
 

The process of issuing paper currency was started in the 18th century. Private
Banks such as the bank of Bengal the bank of Bombay and the Bank of Madras – first
printed paper money.

The first rupee was introduced by Sher Shah Suri based on a ratio of 40 copper
pieces (paisa) per rupee. The name was derived from the Sanskrit word Raupya, meaning
silver. Each banknote has its amount written in 17languages (English and Hindi on the
front and 15 other on the back) illustrating the diversity of the country.

4. 
Banker to the Government: It acts 7. Act as clearing house: For settlement
as banker both to the central and the of banking transactions, RBI manages
state governments. It provides short- 14 clearing houses. It facilitates the
term credit. It manages all new issues exchange of instruments and processing
of government loans, servicing the of payment instructions.
government debt outstanding and
nurturing the market for government 8. 
Custodian of foreign exchange
securities. It advises the government on reserves: It acts as a custodian of
banking and financial subjects. FOREX. It administers and enforces
the provision of Foreign Exchange
5. Banker’s Bank: RBI is the bank of all Management Act (FEMA), 1999. RBI
banks in India as it provides loan to buys and sells foreign currency to
banks, accept the deposit of banks, and maintain the exchange rate of Indian
rediscount the bills of banks. rupee v/s foreign currencies.
6. L ender of last resort: The banks can 9. Regulator of Economy: It controls the
borrow from the RBI by keeping eligible money supply in the system, monitors
securities as collateral at the time of different key indicators like GDP,
need or crisis, when there is no other Inflation, etc.
source.
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 10. 
Managing Government securities: 15. Banking Ombudsman Scheme: RBI
RBI administers investments in introduced the Banking Ombudsman
institutions when they invest specified Scheme in 1995. Under this scheme, the
minimum proportions of their total complainants can file their complaints
assets/liabilities in government in any form, including online and can
securities. also appeal to the Ombudsman against
11. Regulator and Supervisor of Payment the awards and the other decisions of
and Settlement Systems: The Payment the Banks.
and Settlement Systems Act of 2007 16. Banking Codes and Standards Board
(PSS Act) gives RBI oversight authority of India: To measure the performance
for the payment and settlement of banks against Codes and standards
systems in the country. RBI focuses on based on established global practices,
the development and functioning of the RBI has set up the Banking Codes
safe, secure and efficient payment and and Standards Board of India (BCSBI).
settlement mechanisms.
12. Developmental Role: This role 6.5.2. Credit Control
includes the development of the Measures
quality banking system in India and
ensuring that credit is available to the Credit control is the
productive sectors of the economy. It primary mechanism
provides a wide range of promotional available to the Central banks to realize
functions to support national the objectives of monetary management.
objectives. It also includes establishing The RBI is much better placed than many
institutions designed to build the of credit control. The statutory basis for
country’s financial infrastructure. the control of the credit system by the
It also helps in expanding access Reserve Bank is embodied in the Reserve
to affordable financial services and Bank of India Act, 1934 and the Banking
promoting financial education and Regulation Act, 1949.
literacy.
Credit Control Measures
13. 
Publisher of monetary data and
other data: RBI maintains and
provides all essential banking and General Selective
other economic data, formulating and (Quantitative) (Qualitative)
critically evaluating the economic 1. Bank Rate 1. R ationing of
Credit
policies in India. RBI collects, collates 2. O
 pen Market
2. Direct Action
and publishes data regularly. Operations
3. V
 ariable Cash 3. Moral suasion
14. 
E xchange manager and controller: 4. Publicity
Reserve Ratio
RBI represents India as a member 5. R egulation of
of the International Monetary Fund Consumer’ Credit
[IMF]. Most of the commercial banks 6. Marginal
Requirements
are authorized dealers of RBI.
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 harmful for the larger interest of the
6.5.3. Methods of Credit Control
economy. So it will raise the cash reserve
I. Quantitative or General Methods: ratio which the Commercial Banks are
required to maintain with the Central
1. Bank Rate Policy:
Bank.
The bank rate is the rate at which
CRR + SLR
the Central Bank of a country is prepared (When CRR rate is 6% + SLR rate is 20%)
to re-discount the first class securities. It
�1000 CRR SLR
means the bank is prepared to advance Deposit �60 + 200

loans on approved securities to its member

�740 Balance
banks. As the Central Bank is only the
lender of the last resort the bank rate is
Distribute as Individual /
normally higher than the market rate. Corporate Loan
For example: If the Central Bank wants to
control credit, it will raise the bank rate. Similarly, when the Central Bank
As a result, the deposit rate and other desires that the Commercial Banks should
lending rates in the money-market will go increase the volume of credit in order to
up. Borrowing will be discouraged, and bring about an economic revival in the
will lead to contraction of credit and vice economy. The central Bank will lower
versa. down the Cash Reserve Ratio with a view
to expand the lending capacity of the
2. Open Market Operations:
Commercial Banks.
In narrow sense, the Central Bank
starts the purchase and sale of Government Variable Cash Reserve Ratio as an
securities in the money market. objective of monetary policy was first
suggested by J.M. Keynes. It was first
In Broad Sense, the Central Bank
followed by Federal Reserve System in
purchases and sells not only Government
United States of America. The commercial
securities but also other proper eligible
banks as per the statute has to maintain
securities like bills and securities of private
reserves based on their demand deposit
concerns. When the banks and the private
and fixed deposit with central bank is
individuals purchase these securities they
called as Cash Reserve Ratio.
have to make payments for these securities
to the Central Bank.
If the CRR is high, the commercial
3. Variable Reserve Ratio: bank’s capacity to create credit will be less
a) Cash Reserves Ratio: and if the CRR is low, the commercial
bank’s capacity to create credit will be
Under this system the Central Bank
high.
controls credit by changing the Cash
Reserves Ratio. For example, if the b) Statutory Liquidity Ratio:
Commercial Banks have excessive cash
reserves on the basis of which they are Statutory Liquidity Ratio (SLR) is
creating too much of credit,this will be the amount which a bank has to maintain
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 in the form of cash, gold or approved a) 
The variable portfolio ceiling: It
securities. The quantum is specified as refers to the system by which the
some percentage of the total demand central bank fixes ceiling or maximum
and time liabilities (i.e., the liabilities of amount of loans and advances for every
the bank which are payable on demand commercial bank.
anytime, and those liabilities which are
accruing in one month’s time due to b) 
The variable capital asset ratio: It
maturity) of a bank. refers to the system by which the central
bank fixes the ratio which the capital
II. 
Qualitative or Selective Method of of the commercial bank should have to
Credit Control: the total assets of the bank.
The qualitative or the selective 2. Direct Action
methods are directed towards the diversion
of credit into particular uses or channels Direct action against the erring
in the economy. Their objective is mainly banks can take the following forms.
to control and regulate the flow of credit a) 
The central bank may refuse to
into particular industries or businesses. altogether grant discounting facilities
The following are the frequent methods of to such banks.
credit control under selective method:
b) The central bank may refuse to sanction
1. Rationing of Credit further financial accommodation to
a bank whose existing borrowing are
2. Direct Action
found to be in excess of its capital and
3. Moral Persuasion reserves.
4. Method of Publicity c) The central bank may start charging
penal rate of interest on money borrowed
5. Regulation of Consumer’s Credit
by a bank beyond the prescribed limit.
6. R
 egulating the Marginal
Requirements on Security Loans 3. Moral Suasion
This method is frequently adopted
1. Rationing of Credit by the Central Bank to exercise control
This is the oldest method of over the Commercial Banks. Under this
credit control. Rationing of credit as an method Central Bank gives advice, then
instrument of credit control was first requests. and persuades the Commercial
used by the Bank of England by the end Banks to co-operate with the Central Bank
of the 18th Century. It aims to control and in implementing its credit policies.
regulate the purposes for which credit
4. Publicity
is granted by commercial banks. It is
generally of two types. Central Bank in order to make their
policies successful, take the course of
the medium of publicity. A policy can
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 be effectively successful only when an U.S.A. Under this system, the Board of
effective public opinion is created in its Governors of the Federal Reserve System
favour. has been given the power to prescribe
margin requirements for the purpose of
5. Regulation of Consumer’s Credit:
preventing an excessive use of credit for
The down payment is raised and the stock exchange speculation.
number of installments reduced for the
credit sale. This system is specially intended to
help the Central Bank in controlling the
6. C hanges in the Marginal Requirements volume of credit used for speculation in
on Security Loans: securities under the Securities Exchange
This system is mostly followed in Act, 1934.

The Repo Rate and the Reverse Repo Rate are the frequently used tools with which
the RBI can control the availability and the supply of money in the economy. RR is
always greater than RRR in India
Repo Rate: (RR) Reverse Repo Rate: (RRR)
The rate at which the RBI is willing to The rate at which the RBI is willing
lend to commercial banks is called Repo to borrow from the commercial banks
Rate. Whenever banks have any shortage is called reverse repo rate. If the RBI
of funds they can borrow from the RBI, increases the reverse repo rate, it means
against securities. If the RBI increases the that the RBI is willing to offer lucrative
Repo Rate, it makes borrowing expensive interest rate to banks to park their money
for banks and vice versa. As a tool to with the RBI. This results in a decrease in
control inflation, RBI increases the Repo the amount of money available for banks
Rate, making it more expensive for the customers as banks prefer to park their
banks to borrow from the RBI. Similarly, money with the RBI as it involves higher
the RBI will do the exact opposite in a safety. This naturally leads to a higher rate
deflationary environment. of interest which the banks will demand
from their customers for lending money
to them.

6.5.4 Reserve Bank of India and Rural 6.5.5 Role of RBI in agricultural credit
Credit
RBI has been playing a very vital role
In a developing economy like India, in the provision of agricultural finance in
the Central bank of the country cannot the country. The Bank’s responsibility in
confine itself to the monetary regulation this field had been increased due to the
only, and it is expected that it should take predominance of agriculture in the Indian
part in development function in all sectors economy and the inadequacy of the formal
especially in the agriculture and industry. agencies to cater to the huge requirements
of the sector. In order to fulfill this
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 important role effectively, the RBI set up permanent changes in land and also for
a separate Agriculture Credit Department. the redemption of old debts.
However, the volume of informal loans
has not declined sufficiently. With the establishment of
National Bank for Agriculture and Rural
6.5.6 Functions of Agriculture Credit Development (NABARD), all the functions
Department: of the RBIrelating to agricultural credit
had been taken over and looked after
a) To maintain an expert staff to study all by NABARD since 1982. Since then,
questions on agricultural credit; all activities relating to rural credit are
b) To provide expert advice to Central and entirely looked after by NABARD.
State Government, State Co-operative
Banks and other banking activities. 6.6 The Agricultural
Refinance Development
c) 
To finance the rural sector through Corporation (ARDC)
eligible institutions engaged in the
business of agricultural credit and to
Farmers in India require mainly
co-ordinate their activities.
medium term and long term loans and
they face a lot of difficulties in getting
The duties of the RBI in agricultural
them. The only organization providing
credit were much restricted as it had to
long term credit is Land Development
function only in an ex-officio capacity
Banks which have lagged behind and
being the Central Bank of the country.
recorded only limited success. The credit
It could not lend directly to the farmers,
requirements of the agricultural sector are
but the supply of rural credit was done
increasing year after year. With the aim of
through the mechanism of refinance
bridging the gap in agricultural finance
with institutions specializing in rural
and to extend credit for projects involving
credit. Primary societies may borrow
agricultural development, an organization
from Central Co-operative Bank, and the
called the Agricultural Refinance
latter may borrow from the apex or the
Development Corporation (ARDC) was
State Co-operative Bank, which in its turn
established by an Act of Parliament and it
might get accommodation facilities from
started functioning from July 1, 1963.
the RBI.
6.6.1 Objectives of the ARDC:
The RBI was providing medium-
term loans also for a period exceeding 15 (i) To provide necessary funds by way of
months to 5 years for reclamation of land, refinance to eligible institutions such
construction of irrigation works, purchase as the Central Land Development
of machinery, etc. Banks, State Co-operative Banks, and
Scheduled banks.
The Reserve Bank of India was
also providing long-term loans to fiancé
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 (ii) To subscribe to the debentures floated and training expenses of RRB staff are
by the Central Land Development borne by the sponsor banks.
banks, State Co-operative Banks, and
Scheduled banks, provided they were The RBI has been granting many
approved by the RBI. concessions to RRBs:
6.7 (a) 
They are allowed to maintain cash
Regional Rural Banks (RRBs) reserve ratio at 3 per cent and statutory
liquidity ratio at 25 per cent; and
One of the important points of the (b) They also provide refinance facilities
20 points economic programme of Mrs. through NABARD.
Indira Gandhi during emergency was
the liquidation of rural indebtedness by
stages and provide institutional credit
6.8
to farmers and artisans in rural areas. NABARD and its role in
It was in pursuance of this aspect of the Agricultural credit
New Economic programme that the
Government of India setup Regional Since its inception, RBI has shown
Rural Banks (RRBs) on 1975. The share keen interest in agricultural credit and
capital of RRB is subscribed by the Central maintained a separate department for
Government (50%), the State Government this purpose. RBI extended short-term
concerned (15%), and the sponsoring seasonal credit as well as medium-term
commercial bank (35%). and long-term credit to agriculture
through State level co-operative banks
The main objective of the RRBs and Land Development banks.
is to provide credit and other facilities
particularly to the small and marginal
NABARD
farmers, agricultural labourers, artisans
and small entrepreneurs so as to develop
agriculture, trade, commerce, industry
and other productive activities in the rural State Cooperative Bank
areas.

6.7.1 Concessions to RRBs Central Cooperative Bank

From the beginning, the sponsor

banks have continued to provide Primary Cooperative Society
managerial and financial assistance to
RRBs and also other concessions such as
lower rate of interest (8.5 per cent) on the Three Tier Cooperative Credit
latter’s borrowings from sponsor banks. Structure
Further, the cost of staff deputed to RRBs
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 At the same time, RBI has also set up functions performed by RBI with regard
the Agricultural Refinance Development to agricultural credit.
Corporation (ARDC) to provide refinance
support to the banks to promote (i) 
NABARD acts as a refinancing
programmes of agricultural development, institution for all kinds of production
particularly those requiring term credit. and investment credit to agriculture,
With the widening of the role of bank small-scale industries, cottage and
credit from “agricultural development” to village industries, handicrafts and
“rural development” the Government rural crafts and real artisans and
proposed to have a more broad-based other allied economic activities with
organization at the apex level to extend a view to promoting integrated rural
support and give guidance to credit development.
institutions in matters relating to the
formulation and implementation of rural (ii) 
It provides short-term, medium-
development programmes. term and long-term credits to state
co-operative Banks (SCBs), RRBs,
LDBs and other financial institutions
approved by RBI.

(iii) 
NABARD gives long-term loans
(upto 20 Years) to State Government
to enable them to subscribe to the
share capital of co-operative credit
A National Bank for Agriculture societies.
and Rural Development (NABARD), was
(iv) NABARD gives long-term loans to any
therefore, set up in July 1982 by an Act
institution approved by the Central
of parliament to take over the functions
Government or contribute to the
of ARDC and the refinancing functions
share capital or invests in securities
of RBI in relation to co-operative banks
of any institution concerned with
and RRBs. NABARD is linked organically
agriculture and rural development.
with the RBI by the latter contributing
half of its share capital the other half (v) 
NABARD has the responsibility
being contributed by the Government of of co-ordinating the activities of
India(GOI). GOI nominates three of its Central and State Governments, the
Central Board Directors on the board of Planning Commission (now NITI
NABARD.A Deputy Governor of RBI is Aayog) and other all India and State
appointed as Chairman of NABARD. level institutions entrusted with the
development of small scale industries,
6.8.1 Functions of NABARD
village and cottage industries, rural
NABARD has inherited its apex crafts, industries in the tiny and
role from RBI i.e, it is performing all the decentralized sectors, etc.

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 (vi) 
It has the responsibility to inspect
RRBs and co-operative banks, other 6.9.2 All-India Level Institutions:
than primary co-operative societies.
1. 
Industrial Finance Corporation of
(vii) 
It maintains a Research and India (IFCI)
Development Fund to promote This was first in the chain of
research in agriculture and rural establishment of financial corporations to
development provide financial assistance for industrial
6.9 development. This was established
Reserve bank of India on July 1, 1948 under the Act of the
and industrial finance Parliament. IFCI provides assistance to
the industrial concerns in the following
Though industries get finance from ways:
commercial banks, the quantum and the
term will be very much limited generally. i) Long-term loans; both in rupees and
Commercial banks lend for short term foreign currencies.
only, as they get only short-term deposits ii) 
Underwriting of equity, preference
from the public. Further lending to and debenture issues.
industries is only a fragment of the total
iii) Subscribing to equity, preference and
lending by the banks.
debenture issues.
Hence, there is a need and urgency iv) Guaranteeing the deferred payments
of establishing long-term credit facilities in respect of machinery imported
to industries.The institutional set-up from abroad or purchased in India;
in India for financing and promoting and
industries are as follows v) Guaranteeing of loans raised in foreign
currency from foreign financial
6.9.1 Institutional Set-up:
institutions.

Financial assistance of IFCI can be

All-India Level

Industrial Finance Corporation

 
Institutions

of India (IFCI) availed by any Limited Company in the

Industrial Credit and Investment
  public, private or joint sector, or by a co-
Corporation of India (ICICI) operative society incorporated in India,
Industrial Development Bank of
  which is engaged or proposes to be engaged
India (IDBI)
in the specified industrial activities. Such
financial assistance will be available for
the setting up of new industrial projects
Institutions
State Level

State Financial Corporations

  and also for the expansion diversification,
(SFCs)
renovation or modernisation of existing
State Industrial Development
  ones. The IFCI also provides financial
Corporation (SIDCs)
assistance on concessional terms
for setting up industrial projects in
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 industrially less developed districts in the of ICICI was held by private companies,
States or Union Territories notified by the institutions and individuals. But now,
Central Government, a very large part of its equity capital is
held by public sector institutions, such as
The IFCI raises its resources by way banks, LIC, GIC and its subsidiaries, as
of (a) issue of bonds in the market; (b) ‘this private institution was nationalized.
borrowing from Industrial Development
Bank of India and the Central Government; The significant feature of the
(c) foreign credit secured from foreign operations of ICICI is the foreign currency
financial institutions and borrowings in loans sanctioned by this institution to
the international capital markets. industries. Since its inception, nearly 50
per cent of its disbursement had been
3. Industrial Credit and Investment in foreign currencies. This is possible
Corporation of India (ICICI) because of the facility it enjoys of raising
funds in foreign currencies. The World
ICICI [Industrial Credit and Investment Bank has been the single largest source
Corporation of India] of such funds. Since 1973, the ICICI has
entered the international capital markets
also for raising foreign currency loans.

The major portion of its rupee

resources is raised by way of debentures
in the capital market. The ICICI also
Functions of ICICI borrows from the Industrial Development
 Assistance to industries Bank of India and the Government. The
major portion of its assistance has gone to
 Provision of foreign currency loans
the private sector.
 Merchant banking
 Letter of credit 3. Industrial Development Bank of India
 Project promotion (IDBI)
 Housing loans
 Leasing operations

This was set up on 5th January 1955

as a joint-stock company on the advice
given by a three-man mission sponsored
by the World Bank and The Government
of USA to the Government of India. The
principal purpose of this institution is
INDUSTRIAL DEVELOPMENT
to channelize the World Bank funds to BANK OF INDIA
industry in India and also to help build The Industrial Development Bank
up a capital market. Initially the capital of India has been conceived with the
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 primary object of creating an apex SFCs are mainly intended for the
institution to co-ordinate the activities development of small and medium
of other financial institutions, including industrial units within their respective
banks. The Development Bank was a states. However, in some cases they extend
wholly owned subsidiary of the Reserve to neighboring states as well.
Bank of India upto February 15, 1976.
It was delinked from the RBI with effect
from February 16, 1976 and made an
autonomous corporation fully owned by
the Government of India.

Functions of IDBI: The functions

of IDBI fall into two groups (i) Assistance
to other financial institutions; and (ii)
Direct assistance to industrial concerns The SFCs provide loans and
either on its own or in participation with underwriting assistance to industrial
other institutions. The IDBI can provide units having paid-up capital and reserves
refinance in respect of term loans to not exceeding ₹ 1 crore. The maximum
industrial concerns given by the IFC, the amount that can be sanctioned to an
SFCs, other financial institutions notified industrial concern by SFC is ₹ 60 lakhs.
by the Government, scheduled banks and
state cooperative banks. SFCs depend upon the IDBI for
refinance in respect of the term loans
A special feature of the IDBI is the granted by them. Apart from these, the
provision for the creation of a special fund SFCs can also make temporary borrowings
known as the Development Assistance from the RBI and borrowings from IDBI
Fund. The fund is intended to provide and by the sale of bonds.
assistance to industries which require
heavy investments with low anticipated 2. S
 tate Industrial Development
rate of return. Such industries may not Corporations (SIDCOs)
be able to get assistance in the normal The Industrial Development
course. The financing of exports was Corporations have been set up by the state
also undertaken by the IDBI till the governments and they are wholly owned
establishment of EXIM BANK in March, by them. These institutions are not merely
1982. financing agencies; they are entrusted
with the responsibility of accelerating the
6.9.3 State Level Institutions
industrialization of their states.
1. State Financial Corporation (SFCs)
SIDCO
The government of India passed in
1951 the State Financial Corporations Act Small Industrial Development
and SFCs were set up in many states. The Corporation
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 SIDCOs provide financial assistance the doctrine of “monetarism” and who
to industrial concerns by way of loans received Nobel Prize in 1976. He boldly
guarantees and underwriting of or direct announced in his book “Monetary History
subscriptions to shares and debentures. In of the UnitedStates, 1867 – 1960” that the
addition to these, they undertake various Great Depression of the 1930’s was largely
promotional activities, such as conducting the outcome of the bungling monetary
techno-economic surveys, project policies of the Federal Reserve System.
identification, preparation of feasibility
studies and selection and training of 6.10.1 Monetary Policy: Expansionary
entrepreneurs. They also promote joint Vs. Contractionary
sector projects in association with private
promoter in such type of projects. SIDCOs Expansionary policy is cheap money
take 26 percent, private co-promoter takes policy when a monetary authority uses
25 percent of the equity, and the rest is its tools to stimulate the economy. An
offered to the investing public. SIDCOs expansionary policy maintains short-
undertake the development of industrial term interest rates at a lower than usual
areas by providing all infrastructural rate or increases the total supply of
facilities and initiation of new growth money in the economy more rapidly
centers. They also administer various State than usual. It is traditionally used
government incentive schemes. SIDCOs to try to combat unemployment by
get refinance facilities form IDBI. They lowering interest rates in the hope that
also borrow through bonds and accept less expensive credit will entice businesses
deposits. into expanding. This increases aggregate
demand (the overall demand for all goods
6.10 and services in an economy), which boosts
Monetary Policy short-term growth as measured by gross
domestic product (GDP) growth.
Monetary Policy
The Contractionary monetary policy
is the macroeconomic
is dear money policy, which maintains
policy being laid
short-term interest rates higher than usual
down by the Central
or which slows the rate of growth in the
Bank towards the
money supply or even shrinks it. This slows
management of money
short-term economic growth and lessens
supply and interest rate.
Milton Friedman inflation. Contractionary monetary policy
It is the demand side
can lead to increased unemployment and
economic policy used by the government
depressed borrowing and spending by
of a country to achieve macroeconomic
consumers and businesses, which can
objectives like inflation, consumption,
eventually result in an economic recession
growth and liquidity. The monetary policy
if implemented too vigorously.
gained its significance after the World
War II, thanks to the initiation made by
Milton Friedman, who is associated with
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 1. Neutrality of Money
The Two Faces of Monetary Policy
Economists like Wicksteed, Hayek
Inflation
and Robertson are the chief exponents

Cheap Money Policy

1. Borrowing is easy of neutral money. They hold the view
2. Consumers buy more that monetary authority should aim at
3. Businesses expand neutrality of money in the economy.
4. More people are employed Monetary changes could be the root cause
5. People spend more of all economic fluctuations. According to
neutralists, the monetary change causes
Recession distortion and disturbances in the proper
1. Borrowing is difficult operation of the economic system of the
2. Consumers buy less Dear Money Policy country.
3. Businesses Postpone
expansion 2. Exchange Rate Stability
4. Unemployment increases Exchange rate stability was the
5. Production is reduced traditional objective of monetary
authority. This was the main objective
under Gold Standard among different
6.10.2 Objectives of Monetary Policy countries. When there was disequilibrium
in the balance of payments of the
The monetary policy in developed country, it was automatically corrected
economies has to serve the function of by movements. It was popularly known as
stabilization and maintaining proper “Expand Currency and Credit when gold
equilibrium in the economic system. But is coming in; contract currency and credit
in case of underdeveloped countries, the when gold is going out.” This system will
monetary policy has to be more dynamic correct the disequilibrium in the balance
so as to meet the requirements of an of payments and exchange rate stability
expanding economy by creating suitable will be maintained.
conditions for economic progress. It is
now widely recognized that monetary It must be noted that if there is
policy can be a powerful tool of economic instability in the exchange rates, it would
transformation. result in outflow or inflow of gold resulting
in unfavorable balance of payments.
6.10.3 The specific objectives of Therefore, stable exchange rates are
monetary policy are advocated.
1. Neutrality of Money
3. Price Stability
monetary policy

2. Stability of Exchange Rates

Objectives of

3. Price Stability Economists like Crustave Cassel and

4. Full Employment Keynes suggested price stabilization as a
5. Economic Growth main objective of monetary policy. Price
6. Equilibrium in the Balance of Payments stability is considered the most genuine
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 objective of monetary policy. Stable prices equality between demand and supply,
repose public confidence. It promotes flexible monetary policy is the best course.
business activity and ensures equitable
distribution of income and wealth. As 6. E
 quilibrium in the Balance of
a consequence, there is general wave of Payments
prosperity and welfare in the community. Equilibrium in the balance of
But it is admitted that price payments is another objective of monetary
stability does not mean ‘price rigidity’ or policy which emerged significant in the
price stagnation’. A mild increase in the post war years. This is simply due to the
price level provides a tonic for economic problem of international liquidity on
growth. It keeps all virtues of a stable account of the growth of world trade at a
price. more faster speed than the world liquidity.

4. Full Employment It was felt that increasing of deficit in

the balance of payments reduces the ability
During world depression, the of an economy to achieve other objectives.
problem of unemployment had increased As a result, many less developed countries
rapidly. It was regarded as socially have to curtail their imports which
dangerous, economically wasteful and adversely affects development activities.
morally deplorable. Thus, full employment Therefore, monetary authority makes
was considered as the main goal of efforts to maintain equilibrium in the
monetary policy. With the publication of balance of payments.
Keynes’ General Theory of Employment,
Interest and Money in 1936, the objective
6.11
of full employment gained full support as Recent Advancements
the chief objective of monetary policy. in Banking Sector

5. Economic Growth 6.11.1 E- Banking

Economic growth is the process Online banking,
whereby the real per capita income of a also known as
country increases over a long period of internet banking,
time. It implies an increase in the total is an electronic
physical or real output, production of payment system
goods for the satisfaction of human wants. that enables customers of a bank or other
financial institution to conduct a range
Therefore, monetary policy should of financial transactions through the
promote sustained and continuous financial institution’s website. The online
economic growth by maintaining banking system typically connects to or be
equilibrium between the total demand for part of the core banking system operated
money and total production capacity and by a bank and is in contrast to branch
further creating favourable conditions banking which was the traditional way
for saving and investment. For bringing customers accessed banking services.
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 Today, “virtual banks” (or “direct maintained by RBI. NEFT operates in half
banks”) have only an internet presence, hourly batches. Currently there are twenty
which enables them to lower costs than three settlements from 8 am to 7 pm
traditional brick-and-mortar banks. on all working days including working
Saturdays. Therefore, the beneficiary can
expect to get the credit for the transactions
6.11.2 RTGS and NEFT
put through between 8 am to 5.30 pm
Inter Bank Transfer enables on all working days including working
electronic transfer of funds from the Saturdays on the same day.
account of the remitter in one Bank to For transactions settled in the 6.30
the account of the beneficiary maintained and 7 pm batches on all working days
with any other Bank branch. There are including working Saturdays, the credit
two systems of Inter Bank Transfer - will be afforded either on the same day or
RTGS and NEFT. Both these systems are on the next working day.

NEFT RTGS
National electronic Fund Transfer Real Time Gross Settlement

Transactions happens in batches Transactions Happens in real

hence slow time hence fast
Timings : 8:00 am to 6:30 pm Timings : 9:00 am to 4:30 pm
(12: 30 pm on Saturday) (1:30 pm on Saturday)

No minimum limit Minimum amount for RTGS transfer

is ₹ 2 lakhs

6.11.3 ATM (Automated Teller Machine)

ATMs transformed the bank tech National Bank ATMs. These technologies
system when they were first introduced can help overall bank security by
in 1967. The next revolution in ATMs is protecting against ATM hacks.
likely to involve contactless payments.
Much like Apple Pay or Google Wallet,
soon we will be able to conduct contactless
ATM transactions using a smartphone.

Some ATM innovations are already

available overseas. For example, biometric
authentication is already used in India,
and its recognition is in place at Qatar

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 money for payment to a merchant or as a
6.11.4 Paytm cash advance. In other words, credit cards
combine payment services with extensions
Payments Bank. In August 2015,
of credit. Complex fee structures in the
Paytm received a license from RBI to
credit card industry may limit customers’
launch a payments bank. The Paytm
ability to shopping.
Payments Bank is a separate entity in
which founder Vijay Shekhar Sharma will 6.11.6 Recent Issues
hold 51% share, One97 Communications
holds 39% and 10% will be held by a Once the borrower fails to make
subsidiary of One97 and Sharma. interest or principal payments for 90
days the loan is considered to be a non-
6.11.5 Debit card and Credit Card performing asset (NPA). NPAs are
problematic for financial institutions
since they depend on interest payments
for income. As on now the size of NPAs is
estimated to be around 10 lakh crores. As
a result, the banks do not have adequate
capital. Hence the Government (of India)
is forced to infuse capital to the banks by
using poor tax – payers money. Already
A Debit card is a card allowing the
more than a sum of ₹ 2 lakh crores have
holder to transfer money electronically
been injected. During 2018 - 19, the
from their bank account when making a
GOI has infused �68,000 crores into the
purchase.
banking system. Thus the NPAs ultimately
affect the common people.

6.11.7 Merger of Banks

Union Cabinet decided to merge

all the remaining five associate banks of
State Bank Group with State Bank of India
in 2017. After the Parliament passed the
A credit card is a payment card merger Bill, the subsidiary banks have
issued to users (cardholders) to enable the ceased to exist.
cardholder to pay a merchant for goods
and services based on the cardholder’s Five associates and the Bharatiya
promise to the card issuer to pay them Mahila Bank have become the part of State
for the amounts so paid plus the other Bank of India (SBI) beginning April 1,
agreed charges. The card issuer (usually 2017. This has placed State Bank of India
a bank) creates a revolving account and among the top 50 banks in the world. The
grants a line of credit to the cardholder, five associate banks that were merged are
from which the cardholder can borrow State Bank of Bikaner and Jaipur (SBBJ),
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 State Bank of Hyderabad (SBH), State Bank 6.14
of Mysore (SBM), State Bank of Patiala
(SBP) and State Bank of Travancore (SBT). Demonetisation
The other two Associate Banks namely
State Bank of Indore and State Bank of
Saurashtra had already been merged with
State Bank of India. After the merger, the
total customer base of SBI increased to 37
crore with a branch network of around
24,000 and around 60,000 ATMs across
the country.

6.12
Demonitisation is the act of
Money Market stripping a currency unit of its status as
legal tender. It occurs whenever there is a
Money market is the mechanism change of national currency. The current
through which sthort term funds are form or forms of money is pulled from
loaned and borrowed. It designates circulation, often to bereplaced with new
financial instittutions which handle the coins or notes. On 8 November 2016, the
purchase, sale and transfer of short term Indian Prime Minister Mr. Narendra Modi
credit instruments. Commercial banks, announced the demonetization of all ₹500
acceptance houses, Non Banking Financial and ₹1000 bank notes of the Mahatma
Institutions and the Central Bank are the Gandhi Series. However, more than 99%
institutions catering to the requirements of those currencies came back to the RBI.
of short term funds in the money Market.
6.14.1 Objectives of Demonetisation
6.13
1. 
Removing Black Money from the
Capital Market
country.
2. Stopping of Corruption.
Capital Market is a part of financial
3. Stopping Terror Funds.
system which is concerned with raising
capital by dealing in shares, bonds and 4. Curbing Fake Notes
other long term investments. Summary
The market where investment It is well-recognized that the
instruments like bonds, equities and financial sector plays a critical role in
mortgages are traded is known as the the development process of a country.
capital market Financial institutions, instruments and
markets that constitute the financial sector
act as a conduit for the transfer of resources

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 from net savers to net borrowers, that supply, and interest rates. Central banks
is, from those who spend less than they also usually oversee the commercial
earn to those who spend more than they banking system.
earn. The outcome of the various reform
measures so far has been impressive and � B
 ank Rate: It is the rate at which the
banks have responded to the deregulation Central Bank of a country is prepared
and the increasingly competitive to re-discount the first class securities.
environment by restructuring their
operation and upgrading performance � S
 tatutory Liquidity Ratio (SLR):
standards. However, in the 2010s the It is the amount which a bank has to
volumes of NPAs have increased sharply. maintain in the form of cash, gold or
approved securities.
Glossary
� C
 ash Reserve Ratio (CRR): Banks are
� C
 ommercial Banks: These are the required to hold a certain proportion
institutions that make short term loans of their deposits in the form of cash
to business and in the process create with RBI. This is known as CRR.
money. � M
 onetary Policy: It is the
macro-economic policy laid down
� C
 redit Creation: It means the
by the Central Bank towards the
multiplication of loans and advances.
management of money supply and
Commercial banks receive deposits
interest rate.
from the public and use these deposits
to give loans. � C
 apital Market: It is a financial market
in which long-term debt or equity
� N
 on-Bank Financial Institution
backed securities are bought and sold.
(NBFI): It is a financial institution that
does not have a full banking license or � D
 emonetisation: It is the act of
is not supervised by the central bank. stripping a currency unit of its status as
legal tender. It occurs whenever there
� C
 entral Bank: It is an institution that
is a change of national currency.
manages a state’s currency, money

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 MODEL QUESTIONS
Part – A
Multiple choice questions

1. A Bank is a 6. NBFI does not have.

a) Financial institution a) Banking license
b) Corporate b) government approval
c) An Industry c) Money market approval
d) Service institutions d) Finance ministry approval

2. A Commercial Bank is an institutions 7. C entral bank is --------------- authority

that provides services of any country.
a) Accepting deposits a) Monetary
b) Providing loans b) Fiscal
c) Both a and b c) Wage
d) None of the above d) National Income

3. The Functions of commercial banks are 8. 

Who will act as the banker to the
broadly classified into Government of India?
a) Primary Functions a) SBI
b) Secondary functions b) NABARD
c) Other functions c) ICICI
d) a, b, and c d) RBI

4. Bank credit refers to 9. Lender of the last resort is one of the

functions of.
a) Bank Loans
b) Advances a) Central Bank
c) Bank loans and advances b) Commercial banks
d) Borrowings c) Land Development Banks
d) Co-operative banks
5. Credit creation means.
10. Bank Rate means.
a) Multiplication of loans and
advances a) Re-discounting the first class
b) Revenue securities
c) Expenditure b) Interest rate
d) Debt c) Exchange rate
d) Growth rate

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 11. Repo Rate means. 16. The State Financial Corporation Act
was passed by
a) R
 ate at which the Commercial
Banks are willing to lend to RBI a) Government of India
b) R
 ate at which the RBI is willing b) Government of Tamilnadu
to lend to commercial banks c) Government of Union Territories
c) Exchange rate of the foreign bank d) Local Government.
d) Growth rate of the economy 17. Monetary policy his formulated by.

12. Moral suasion refers. a) Co-operative banks

b)Commercial banks
a) Optimization c) Central Bank
b) Maximization d) Foreign banks
c) Persuasion
d) Minimization 18. Online Banking is also known as.
a) E-Banking
13. ARDC started functioning from b) Internet Banking
a) June 3, 1963 c) RTGS
b) July 3, 1963 d) NEFT
c) June 1, 1963 19. Expansions of ATM.
d) July 1, 1963
a) Automated Teller Machine
14. NABARD was set up in. b) Adjustment Teller Machine
c) Automatic Teller mechanism
a) July 1962
d) Any Time Money
b) July 1972
c) July 1982 20. 
2016 Demonetization of currency
d) July 1992 includes denominations of

15. EXIM bank was established in. a) �500 and �1000

b) �1000 and �2000
a) June 1982
b) April 1982 c) �200 and �500
c) May 1982 d) All the above
d) March 1982

Answers

1 2 3 4 5 6 7 8 9 10
a c d c a a a d a a
11 12 13 14 15 16 17 18 19 20
b c d c d a c b a a

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 Part - B
Answer the following questions in one or two sentences

21. Define Commercial banks.

22. What is credit creation?
23. Define Central bank.
24. Distinguish between CRR and SLR.
25. Write the meaning of Open market operations
26. What is rationing of credit?
27. Manson the functions of agriculture credit department.

Part - C
Answer the following questions in about a paragraph

28. Write the mechanism of credit creation by commercial banks.

29. Give a brief note on NBFI.
30. Bring out the methods of credit control.
31. What are the functions of NABARD?
32. Specify the functions of IFCI.
33. Distinguish between money market and capital market.
34. Mention the objectives of demonetizations.
Part - D
Answer the following questions in one page

35. Explain the role of Commercial Banks in economic development.

36. Elucidate the functions of Commercial Banks.
37.Describe the functions of Reserve Bank of India.
38. What are the objectives of Monetary Policy? Explain.

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 ACTIVITY
1. S tudents are to be asked to visit the nearby commercial bank to
observe the functioning of the bank. They are also instructed to
submit a brief report about their learning experiences.
2. S tudents are asked to do a brief survey about impact of 2016
Demonetisation of currency on the general public.

References

1. J hingan, M.L. (2011), Monetary Economics, Vrinda publications (P) Ltd, Delhi.
2. Paul, R.R. (2011), Monetary Economics, Kalyani publications, New Delhi.
3. Hajela, T.N. (2009), Money, Banking and Public Finance – Ane books Pvt.Ltd, New
Delhi.
4. Sankaran, S. (2010), Money, Banking and International Trade, Margham Publication,
Chennai.
5. Sundharam, K.P.M. (2000), Money, Banking and International Trade, Sultan Chand
& Sons, New Delhi.

Websites / e-books

1. Ken Hoyle (1982), Money and Banking, https://www.elsevier.com/books/money-

and-banking/hoyle/978-0-434-98505-0

2. Robert Wright (2012), Money and Banking, https://open.umn.edu/ opentextbooks/

textbooks/money-and-banking

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 CHAPTER

7 International Economics

“Economies are linked internationally through trade in goods

and through financial markets”.
- Dornbusch, Fischer and Startz

Learning Objectives

1 To explain the importance of international trade and different theories of

international trade.

2 To provide an understanding about the exchange rate determination,

variation in exchange rate and Balance of Payments.

3 To provide an insight into FDI and Trade.

7.1 International Economics studies the

Introduction entire range of international economic
transactions that consist of not only trade
The subject ‘International in goods and services but also capital flows,
Economics’ evolved from a simple theory technology transfer, the rate of exchange,
of international trade was formulated to balance of payments, and issues relating to
answer a few basic questions. The subject tariffs, protection, free trade, investment
first originated in Western flows, role of fiscal and monetary policies
Europe on account of pursued by individual countries.
increasing importance of
7.2
foreign trade in that part of
the world. The contributions Meaning of International
of classical economists Economics
Haberler
like Adam Smith, David International Economics is that branch
Ricardo, F.W. Taussig, Haberler, J.S.Mill of economics which is concerned with the
and Bela Balassa shaped the subject matter exchange of goods and services between
of International Economics. two or more countries. Hence the subject
matter is mainly related to foreign trade.
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 In other words, International It also discusses the operation of Multi
Economics is a specialized field of National Corporations (MNCs).
Economics which deals with the economic
interdependence among countries and 4. 
International Financial and Trade
studies the effects of such interdependence Regulatory Institutions
and the factors that affect it.
The financial institutions like
7.3 International Monetary Fund IMF, IBRD,
Subject Matter of International WTO etc which influence international
Economics economic transactions and relations shall
also be the part of international economics.
The subject matter of International
Economics includes large number of
7.4
segments which are classified into the Meaning of Trade
following parts.
Trade is one of the powerful forces
1. Pure Theory of Trade of economic integration. The term ‘trade’
means exchange of goods, wares or
This component explains the causes
merchandise among people.
for foreign trade, composition, direction
and volume of trade, determination of the Trade is of two types. They are:
terms of trade and exchange rate, issues
related to balance of trade and balance of a) Internal Trade and
payments. b) International Trade.

2. Policy Issues

Under this part, policy issues such

as free trade vs. protection, methods of
regulating trade, capital and technology
flows, use of taxation, subsidies and
dumping, exchange control and
convertibility, foreign aid, external
borrowings and foreign direct investment,
measures of correcting disequilibrium in 7.4.1 Internal Trade
the balance of payments etc are covered.
It refers to the exchange of goods
3. International Cartels and Trade Blocs and services within the political and
geographical boundaries of a nation. It
This part deals with the economic is a trade within a country. This is also
integration in the form of international known as ‘domestic trade’ or ‘home trade’
cartels, customs unions, monetary unions, or ‘intra-regional trade’.
trade blocs, economic unions and the like.
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 7.4.2 International Trade

It refers to the trade or exchange of goods and services between two or more countries.
In other words, it is a trade among different countries or trade across political boundaries.
It is also called as ‘external trade’ or ‘foreign trade’ or ‘inter-regional trade’.

7.4.3 Differences between ‘Internal Trade’ and ‘International Trade’

Sl.No. Internal Trade International Trade

1. Trade takes place between different Trade takes place between different
individuals and firms within the same individuals and firms in different
nation. countries.
2. Labour and capital move freely from Labour and capital do not move easily
one region to another. from one nation to another.
3. There will be free flow of goods and Goods and services do not easily move
services since there are no restrictions. from one country to another since
there are a number of restrictions like
tariff and quota.
4. There is only one common currency. There are different currencies.
5. The physical and geographical There are differences in physical and
conditions of a country are more or geographical conditions of the two
less similar. countries.
6. Trade and financial regulations are Trade and financial regulations such as
more or less the same. interest rate, trade laws differ between
countries.
7. There is no difference in political Differences are pronounced in political
affiliations, customs and habits of the affiliations, habits and customs of the
people and government policies. people and government policies.

7.5
Theories of
was David Ricardo who formulated as an
International Trade
explicit and precise theory, namely, the
theory of comparative cost advantage,
which was later improved and refined
7.5.1 The Classical Theory of
by the economists like J.S Mill, Cairnes,
International Trade
Bastable,Taussig and Haberler. We shall
Introduction first discuss the Adam Smith’s theory of
Adam Smith (1776) developed the absolute cost advantage.
theory of absolute cost advantage. But it
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 Assumptions
Classical Trade Theories
1. 
There are two countries and two
Mercantilism (pre - 16th century)
commodities (2 x 2 model).
 Takes an us-versus - them view of 2. L abour is the only factor of production.
trade
3. L
 abour units are homogeneous.
 Other country's gain is our
country's loss 4. The cost or price of a commodity is
measured by the amount of labour
Free Trade theories
required to produce it.
Absolute Advantage (Adam Smith,
 
1776) 5. There is no transport cost.
C omparative Advantage (David
 
Illustration
Ricardo, 1817)
Specialization
  of production Absolute cost advantage theory can
and free flow of goods benefit all be illustrated with the help of the following
trading partner's economies example.
Free Trade refined Absolute Cost Advantage
 Factor - proporations (Heckscher -
Country India China
Ohlin, 1919)
(Output per unit of labour)
International Product life cycle
 
Wheat 20 8
(Ray Vernon, 1966)
Cloth 6 14

7.5.2. Adam Smith’s Theory of Absolute y

Cost Advantage
Wheat

20
Adam Smith argued that all nations India
can be benefitted when there is free
trade and specialisation in terms of their 8
absolute cost advantage. China
0 6 14 x
The Theory Cloth
Figure 7.1
According to Adam Smith, the basis
of international trade was absolute cost From the illustration, it is clear
advantage. Trade between two countries that India has an absolute advantage in
would be mutually beneficial when one the production of wheat over China and
country produces a commodity at an China has an absolute advantage in the
absolute cost advantage over the other production of cloth over India. Therefore,
country which in turn produces another India should specialize in the production
commodity at an absolute cost advantage of wheat and import cloth from China.
over the first country. China should specialize in the production

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 of cloth and import wheat from India. 5. 
Production is subject to the law of
This kind of trade would be mutually constant returns.
beneficial to both India and China. 6. F
 oreign trade is free from all barriers.
7.5.3. Ricardo’s Theory of Comparative 7. N
 o change in technology.
Cost Advantage 8. N
 o transport cost.
David Ricardo , the British economist 9. P
 erfect competition.
in his ‘Principles of Political Economy and 10. F
 ull employment.
Taxation’ published in 1817, formulated
a systematic theory called ‘Comparative 11. N
 o government intervention.
Cost Theory’. Later it was refined by J.S
Illustration
Mill, Marshall, Taussig and others.
Ricardo’s theory of comparative
Ricardo demonstrates that the basis cost can be explained with a hypothetical
of trade is the comparative cost difference. example of production costs of cloth and
In other words, trade can take place even wheat in America and India.
if the absolute cost difference is absent but
there is comparative cost difference. Comparative Cost Advantage
(Units of labour required to produce
According to Ricardo, a country
one unit)
can gain from trade when it produces
at relatively lower costs. Even when a Domestic
Country Cloth Wheat
country enjoys absolute advantage in both Exchange Ratios
goods, the country would specialize in America 100 120 1 wheat =1.2 cloth
the production and export of those goods India 90 80 1 wheat=0.88 cloth
which are relatively more advantageous.
Similarly, even when a country has absolute
y
disadvantage in production of both goods,
Labour required for one

120
the country would specialize in production
unit of wheat

and export of the commodity in which it America

is relatively less disadvantageous. 80

Assumptions India

1. 
There are only two nations and two
0 90 100 x
commodities (2x2 model)
Labour required for one
2. L abour is the only element of cost of Figure 7.2 unit of cloth
production.
Note: Slopes are not equal
3. All labourers are of equal efficiency.
4. L abour is perfectly mobile within the It is evident from the example
country but perfectly immobile between that India has an absolute advantage
countries. in production of both cloth and wheat.

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 However, India should concentrate on international trade is the difference in
the production of wheat in which she factor endowments. It is otherwise called
enjoys a comparative cost advantage. as ‘Factor Endowment Theory’.
(80/120 < 90/100). For America the
comparative cost disadvantage is lesser Factor endowment model
in cloth production. Hence America will  Developed by Heckscher and Ohlin
specialize in the production of cloth and
Countries with a relative factor
 
export it to India in exchange for wheat.
abundance can specialise and trade
(Any exchange ratio between 0.88 units
and 1.2 units of cloth against one unit Abundance of skilled labour
 
of wheat represents gain for both the → specialisation → export →
nations). With trade, India can get 1 unit exchange for goods are services
of cloth and 1 unit of wheat by using produced by countries with
its 160 labour units. In the absence of abundance of unskilled labour
trade, for getting this benefit, India will E xports embody the abundant
 
have to use 170 units of labour. America factor
also gains from this trade. With trade,
Imports embody the scarce factor
 
America can get 1 unit of cloth and one
unit of wheat by using its 200 units of  Assumes a high degree of factor
labour. Otherwise, America will have to mobility
use 220 units of labour for getting 1 unit
of cloth and 1 unit of wheat. The Theory
The classical theory argued that the
Criticisms basis for foreign trade was comparative
1. L abour cost is a small portion of the cost difference and it considered only
total cost. Hence, theory based on labour factor. But the modern theory of
labour cost is unrealistic. international trade explains the causes
for such comparative cost difference. This
2. L abourers in different countries are not theory attributes international differences
equal in efficiency. in comparative costs to:

7.5.4. Modern Theory of International i) difference in the endowments of factors

Trade of production between countries, and

Introduction ii) 
differences in the factor proportions
required in production.
The modern theory of international
trade was developed by Swedish economist Assumptions
Eli Heckscher and his student Bertil Ohlin
in 1919. This model was based on the 1. 
There are two countries, two
Ricardian theory of international trade. commodities and two factors. (2x2x2
This theory says that the basis for model)

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 2. Countries differ in factor endowments. 5. 
Countries have identical demand
3. Commodities are categorized in terms conditions.
of factor intensity. 6. There is perfect competition in both
4. 
Countries use same production product and factor markets in both the
technology. countries.

Heckscher - Ohlin (H-O) theorem

(H-O theorem) Factor Exports

"A capital abundant A country exports those
country will export the Factor proportions model
commodities produced
capital - intensive good, which links exports
with relatively large
while the labor - abundant and imports to factor
quantities of the country's
country will export the endowments.
relatively abundant factor.
labor - intensive good."

Explanation
According to Heckscher - Ohlin, “a capital-abundant country will export the capital
–intensive goods, while the labour-abundant country will export the labour-intensive
goods”. A factor is regarded abundant or scare in relation to the quantum of other factors.
A country can be regarded as richly endowed with capital only if the ratio of capital to
other factors is higher than other countries.
Illustration

Particulars India America

Supply of Labour 50 24

Supply of Capital 40 30

Capital-Labour Ratio 40/50 = 0.8 30/24 = 1.25

In the above example, even though India has more capital in absolute terms, America
is more richly endowed with capital because the ratio of capital in India is 0.8 which is less
than that in America where it is 1.25. The following diagram illustrates the pattern of
word trade.

Capital Export of capital- intensive goods Labour

abundant abundant
country. Export of labour –intensive goods country.

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 Limitations
1. Factor endowment of a country may change over time.

2. The efficiency of the same factor (say labour) may differ in the two countries. For
example, America may be labour scarce in terms of number of workers. But in
terms of efficiency, the total labour may be larger.

7.5.5 Comparison of Classical Theory and Modern Theory

Classical Theory of International

S.No Modern Theory of International Trade
Trade
1. The classical theory explains the The modern theory explains the phenomenon
phenomenon of international trade of international trade on the basis of general
on the basis of labour theory of value. theory of value.
2. It presents a one factor (labour) It presents a multi - factor (labour and capital)
model model.
3. It attributes the differences in the It attributes the differences in comparative
comparative costs to differences in costs to the differences in factor endowments
the productive efficiency of workers in the two countries.
in the two countries.

7.6 absolute or comparative advantages.

International specialization offers the
Gains from International Trade following gains.

International trade helps a country 1. Better utilization of resources.

to export its surplus goods to other
countries and secure a better market for 2. 
C oncentration in the production of
it. Similarly, international trade helps a goods in which it has a comparative
country to import the goods which cannot advantage.
be produced at all or can be produced at a 3. Saving in time.
higher cost. The gains from international
trade may be categorized under four 4. Perfection of skills in production.
heads. 5. 
Improvement in the techniques of
production.
I. Efficient Production
6. Increased production.
International trade enables each
7. Higher standard of living in the trading
participatory country to specialize in
countries.
the production of goods in which it has

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 II. Equalization of Prices between Terms Of Trade (TOT) =
Index Of Export Prices
X 100
Index Of Import Prices
Countries
International trade may help to
equalize prices in all the trading countries.

1. Prices of goods are equalized between

the countries (However, in reality it has
not happened). 7.7.1 Meaning

2. The difference is only with regard to the It is the rate at which the goods of
cost of transportation. one country are exchanged for goods of
3. Prices of factors of production are also another country. It is expressed as the
equalized (However, in reality it has not relation between export prices and import
happened). prices. Terms of trade improves when
average price of exports is higher than
III. Equitable Distribution of Scarce average price of imports.
Materials
International trade may help the 7.7.2 Types of Terms of Trade
trading countries to have equitable
The different concepts of terms of
distribution of scarce resources.
trade were classified by Gerald M.Meier
IV. General Advantages of International into the following three categories:
Trade
Terms of Trade related to the Ratio of
1. Availability of variety of goods for Exchange between Commodities
consumption.
2. Generation of more employment Terms of Trade
opportunities.
Net Barter Terms of Trade - Taussig
3. Industrialization of backward nations.
4. Improvement in relationship among Gross Barter Terms of Trade - Taussig
countries (However, in reality it has not
Income Terms of Trade - G.S.Dorrance
happened).
1. Net Barter Terms of Trade
5. Division of labour and specialisation.
6.Expansion in transport facilities. This type was developed by Taussig
in 1927.The ratio between the prices of
7.7
exports and of imports is called the “net
Terms of Trade barter terms of trade’. It is named by Viner
as the ‘commodity terms of trade’.
The gains from international trade
depend upon the terms of trade which It is expressed as:
refers to the ratio of export prices to
Tn= (Px / Pm) x 100
import prices.
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 Where, Where, Px = Price index of exports
Tn = Net Barter Terms of Trade Pm = Price index of imports
Px = Index number of export prices Qx = Quantity index of exports
Pm = Index number of import prices
7.7.3. 
Terms of Trade related to the
This is used to measure the gain Interchange between Productive
from international trade. If ‘Tn’ is greater Resources
than 100, then it is a favourable terms of
trade which will mean that for a rupee of
1 The Single Factoral Terms of Trade
export, more of imports can be received
by a country. Viner has devised another concept
called ‘‘the single factoral terms of trade’’
2 Gross Barter Terms of Trade as an improvement upon the commodity
This was developed by Taussig in terms of trade. It represents the ratio
1927 as an improvement over the net of export-price index to the import-
terms of trade. It is an index of relationship price index adjusted for changes in the
between total physical quantity of imports productivity of a country’s factors in the
and the total physical quantity of exports. production of exports. Symbolically, it can
be stated as
Tg= (Qx/Qm) x 100
Tf = (Px / Pm) Fx
Where, Qm = Index of import quantities
Qx = Index of export quantities Where, Tf stands for single factoral
terms of trade index. Fx stands for
If for a given quantity of export, productivity in exports (which is measured
more quantity of import can be consumed as the index of cost in terms of quantity
by a country, then one can say that terms of factors of production used per unit of
of trade are favourable. export).

3 Income Terms of Trade 2 Double Factoral Terms of Trade

The income terms of trade was given
Viner constructed another index
by G.S.Dorrance in 1948. It is the index of
called ‘‘Double factoral terms of Trade’’. It
the value of exports divided by the price
is expressed as
index for imports multiplied by quantity
index of experts. In other words, it is the
net barter terms of trade of a country Tff = (Px / Pm) (Fx / Fm)
multiplied by its exports-volume index.
which takes into account the
Ty = (Px / Pm)Qx productivity in country’s exports, as well
as the productivity of foreign factors.

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 Here, Fm represents import index (which Favourable BOT
is measured as the index of cost in terms
When the total value of commodity
of quantity of factors of production
exports of a country exceeds the total value
employed per unit of imports).
of commodity imports of that country, it
7.8 is said that the country has a ‘favourable’
Balance of Trade Vs Balance of balance of trade.
Payments
Unfavourable BOT
Balance of Trade and Balance of If total value of commodity exports
Payments are two different concepts in of a country is less than the total value of
the subject of international trade. commodity imports of that country, that
country is said to have an ‘unfavourable’
7.8.1 Balance of Trade (BOT) balance of trade.

Balance of Trade (BOT) refers to

the total value of a country’s exports of 7.8.2 Balance of Payments (BOP)
commodities and total value of imports
of commodities. Only export and BoP is a systematic record of
import of commodities are included in a country’s economic and financial
the statement of Balance of Trade of a transactions with the rest of the world
country. Movements of goods (export and over a period of time.
imports of commodities) are also known
as ‘visible trade’, because the movement
of commodities between countries can be
seen by eyes and felt by hands and can be
verified physically by custom authorities
of a country.

Balance of Trade
Favourable Conditions

When a payment is received from a

s
rt

foreign country, it is a credit transaction

po

while a payment to a foreign country is

Ex

a debit transaction. The principal items

shown on the credit side are exports
s
rt

of goods and services, transfer receipts

po

in the form of gift etc., from foreigners,

Im

borrowing from abroad, foreign direct

investment and official sale of reserve
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 assets including gold to foreign countries of goods and services, international
and international agencies. service transactions (i.e. tourism,
transportation and royalty fees) and
The principal items on the debit side international unilateral transfers (i.e.
include imports of goods and services, gifts and foreign aid).
transfer payments to foreigners, lending
to foreign countries, investments by b) The Capital Account: Financial
residents in foreign countries and official transactions consisting of direct
purchase of reserve assets or gold from investment and purchases of interest-
foreign countries and international bearing financial instruments, non-
agencies. interest bearing demand deposits and
gold fall under the capital account.
7.8.3. Components of BOPs
c) The Official Reserve Assets Account:
The credit and debit items are shown Official reserve transactions consist of
vertically in the BOP account of a country. movements of international reserves by
Horizontally, they are divided into three governments and official agencies to
categories, i.e. accommodate imbalances arising from
a) The current account, the current and capital accounts.
b) The capital account and
The official reserve assets of a country
c) The official settlements account or include its gold stock, holdings of its
official reserve assets account. convertible foreign currencies and Special
Drawing Rights (SDRs) and its net
a) The Current Account: It includes position in the International Monetary
all international trade transactions Fund (IMF).
Balance of Payment (BOP) Account Chart

Credit (Receipts) – Debit (Payments) = Balance [Deficit (-) , Surplus (+)]

Deficit if Debit > Credit

7.8.4. Balance of Payments

B.O.P DISEQUILIBRIUM
Disequilibrium Occurs when:
Demand ≠ Supply
The BoP is said to be balanced when
Debit > Credit → Deficit
the receipts (R) and payments (P) are just
equal, i.e,
Disequilibrium
R / P =1.

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 Favourable BoP balance of payments disequilibrium.
Such structural changes include
When receipts exceed payments, the
development of alternative sources
BoP is said to be favourable. That is,
of supply, development of better
R / P > 1. substitutes, exhaustion of productive
resources or changes in transport routes
Unfavourable BOP and costs.

When receipts are less than payments, 7.8.6. Causes for BoP Disequilibrium
the BoP is said to be unfavourable or
adverse.That is The following are the major causes
producing disequilibrium in the balance
R / P < 1. of payments of a country.
1. Cyclical Fluctuation: Cyclical
7.8.5. Types BOP Disequilibrium:
disequilibrium in different countries
There are three main types of BOP is caused by their cyclical fluctuations,
Disequilibrium, which are discussed their phases and magnitude. World
below. trade shrinks during depression while
trade flourishes during prosperity
(a) Cyclical Disequilibrium,
(b) Secular Disequilibrium, 2. Structural Changes: Structural
disequilibrium is caused by the structural
(c) Structural Disequilibrium.
changes brought by huge development
a) Cyclical Disequilibrium: Cyclical and investment programmes in
disequilibrium occurs because of two the developing economies. Such
reasons. First, two countries may be economies may have high propensity
passing through different phases of to import for want of capital for rapid
business cycle. Secondly, the elasticities industrialization, while export may not
of demand may differ between be boosted up to that extent.
countries.
3. Development Expenditure:
b) S ecular Disequilibrium: The secular or Development disequilibrium is caused
long-run disequilibrium in BOP occurs by rapid economic development which
because of long-run and deep seated results in income and price effects.
changes in an economy as it advances The less developed countries in the
from one stage of growth to another. early stage of development are not
In the initial stages of development, self sufficient. Income, savings and
domestic investment exceeds domestic investment are abysmally low. They
savings and imports exceed exports, as depend upon developed countries for
it happens in India since 1951. import of commodities, capital and
technology. Export potential is low and
c) Structural Disequilibrium: Structural
import intensity is high. So the LDCs
changes in the economy may also cause
suffer from adverse BoP.
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 4. Consumerism: Balance of payments their export earnings and creating trade
position of a country is adversely affected deficit. Thus UDCs are trapped forever.
by a huge increase in consumption.
This increases the need for imports and 7.8.7. Measures to Correct BOP
decreases the capacity to export. Disequilibrium
5. Demonstration Effect: Deficit Measures to Correct Bop
in the balance of payments of Disequilibrium
developing countries is also caused by
Depreciation
demonstration effect which influences Export
Devaluation
the people in UDCs to imitate western
styled goods. This will raise the Import control
propensity to import causing adverse Export promotion
balance of payments. This is good for
the developed countries.
Exchange controls
Import
Production of import substitutes

6. Borrowing: International borrowing Monetary policy

and investment may cause a deficit in Capital import
the balance of payments. When the
international borrowing is heavy, a There are a number of measures
country’s balance of payments will available for correcting the balance
be adverse since it repays loans with of payments disequilibrium. They are
interest. Servicing of debt is a huge divided into two broad groups, namely,
burden. That is why the UDCs are (i) automatic correction and (ii) deliberate
forced to borrow more. measures.

I. Automatic Correction
7. Technological Backwardness: Due to
technological backwardness, the people If the market forces of demand
(Indians) are unable to use the energy and supply are allowed to play freely,
(Solar) available with them. As a result equilibrium will be automatically restored
they import huge petroleum products in course of time. Under the free exchange
from foreign countries, increasing the rate system, the automatic adjustments of
trade deficit. the balance of payments can take place
through changes in the variables like
8. Global Politics: The rich countries price, interest, income and capital flows.
(Eg. USA) need to sell their weapons
to promote their economy and generate 1. Price Adjustments
employment. Hence, wars between
As a result of foreign exchange
countries (for example Iran and Irag,
outflow from a deficit country to a surplus
Pakistan and India) are stimulated
country, there will be a fall in the money
In order to win the wars, the poor
supply in the deficit country and increase
countries are forced to buy the weapons
in the money supply in the surplus country.
from weapon – rich countries, using
This will result in rise in the price in the
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 surplus country which will encourage deficit country will encourage investors
imports and discourage exports. Fall in to withdraw their funds from abroad and
prices in the deficit country will encourage invest in their home country. The opposite
exports and discourage imports, leading happens in the surplus country.
to restoration of BoP equilibrium.
3. Income Adjustments
2. Interest Rate Adjustments A nation with payments surplus
The contraction or expansion of will experience rising income which
money supply resulting from the BoP will increase imports and thereafter
deficit or surplus leads to a rise or fall in the equilibrium is restored in Balance of
interest rates. A rise in interest rate in the Payments.

Correction of Balance of payment Disequilibrium

Automatic Correction Deliberate Measures

1. Price adjustments
2. Interest rate adjustments
3. Income adjustments
4. Capital flows

Miscellaneous Measures
Monetary measures 1. Foreign Loans
1. Monetary Contraction / Expansion 2. Incentives for Foreign investment
2. Devaluation/ revaluation 3. Tourism Development
3. Exchange Control 4. Incentives for foreign remittances
5. Import Substitution

Trade Measures

Export Promotion Import Control

1. Abolition / reduction of duties 1. Import Duties
2. Export Subsidies 2. Import Quotas
3. Export Incentives 3. Import Prohibition

4. Capital Flows II. Deliberate Measures

Changes in the interest rate The deliberate measures may be
consequent to the BoP disequilibrium broadly grouped into (a) monetary
will encourage capital flows from the measures (b) trade measures and
surplus nations to deficit nations helping (c) miscellaneous measures.
restoration of the BoP equilibrium.
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 a. Monetary Measures 3. Exchange Control
1. Monetary Contraction Exchange control means the state
High domestic price level is intervention in the forex market. It is a
responsible for high imports and low popular method employed to influence the
exports. In order to control inflation, balance of payments position of a country.
the central monetary authority controls Under exchange control, the government
credit. As a result, the prices come down or central bank assumes complete control
and exports increase. This will help to over the foreign exchange reserves and
correct adverse BoP. However, if credit earning of the country. The recipients
is controlled, investment will decline, of foreign exchange, like exporters, are
production will go down, prices will required to surrender foreign exchange to
increase. This is the cause of confusion the government / central bank in exchange
between government and RBI in India in for domestic currency. By virtue of its
2010s. control over the use of foreign exchange,
the government can control imports.
2. Devaluation Does it happen in India? Too much of
Devaluation means deliberate imports control would invite more and
reduction of the official rate at which more smuggled goods. Smuggling of gold
domestic currency is exchanged for into Indian airports regularly happens, as
another currency. In other words, per the reports in the media.
devaluation refers to a reduction in the
III. Trade Measures
external value of a currency in the terms
of other currencies. For instance, instead Trade measures include measures to
of 70 ₹ per US$, making ₹ 80 per US$. promote exports and to reduce imports.
Devaluation of Indian Currency 1. Export Promotion
Indian rupee was devalued
three times since 1947. Exports may be encouraged by
i).reducing or abolishing export duties, ii).
1. On 29th September, 1949. providing export subsidy, iii).encouraging
2. On 6th June, 1966
export production by giving monetary,
3. On 1st July, 1991
fiscal, physical and institutional incentives.
A country with fundamental (Then local people and domestic industries
disequilibrium in the balance of payments would suffer)
may devalue its currency in order to
2. Import Control
stimulate its exports and discourage
imports to correct the disequilibrium. Imports may be controlled by
Devaluation makes exports cheaper i).imposing or enhancing import duties,
and imports dearer. That means making ii).restricting imports through import
Indian good cheaper for foreigners, and quotas, iii).licensing and even prohibiting
foreign goods costlier for Indians. altogether the import of certain non-

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 essential items. But this would encourage price paid in the home currency (say ₹ 75)
smuggling. for a unit of foreign currency (say 1 US $).
It can be quoted in two ways:
IV. Miscellaneous Measures
1. One unit of foreign money (1 USD) to
In addition to the measures
so many units of the domestic currency
mentioned above, there are a number
(₹); or
of other measures that can help make
the balance of payments position 2. A certain number of units of foreign
more favourable, like i). foreign loans, currency (USD)to one unit of domestic
ii).encouraging foreign investment in the money (₹ 1)
home country, iii).development of tourism For instance:
to attract foreign tourists, iv).providing 1 U.S Dollar = ₹ 70 , or
incentives to enhance inward remittances ₹ 1 = U.S.1.42 cents
and v). import substitution.
7.9
Exchange Rate

7.9.1 Meaning of Foreign Exchange �1 = $1 => 1947

(FOREX)
FOREX refers to foreign currencies.
The mechanism through which payments
�70 = $1 => 2018
are effected between two countries having
different currency systems is called FOREX Exchange Rate
system . It covers methods of payment, The rate at which one country's currency can
rules and regulations of payment and the be traded for another country's currency
institutions facilitating such payments.

7.9.2 Definition of FOREX

“FOREX is the system or process
of converting one national currency into
another, and of transferring money from 7.9.4. Definition of Equilibrium
one country to another”. Exchange Rate
“The equilibrium exchange rate is
7.9.3 Rate of Exchange that rate, which over a certain period of
The transactions in the exchange time, keeps the balance of payments in
market are carried out at exchange rates. It equilibrium”.
is the external value of domestic currency. - Ragner Nurkse
Thus, exchange rate may be defined as the

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 1. Fixed Exchange Rates
7.9.5. Determination
of Equilibrium Countries following the fixed
Exchange Rate exchange rate (also known as stable
exchange rate and pegged exchange rate)
The equilibrium rate
system agree to keep their currencies
of exchange is determined
at a fixed rate as determined by the
in the foreign exchange market in
Government. Under the gold standard,
accordance with the general theory of
the value of currencies was fixed in terms
value, i.e., by the interaction of the forces
of gold.
of demand and supply. Thus, the rate of
exchange is determined at the point where 2. Flexible Exchange Rates
demand for forex is equal to the supply of
forex. Under the flexible exchange rate (also
known as floating exchange rate) system,
Y
exchange rates are freely determined in an
of exchange rate) or external
Dollar value of Rupee (Price

value of Rupee in term of $

D Excess Demand S
open market by market forces of demand
P1
a b and supply.
E
P2
7.9.7. Types of Exchange Rates
c d
P3 Exchange rates are also in the form
S D
Excess Supply of (a) Nominal exchange rate (b) Real
0 Q x exchange rate (c) Nominal Effective
Quantities of Foreign Exchange Exchange Rate (NEER) and (d) Real
Figure 7.3 Demanded and Supplied Effective Exchange Rate (REER)

In the above diagram, Y axis If 1 US Dollar = ₹ 75,

represents exchange rate, that is, value of Nominal exchange rate = 75/1 = 75.
rupee in terms of dollars. X axis represents This is the bilateral nominal exchange
demand and supply of forex. E is the point rate.
of equilibrium where DD intersects SS.
The exchange rate is P2. ePf
Real Exchange rate =
P
7.9.6. Types of Exchange Rate Systems
Broadly, there are two major P = Price levels in India
exchange rate systems, namely, (1) fixed Pf = Price levels in abroad (say US)
(or pegged) exchange rate system and
(2) flexible (or floating) exchange rate e = nominal exchange rate.
system. Managed Floating Exchange Rate If a pen costs ₹ 50 in India and it costs 5
system also prevails in some countries USD in the US,
(like India). 75x5
Real Exchange Rate = = 7.5
50
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 If real exchange rate is equal to 1, the 2. Differentials in Interest Rates
currencies are at purchasing power
There is a high degree of correlation
parity.
between interest rates, inflation and
It the price of the pen in US is 0.66 USD, exchange rates. Central banks can
0.66x75 influence over both inflation and
then the real exchange rate = 1
50 exchange rates by manipulating interest
then it could be said that the USD and rates. Higher interest rates attract foreign
Indian rupee are at purchasing power capital and cause the exchange rate to rise
parity. and vice versa.
NEER and REER are not explained here. 3. Current Account Deficits
Interested students and teachers can A deficit in the current account
search for them. implies excess of payments over receipts.
The country resorts to borrowing
7.9.8. Determinants of Exchange Rates capital from foreign sources to make up
the deficit. Excess demand for foreign
Exchange rates are determined by currency lowers a country’s exchange rate.
numerous factors and they are related to
the trading relationship between two 4. Public Debt
countries.
Large public debts are driving out
foreign investors, because it leads to
Factors determining Exchange Rate

1. Differentials in Inflation
inflation. As a result, exchange rate will
2. Differential in Interest Rates be lower.
3. Current Account Deficits
5. Terms of Trade
4. Public Debt
A country’s terms of trade also
5. Terms of Trade
determines the exchange rate. If the price
6. Political and Economic Stability of a country’s exports rises by a greater rate
7. Recession than that of its imports, its terms of trade
will improve. Favorable terms of trade
8. Speculation
imply greater demand for the country’s
exports and thus BoP becomes favorable.
1. Differentials in Inflation
6. Political and Economic Stability
Inflation and exchange rates are
inversely related. A country with a If a nation’s political climate is stable
consistently lower inflation rate exhibits and economic performance is good, its
a rising currency value, as its purchasing currency value will be appreciated by
power increases relative to other attracting more foreign capital.
currencies.

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 7. Recession
An investment becomes foreign
Interest rates are low during the investment when..
recession phase. This will decrease
inflow of foreign capital. As a result, a Foreign
currency will be depreciated against other Investment
through
currencies, thereby lowering the exchange
rate.

8. Speculation Foreign Foreign

Direct Institutional
If a country’s currency value is Investments Investors
expected to rise, investors will demand
more of that currency in order to make
Investment done by citizens and government
a profit in the near future. This results
of one country (home country) in industries
in appreciation of the exchange rate. of another country (host country).
Beside the above determinants, relative
dominance in the global politics and the
When the export earnings of a
power to announce economic sanctions
country are not sufficient to finance for
over other countries also determine
imports, FDI may be required to fill the
exchange rates.
trade gap.
7.10
Foreign Direct Investment FDI is encouraged by the factors
(FDI) and Trade such as foreign exchange shortage, desire
to create employment and acceleration of
FDI is an important factor in global the pace of economic development. Many
economy. Foreign trade and FDI are developing countries strongly prefer
closely related. In developing countries foreign investment to imports. However,
like India, FDI in the natural resource the real impact of FDI on different
sector, including plantations, increases sections of an economy (say India) may
trade volume. Foreign production by FDI differ. It could be a boon for some as well
is useful to substitute foreign trade. FDI is as bane for others. This may be discussed
also influenced by the income generated in the class – room. Large demand for
from the trade and regional integration USD, generated by IMF and World Bank
schemes. policies (FUND – BANK POLICIES), help
the USD to gain value continuously. This
FDI is helpful to accelerate the is one of the hidden agenda of Fund –
economic growth by facilitating essential Bank policies.
imports needed for carrying out
development programmes like capital 7.10.1 Meaning of FDI
goods, technical know-how, raw materials
and other inputs and even scarce consumer FDI means an investment in a foreign
goods. country that involves some degree of
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 control and participation in management. The important advantages of foreign
It corresponds to the investment made direct investment are the following:
by a multinational enterprise in a foreign
1. FDI may help to increase the investment
country. It is different from portfolio
level and thereby the income and
investment, which is primarily motivated
employment in the host country.
by short term profit and it does not seek
management control. 2. Direct foreign investment may facilitate
transfer of technology to the recipient
Foreign Portfolio Investment (FPI) country.
means the entry of funds into a nation 3. 
FDI may also bring revenue to the
where foreigners deposit money in a government of host country when it
nation’s bank or make purchase in the taxes profits of foreign firms or gets
stock and bond markets, sometimes royalties from concession agreements.
for speculation. FPI is part of capital
account of BoP. 4. 
A part of profit from direct foreign
investment may be ploughed back
into the expansion, modernization or
development of related industries.
7.10.2 Objectives of FDI
5. It may kindle a managerial revolution
FDI has the following objectives. in the recipient country through
1. Sales Expansion professional management and
sophisticated management techniques.
2. Acquisition of resources
3. Diversification 6. Foreign capital may enable the country
4. Minimization of competitive risk. to increase its exports and reduce
import requirements. And thereby ease
BoP disequilibrium.
Foreign Institutional Investment (FII)
is an investment in hedge funds, 7. 
Foreign investment may also help
insurance companies, pension funds increase competition and break
and mutual funds. Foreign institutional domestic monopolies.
investment is a common term in the
financial sector of India. For example, 8. If FDI adds more value to output in the
a mutual fund in the United States can recipient country than the return on
make investment in an India-based capital from foreign investment, then
company. the social returns are greater than the
private returns on foreign investment.

7.10.3 Advantages of FDI 9. By bringing capital and foreign exchange

FDI may help in filling the savings gap
Foreign investment mostly takes the and the foreign exchange gap in order
form of direct investment. Hence, we deal to achieve the goal of national economic
here with the foreign direct investment. development.

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 10. 
Foreign investments may stimulate 6. Foreign investment in some cases leads
domestic enterprise to invest in to the destruction or weakening of
ancillary industries in collaboration small and medium enterprises.
with foreign enterprises.
7. 
S ometimes foreign investment can
11. L astly, FDI flowing into a developing result in the dangerous situation of
country may also encourage its minimizing / eliminating competition
entrepreneurs to invest in the other and the creation of monopolies or
LDCs. Firms in India have started oligopolistic structures.
investing in Nepal, Uganda, Ethiopia 8.`Often, there are several costs associated
and Kenya and other LDCs while with encouraging foreign investment.
they are still borrowing from abroad.
Larger FDI to India comes from a
7.10.5. FDI in India
small country (Mauritius).
The early 1991 witnessed reforms in
7.10.4. Disadvantages of FDI the economic policy. This helped to open
up Indian markets to FDI. FDI in India
The following criticisms are leveled has increased over the years. In India,
against foreign direct investment. FDI has been advantageous in terms of
1. Private foreign capital tends to flow to free flow of capital, improved technology,
the high profit areas rather than to the management expertise and access to
priority sectors. international markets.

2. 
The technologies brought in by the The major sectors benefited from FDI in
foreign investor may not be appropriate India are:
to the consumption needs, size of the
(i) f inancial sector (banking and
domestic market, resource availabilities,
non-banking)
stage of development of the economy,
etc. (ii) insurance
(iii) telecommunication
3. 
Foreign investment, sometimes, have
(iv) hospitality and tourism
unfavorable effect on the Balance of
Payments of a country because when (v) pharmaceuticals and
the drain of foreign exchange by way (vi) s oftware and information
of royalty, dividend , etc. is more than technology.
the investment made by the foreign
concerns. FDI is not permitted in the industrial
sectors like
4. Foreign capital sometimes interferes in
the national politics. (i) Arms and ammunition
(ii) atomic energy,
5. Foreign investors sometimes engage in
(iii) railways,
unfair and unethical trade practices.

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 (iv) coal and lignite and and BRICS which play a vital role in
(v) m
 ining of iron, manganese, international trade are covered in the next
chrome, gypsum, sulphur, gold, chapter.
diamonds, copper etc., Think and Do
FDI inflow in India has increased 1. Suppose the exchange rate between
from $97 million in 1990-91 to $5,535 Indian Currency and US Dollar is
million in 2004-2005. It amounted to ₹1= $65. If it changes to ₹1 = $55, the
$32,955 million in 2011-2012. UNCTAD’s value of which currency increased
World Investment Report 2018 reveals and decreased?
that FDI to India declined to $40 billion
2. Suppose a doctor from England is
in 2017 from $44 billion in 2016.
invited to diagnose the health status
of a VIP in our State. The fees which
Summary we pay to the doctor are entered in to
International Economics is a which account of the BOPs Account?
valuable branch of Economics dealing
with how trade benefits nations Several Glossary
theories have been propounded on causes � I nternational Economics: A special
of international trade starting from Adam branch of Economics which primarily
Smith. The controversy over the need for deals with the basics of international
a separate theory has been resolved by the trade.
Modern Theory of International Trade.
The gains from trade, Terms of Trade, � I nternal Trade: A trade within the
Balance of Payments constitute the major geographical boundary of a particular
areas of discussion. nation.

The Exchange rate, either fixed or � I nternational Trade: A trade between

flexible is a major factor determining two or more countries and it is a trade
the economic strength of the nation. beyond the geographical and political
In the line of foreign trade and foreign boundaries.
capital, foreign investment (especially � A
 bsolute Cost Differences: The
FDI) plays a major role in determining difference in the actual costs of
economic development of Less Developed production of a commodity between
Countries and developing countries. two nations.
international trade has helped the
economically developed countries largely � C
 omparative Cost Differences:
and disappointed many african and asian The difference in the absolute costs
countries. of production of two commodities
between two countries.
The international economic
organizations such as IMF, IBRD and � F
 actor Endowment: Abundance in the
WTO and the trade blocs SAARC, ASEAN availability of a factor in a country.

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 � T
 erms of Trade: The rate at which � E
 xchange Rate: The rate at which one
goods of one country are exchanged currency is exchanged for another
for that of another country ie ratio of currency.
export price and import price.
� F
 ixed Exchange Rates: An exchange
� B
 alance of Trade: The balance rate that is held within a narrow band
between the values of goods exchanged by the monetary authorities..
between two countries. It is a trade
� F
 lexible Exchange Rates: Flexible
in merchandise items or visible items
exchange rates are freely determined
only.
in an open market primarily by private
� B
 alance of Payments: The balance dealings, and they, like other market
between the values of goods and prices, vary from day by day.
services exchanged between two
� F
 oreign Direct Investment: The
countries. It is a trade in both visible
investment made by a multinational
and non-visible items.
enterprise in a foreign country and an
� D
 evaluation: It means official investment in a foreign country that
reduction in the value of a currency in involves some degree of control and
terms of gold or other currencies. participation in management.
� F
 oreign Exchange: The currency of
another country.

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 MODEL QUESTIONS
Part A
Multiple Choice Questions

1. Trade between two countries is known 5. Which of the following is a modern

as ………….trade theory of international trade?

a) External a) absolute cost

b) Internal b) comparative cost
c) Inter-regional c) Factor endowment theory
d) Home d) none of these

2. Which of the following factors influence 6. Exchange rates are determined in

trade? a) money market
a) T
 he stage of development of a b) foreign exchange market
product c) stock market
b) T
 he relative price of factors of d) capital market
productions.
7. 
Exchange rate for currencies is
c) Government. determined by supply and demand
d) All of the above. under the system of

3. 
International trade differs from a) Fixed exchange rate
domestic trade because of b) Flexible exchange rate
c) Constant
a) Trade restrictions d) Government regulated
b) Immobility of factors
c) Different government policies 8. Net export equals ……
d) All the above
a) Export x Import
4. In general, a primary reason why nations b) Export + Import
conduct international trade is because c) Export – Import
a) Some nations prefer to produce d) Exports of services only
one thing while others produce
9. Who among the following enunciated
another
the concept of single factoral terms of
b) Resources are not equally
trade?
distributed among all trading
nations a) Jacob Viner
c) Trade enhances opportunities to b) G.S.Donens
accumulate profits c) Taussig
d) Interest rates are not identical in d) J.S.Mill
all trading nations

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 10. 
Terms of Trade of a country show 15. In the case of BOT,
……………
a) 
Transactions of goods are
a) R
 atio of goods exported and recorded.
imported b) Transactions of both goods and
b) Ratio of import duties services are recorded.
c) R
 atio of prices of exports and c) B oth capital and financial accounts
imports are included.
d) Both (a) and (c) d) All of these

11. 
Favourable trade means value of 16. 
Tourism and travel are classified
exports are ……. Than that of imports. in which of balance of payments
a) More accounts?
b) Less a)merchandise trade account
c) More or Less b) services account
d) Not more than c)unilateral transfers account
d) capital account
12. If there is an imbalance in the trade
balance (more imports than exports), 17.Cyclical disequilibrium in BOP occurs
it can be reduced by because of
a) decreasing customs duties a) Different paths of business cycle.
b) increasing export duties b) The income elasticity of demand
c) stimulating exports or price elasticity of demand is
d) stimulating imports different.
13. BOP includes c) long-run changes in an economy
d) Both (a) and (b).
a) visible items only
b) invisible items only 18. 
Which of the following is not an
c) both visible and invisible items example of foreign direct investment?
d) merchandise trade only a) 
the construction of a new auto
assembly plant overseas
14. C omponents of balance of payments
b) the acquisition of an existing steel
of a country includes
mill overseas
a) Current account c) 
the purchase of bonds or stock
b) Official account issued by a textile company
c) Capital account overseas
d) All of above d) the creation of a wholly owned
business firm overseas

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 19. 
Foreign direct investments not 20 Benefits of FDI include, theoretically
permitted in India
a) Boost in Economic Growth
a) Banking b) Increase in the import and export
b) Automic energy of goods and services
c) Pharmaceutical c) 
Increased employment and skill
d)Insurance levels
d) All of these
Answers

1 2 3 4 5 6 7 8 9 10
a d d b c b b c a c
11 12 13 14 15 16 17 18 19 20
a c c d a b d c b d

Part B
Answer the following questions. Each question carries 2 marks.
21. What is International Economics?
22. Define international trade.
23. State any two merits of trade.
24. What is the main difference between Adam Smith and Ricardo with regard to the
emergence of foreign trade?
25. Define Terms of Trade.
26. What do you mean by balance of payments?
27. What is meant by Exchange Rate?

Part C
Answer the following questions. Each question carries 3 marks.
28. Describe the subject matter of International Economics.
29. C
 ompare the Classical Theory of international trade with Modern Theory of
International trade.
30. Explain the Net Barter Terms of Trade and Gross Barter Terms of Trade.
31. Distinguish between Balance of Trade and Balance of Payments.
32. What are import quotas?
33. Write a brief note on flexible exchange rate.
34. State the objectives of Foreign Direct Investment.

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 Part D
Answer the following questions. Each question carries 5 marks.
35. Discuss the differences between Internal Trade and International Trade.
36. Explain briefly the Comparative Cost Theory.
37. Discuss the Modern Theory of International Trade.
38. Explain the types of Terms of Trade given by Viner.
39. Bring out the components of balance of payments account.
40. Discuss the various types of disequilibrium in the balance of payments.
41. How the Rate of Exchange is determined? Illustrate.
42. 
Explain the relationship between Foreign Direct Investment and economic
development

ACTIVITY
1. S tudents may be brought to any firm or industry which is
involved in foreign trade to make them know the different
procedures followed and activities done.
2. S tudents may be grouped as countries and directed to have a
look at some available goods to be exchanged between them as if
they involve in foreign trade.

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 References

1. Bhargava, B.K (1992). Competition Success Review Economics for Civil Services
Preliminary Examination, Sudha Publications Pvt. Ltd, New Delhi, 405 – 630.
2. Francis Cherunilam (2009). International Economics, Tata McGraw Hill Education
Pvt. Ltd, New Delhi, 3-26,122-190, 357-373, 410-426.
3. Jhingan, M.L (2011). International Economics, Vrinda Publications (Pvt.) Ltd,
Delhi, 295.
4. Mithani, D.M (2015). International Economics, Himalaya Publishing House, New
Delhi, 1 – 250.
5. Neelamegam, V (2010). International Trade, Vrinda Publications (P) Ltd, Delhi,
1-160.
6. Sundharam, K.P.M (1986). Money, Banking, Trade and Finance, Sulthan Chand
and Sons, New Delhi, 4.1 – 4.94.
7. True Man Book Company (2005). UGC NET / SET Economics, Danika Publishing
Company, New Delhi, 156 – 205.

Websites

1. h ttp://www.studyingeconomics.ac.uk/module-options/international-
economics/
2. http://cis01.central.ucv.ro/iba/files/summary.pdf
3. https://www.thoughtco.com/definition-of-international-economics-1146350
4. h ttps://keydifferences.com/difference-between-balance-of-trade-and-
balance-of-payment.html
5. https://www.youtube.com/watch?v=IKDfze_KodA
6. https://www.investopedia.com/terms/f/foreign-portfolio-investment-fpi.asp
7. https://www.investopedia.com/terms/f/fii.asp
8. http://www.eiiff.com/investment/foreign-institutional.html
9. https://connectusfund.org/17-big-advantages-and-disadvantages-of-foreign-
direct-investment.

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 CHAPTER

8 International Economic
Organisations

“Foreign capital infinitely prefers situations where the upside potential

is vast, if risks must be taken to get in”.
– Rudi Dorbush

Learning Objectives

1 To understand the role of international economic organizations in enhancing

the magnitude of global business.

2 To know the objectives, functions and achievements of International

Monetary Fund, World Bank and World Trade Organisation.

3 To study about the trade blocks, viz., SAARC, ASEAN and BRICS and their
objectives, functions and achievements.
8.1
Introduction
In the previous chapter, we have
studied the basis of trade, gains from
trade, terms of trade, BoP and foreign
exchange. When trade takes place among
countries, the developed countries always
stand to gain and the LDCs suffer from
adverse terms of trade as well as balance of
payments and they affect their exchange
rates. The Great Depression of 1930s and
World War II led to purely nationalistic
John Maynard Keynes (right) and
policies in which almost every country
Harry Dexter White, the “founding
imposed trade restrictions, exchange
fathers” of both the World Bank and the
controls and exchange depreciation so as
International Monetary Fund (IMF)
to boost exports and to restrict imports
considerably.

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 The Brettonwoods Conference proposed IMF, World Bank and International Trade
Organisation (ITO) in 1944. The IMF and World Bank were started in 1945. Instead of
ITO, an interim arrangement was made and named GATT (General Agreement on Tariff
and Trade). The GATT was transformed into WTO (World Trade Organisation) from
1995. The IMF, IBRD and WTO headquarters are presented in the table.

Institution Headquarters Year of Establishment

International Monetary Fund Washington D.C 1945

World Bank Washington D.C 1945
World Trade Organisation Geneva 1995

8.2 iii) To ensure exchange rate stability

International Monetary Fund by curbing competitive exchange
depreciations.
The purpose of International
Monetary Fund is to secure and promote iv) To eliminate or reduce exchange
economic and financial cooperation controls imposed by member nations.
among member countries. The IMF was v) To establish multilateral trade and
established to assist the member nations payment system in respect of current
to tide over the Balance of Payments transactions instead of bilateral trade
disequilibrium in the short term. At agreements.
present, the IMF has 189 member
countries with Republic of Nauru joined vi) To promote the flow of capital from
in 2016. developed to developing nations.
vii) To solve the problem of international
liquidity.

8.2.2 Functions Of IMF

Exchange Stability
BoP crisis
assistance
8.2.1. Objectives Of IMF IMF
Functions
i) To promote international monetary
cooperation among the member nations. Facilitate
Foster sustainable
international
ii) To facilitate faster and balanced growth economic growth
trade
of international trade.

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 i) Bringing stability in exchange rate v) Reducing trade restrictions
The IMF is maintaining exchange The Fund also aims at reducing
rate stability and emphasising devaluation tariffs and other trade barriers imposed
criteria, restricting members to go in for by the member countries with the purpose
multiple exchange rates and also to buy or of removing restrictions on remittance of
sell gold at prices other than declared par funds or to avoid discriminating practices.
value.
vi) Providing credit facilities
ii) Correcting BOP Disequilibrium
IMF is providing different borrowing
The IMF is helping the member and credit facilities with the objective of
countries in eliminating or minimizing helping the member countries. These credit
the short-period disequilibrium in their facilities offered by it include basic credit
balance of payments either by selling or facility, extended fund facility for a period
lending foreign currencies to the member of three years, compensatory financing
nation. facility and structural adjustment facility.

iii) Determining par values The functions of the IMF are grouped
under three heads.
IMF enforces the system of
determination of par values of the 1. Financial – Assistance to correct short
currencies of the member countries. and medium term deficit in BOP;
According to the Articles of Agreement
2. R
 egulatory – Code of conduct and
of the IMF, every member nation should
declare the par value of its currency in 3. C onsultative - Counseling and technical
terms of gold or US dollars. Under this consultancy.
article, IMF ensures smooth working of
the international monetary system, in 8.2.3 Facilities offered by IMF
favour of some developed countries.
The Fund has created several new credit
iv) 
Balancing demand and supply of facilities for its members. Chief among
currencies them are:
IMF is entrusted with the important (i) Basic Credit Facility:
function of maintaining balance between
demand and supply of various currencies. The IMF provides financial assistance
The Fund (IMF) can declare a currency as to its member nations to overcome their
scarce currency which is in great demand temporary difficulties relating to balance
and can increase its supply by borrowing of payments. A member nation can
it from the country concerned or by purchase from the Fund other currencies
purchasing the same currency in exchange or SDRs, in exchange for its own currency,
of gold. to finance payment deficits. The loan is
repaid when the member repurchases its

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 own currency with other currencies or (iii) Compensatory Financing Facility
SDRs. A member can unconditionally
In 1963, IMF established
borrow from the Fund in a year equal to
compensatory financing facility to provide
25% of its quota. This unconditional
additional financial assistance to the
borrowing right is called the reserve
member countries, particularly primary
tranche.
producing countries facing shortfall in
export earnings. In 1981, the coverage of
Special Drawing Rights (SDRs) the compensatory financing facility was
The Fund has succeeded in extended to payment problem caused by
establishing a scheme of Special the fluctuations in the cost of cereal inputs.
Drawing Rights (SDRs) which is
(iv) Buffer Stock Facility
otherwise called ‘Paper Gold’. They
are a form of international reserves The buffer stock financing facility
created by the IMF in 1969 to solve was started in 1969. The purpose of this
the problem of international liquidity. scheme was to help the primary goods
They are allocated to the IMF members (food grains) producing countries to
in proportion to their Fund quotas. finance contributions to buffer stock
SDRs are used as a means of payment arrangements for the stabilisation of
by Fund members to meet balance primary product prices.
of payments deficits and their total
reserve position with the Fund. Thus (v) Supplementary Financing Facility
SDRs act both as an international unit
Under the supplementary financing
of account and a means of payment. All
facility, the IMF makes temporary
transactions by the Fund in the form of
arrangements to provide supplementary
loans and their repayments, its liquid
financial assistance to member countries
reserves, its capital, etc., are expressed
facing payments problems relating to their
in the SDR.
present quota sizes.
The achievements of the fund can
(vi) Structural Adjustment Facility
be summed up in the words of Haien
that ‘Fund is like an International The IMF established Structural
Reserve Bank.’ Adjustment Facility (SAF) in March 1986
to provide additional balance of payments
(ii) Extended Fund Facility assistance on concessional terms to the
poorer member countries. In December
Under this arrangement, the IMF 1987, the Enhanced Structural Adjustment
provides additional borrowing facility Facility (ESAF) was set up to augment the
up to 140% of the member’s quota, over availability of concessional resources to
and above the basic credit facility. The low income countries. The purpose of SAF
extended facility is limited for a period up and ESAF is to force the poor countries
to 3 years and the rate of interest is low. to undertake strong macroeconomic

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 and structural programmes to improve
their balance of payments positions and 8.2.5. India and IMF
promote economic growth.
Till 1970, India stood fifth in the
Fund and it had the power to appoint a
8.2.4. Achievements Of IMF
permanent Executive Director. India has
The main achievements of been one of the major beneficiaries of the
International Monetary Fund are as Fund assistance. It has been getting aid
follows: from the various Fund Agencies from time
to time and has been regularly repaying its
i) 
Establishment of monetary reserve debt. India’s current quota in the IMF is
fund SDRs (Special Drawing Rights) 5,821.5
million, making it the 13th largest quota
The Fund has played a major role in
holding country at IMF with shareholdings
achieving the sizeable stock of the national
of 2.44%. Besides receiving loans to meet
currencies of different countries. To meet
deficit in its balance of payments, India
the foreign exchange requirements of the
has benefited in certain other respects
member nations, IMF uses its stock to
from the membership of the Fund.
help the member nations to meet foreign
exchange requirements.
What is SDR?
ii) 
Monetary discipline and  Fiat Money of the IMF
cooperation  A
 Potential Claim on Underlying
Currency Basket
The IMF has shown keen interest
in maintaining monetary discipline What Does SDR Stand For?
and cooperation among the member
 Special Drawing Rights (SDR)
countries. To achieve this objective, it
has provided assistance only to those Why Was the SDR Created?
countries which make sincere efforts to
 To be “The” World Reserve Currency
solve their problems.
 Create Global Liquidity
iii) Special interest in the problems of How is the SDR Valued?
UDCs
 Original 1969 Creation
The notable success of the Fund is
the maintenance of special interest in the “The value of the SDR was
acute problems of developing countries. initially defined as equivalent to
The Fund has provided financial assistance 0.888671 grams of fine gold - which,
to solve the balance of payment problem at the time, was also equivalent to one
of UDCs. However, many UDCs continue U.S. dollar.”
to be UDCs, while the developed countries
have achieved substantial growth.

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 8.3 membership in International Monetary
Fund is a prerequisite to become a member
International Bank For
of IBRD. The IBRD was established to
Reconstruction And Development
provide long term financial assistance to
(IBRD) or World Bank
member countries.
The International Bank for
Reconstruction and Development (IBRD),
otherwise called the World Bank(WB)
was established in 1945 under the Bretton
Woods Conference in 1944. The purpose
is to bring about a smooth transition from
a war-time to peace-time economy. It is
known as a sister institution along with
the International Monetary Fund. The

World Bank Group

International Bank International International Multilateral International Centre

for Reconstruction Development Finance Investment for Settlement of
and Development Association Corporation Guarantee Agency Investment Disputes
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The following are the objectives of the

8.3.1. Objectives of IBRD World Bank:

1. To help member countries for economic

Objectives of the World Bank reconstruction and development.
2. To stimulate long-run capital investment
1. Reconstruction and Development for restoring Balance of Payments
2. Encouragement to Capital Investment (BoP) equilibrium and thereby ensure
balanced development of international
3. Encouragement to International Trade
trade among the member nations.
4. Establishment of Peace-time Economy
3. To provide guarantees for loans meant
5. Environmental Protection
for infrastructural and industrial
projects of member nations.
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 4. 
To help war ravaged economies 1. Investment for productive purposes
transform into peace economies.
The World Bank performs the
5. 
To supplement foreign private function of assisting in the reconstruction
investment by direct loans out of its and development of territories of member
own funds for productive purposes. nations through facility of investment for
productive purposes. It also encourages
World Bank’s Lending Procedure: the development of productive facilities
The Bank advances loans to members and resources in less developed countries.
in three ways
2. 
Balanced growth of international
i) Loans out of its own fund, trade
ii) Loans out of borrowed capital and Promoting the long range balanced
iii) Loans through Bank’s guarantee. growth of trade at international level
and the maintaining equilibrium in
The Bank(WB) has changed its BOPs of member nations by encouraging
development loan strategy and lays more international investment.
emphasis on financing schemes which
directly influence the well being of poor 3. Provision of loans and guarantees
masses of the member countries, especially
Arranging the loans or providing
the developing countries. The amount
guarantees on loans by various other
of agricultural loans has increased more
channels so as to execute important
rapidly than in any other sector. The bank
projects.
now also takes interest in the activities of
the development of rural areas such as: 4. P
 romotion of foreign private
investment
a) spread of education among the rural
people The promotion of private foreign
investment by means of guarantees on
b) development of roads in rural areas and
loans and other investment made by
c) electrification of the villages. private investors. The Bank supplements
private investment by providing finance
8.3.2 Functions of IBRD for productive purpose out of its own
resources or from borrowed funds.
The World Bank performs the major
role of providing loans for development 5. Technical services
works to member countries, especially
The World Bank facilitates different
to underdeveloped countries. The World
kinds of technical services to the member
Bank provides long-term loans for various
countries through Staff College and
development projects. Article 1 of the
experts.
Agreement states the functions performed
by the world bank as follows.

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 v) 
The International Development
8.3.3. Achievements of World Bank
Association (IDA), the Soft Loan
Window of the Bank provides loans
The World Bank is said to be successful
to UDCs at very low rate of interest.
in achieving its primary objective of
However, the economic inequality
reconstruction and development of war
among the member-countries goes on
ravaged nations. It helped greatly in
increasing. Many African countries are
the reconstruction of Europe after the
yet to improve their economic status.
World War II. It has been providing the
developed and developing countries the
8.3.4. India and World Bank:
same treatment in the process of growth.
The name “International Bank
i) It is noted that the Bank’s membership for Reconstruction and Development”
has increased from the initial number of was first suggested by India to the
30 countries to 68 countries in 1960 and drafting committee. Since then the two
to 151 countries in 1988. The IBRD has have developed close relationship with
189 member countries. each other from framing the policies
of economic development in India to
ii) 
The Bank grants medium and long-
financing the implementation of these
term loans (i.e., payable over a period
policies. The World Bank has given large
of 15-20 years) for reconstruction and
financial assistance to India for economic
development purposes to the member
development. Special mention may be
countries. The actual term of a loan
made of the assistance World Bank has
depends upon the estimated useful life
given to India in the development of
of the equipment or plant financed.
infrastructure such as electric power,
iii) Initially the World Bank’s loans were transport, communication, irrigation
mainly directed at the European projects and steel industry.
countries for financing their
The World Bank has assisted a
programmes of reconstruction. Later it
number of projects in India. The IFC
changed its development loan strategy
has identified five priority areas, namely,
and lays more emphasis of financing
capital market development, direct foreign
schemes for the poor masses of the
investment, access to foreign markets,
developing countries.
equity investments in new and expanding
iv) 
The World Bank grants loans to companies and infrastructure. The World
member countries only for productive Bank has also assisted India in accelerating
purposes particularly for agriculture, programmes of poverty alleviation and
irrigation, power and transport. In economic development. Until China
other words, the Bank strengthens became the member of World Bank in
infrastructure needed for further 1980, India was the largest beneficiary of
development. the World Bank assistance.

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 INDIA & IBRD : A Sustainable Relationship
 India is a member of four of the five constituents of the World Bank Group.
 International Bank for Reconstruction and Development(IBRD, 1945)
 International Development Association (IDA, 1960)
 International Finance Corporation (IFC, 1956)
 Multilateral Investment Guarantee Agency (MIGA, 1958)
 International Centre for Settlement of Investment Disputes (ICSID, 1966)
[India is not its member]
 India is one of the founder members of IBRD, IDA and IFC. World Bank
assistance in India started from 1948 when a funding for Agricultural Machinery
Project was approved.
 First investment of IFC in India took place in 1959 with US$ 1.5 million.
 India became a member of MIGA in January 1994.
 India has an Executive Director, in the Board of Directors of IBRD / IFC / IDA/
MIGA.

8.4 was held at Singapore in 1996. The recent

conference was held at Argentina in 2017.
World Trade Organization
It was planned to organize 12th ministerial
conference at Kazakhstan in 2020.
The WTO
was established in
1995 as a successor World Trade Centre
to the GATT. It is a
new international
organization set up
as a permanent body
and is designed to
play the role of watch dog in the spheres
of trade in goods and services, foreign
investment and intellectual property
rights. The Dunkel Draft, formulated
by Arthur Dunkel, its Secretary General
became the base for WTO. WTC headquarters located at New York,
USA. It featured the landmark Twin Towers
Every two years, the member which was established on 4th April 1973.
countries’ Commerce Ministers Later it was destroyed on 11th September
Conference are being organized to discuss 2001 by the craft attack. It brings together
and settle the important souls and trade businesses involved in international trade
related matters. The first WTO conference from around the globe.

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 8.4.1. Objectives of WTO
The establishment of
the WTO's TRIPS
The basic aim is to expand
(trade-related aspects of
international trade and bring about
intellectual property rights) Agreement
economic prosperity by liberalizing trade
in 1995 changed the face of international
restrictions.
intellectual property (IP) law and
i) To ensure reduction of tariff and other policy-making. TRIPS negotiators
barriers. recognized that short comings and
inconsistencies in IP protection can
ii) To eliminate discrimination in trade. distort trade and impede its benefits.
iii) To facilitate higher standard of living. The TRIPS Agreement helps ease trade
tensions about IP issues while leaving
iv) 
To facilitate optimal use of world’s WTO members ample space to pursue
resources. diverse domestic policies.
v) To enable the LDCs to secure fair share
in the growth of international trade. Agreement on Trade Related Investment
Measures (TRIMs)
vi) 
To ensure linkages between trade
policies, environmental policies and TRIMs are related to conditions or
sustainable development. restrictions in respect of foreign investment
in the country. It calls for introducing
equal treatment for foreign companies on
WTO Agreements
par with national companies. TRIMs were
widely employed by developing countries.
Agreement on Trade
Restrictions on foreign investment on
Related Intellectual
following grounds are to be removed.
Property Rights (TRIPs)
 No restriction on area of investment.
Intellectual Property Rights
 No binding on use of local material.
include copy right, trade marks, patents,
 No mandatory exports.
geographical indications, trade secrets,
 No restriction on repatriation of royalty,
industrial designs, etc. TRIPS Agreement
dividend and interest.
provides for granting product patents
N  o trade balancing requirement,
instead of process patents. The period
i.e. imports not exceeding exports.
of protection will be 20 years for patents,
50 years for copy rights, 7 years for trade
General Agreement on Trade in Services
marks and 10 years for layout designs. As
(GATS)
a result of TRIPS, the dependence of LDCs
on advanced countries for seeds, drugs, GATS is the first multilateral set
fertilizers and pesticides has increased. of rules covering trade in services like
Farmers are depending on the industrial banking, insurance, transportation,
firm for their seeds. communication, etc., All member
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 countries are supposed to extend MFN ii) It provides the forum for negotiations
(Most Favoured Nation) status to all other among its members, concerning their
countries without any discrimination. multilateral trade relations in matters
Transparency should be maintained by relating to the agreements.
publishing all relevant laws and regulations
iii) It administers the Understanding on
over services.
Rules and Procedures governing the
Phasing out of Multi Fibre Agreement Settlement of Disputes.
(MFA) iv) It cooperates with the IMF and the
The multi fibre agreement governed World Bank and its affiliated agencies
the world trade in textiles and garments with a view to achieving greater
since 1974. It imposed quotas on export coherence in global economic policy
of textiles by developing nations to the making.
developed countries. This quota system
was to be phased out over a period of ten Major WTO Functions
years. This was beneficial to India.  Administering WTO trade agreements
 Forum for trade negotiations
Agreement on Agriculture (AoA)
 Handling trade disputes
Agriculture was included for the first  Monitoring national trade policies
time under GATT. The important aspects  Technical assistance and training for
of the agreement are Tariffication, Tariff developing countries
cuts and Subsidy reduction.  Cooperation with other international
organizations
Dispute Settlement Body
The Disputes Settlement Body 8.4.3. Achievements of WTO
puts an end to procedural delays. It is
mandatory to settle any dispute within The major achievements of WTO are as
18 months. The disputes are resolved follows
through multilateral trading system.
However, India has lost a huge export 1) 
Use of restrictive measures for BoP
earnings because of the conditions laid problems has declined markedly;
out by the Body. 2) S ervices trade has been brought into the
multilateral system and many countries,
8.4.2. Functions of WTO as in goods, are opening their markets
for trade and investment;
The following are the functions of the
WTO 3) 
The trade policy review mechanism
has created a process of continuous
i) 
It facilitates the implementation,
administration and operation of the monitoring of trade policy
objectives of the Agreement and of the developments.
Multilateral Trade Agreements.
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 3. Advanced technology has been obtained
WTO Ministerial Conferences at cheaper cost.
4. India is in a better position to get quick
redressal from the trade disputes.
5. The Indian exporters benefited from
12. Kazakhstan - 2020 wider market information.
11. Buenos Aires, 10-13
December 2017
8.5
10. Nairobi, 15-18 December 2015 Trade Blocks
09. Bali, 3-6 December 2013
 Some countries create business
08. Geneva, 15-17 December 2011
opportunities for themselves by
07. Geneva, 30 November - integrating their economies in order to
2 December 2009 avoid unnecessary competition among
06. Hong Kong, 13-18 December 2005 them. Trade blocks cover different
05. Cancún, 10-14 September 2003 kinds of arrangements between or
among countries for mutual benefit.
04. Doha, 9-13 November 2001
Economic integration takes the form
03. Seattle, November 30 – of Free Trade Area, Customs Union,
December 3 1999
Common Market and Economic Union.
02. Geneva, 18-20 May 1998
 A free trade area is the region
01. Singapore, 9-13 December 1996
encompassing a trade bloc whose
member countries have signed a
8.4.4. WTO and India free-trade agreement (FTA). Such
agreements involve cooperation
India is the founding member between at least two countries to
of the WTO. India favours multilateral reduce trade barriers. e.g. SAFTA,
trade approach. It enjoys MFN status and EFTA.
allows the same status to all other trading
partners. India benefited from WTO on  A customs union is defined as a type
following grounds: of trade block which is composed of
a free trade area with no tariff among
1. By reducing tariff rates on raw materials,
members and (zero tariffs among
components and capital goods, it was
members) with a common external
able to import more for meeting her
tariff. e.g. BENELUX (Belgium,
developmental requirements. India's
Netherland and Luxumbuarg).
imports go on increasing.
2. India gets market access in several  Common market is established
countries without any bilateral trade through trade pacts. A group formed
agreements. by countries within a geographical

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 area to promote duty free trade and both common policies on product
free movement of labour and capital regulation, freedom of movement
among its members. e.g. European of goods, services and the factors of
Common Market (ECM) production and a common external
trade policy. (e.g. European Economic
 An economic union is composed Union)
of a common market with a customs
union. The participant countries have

Institution Headquarters Year of Establishment

South Asian Association for Regional
Kathmandu 1985
Cooperation (SAARC)
ASEAN Bangkok 1967
BRICS Shangai 2001

8.6 The Maldives, Nepal, Pakistan and Sri

South Asian Association For Lanka. In April 2007, Afghanistan became
Regional Co-Operation (SAARC) its eighth member. The basic aim of the
organisation is to accelerate the process
The South Asian Association for
of economic and social development of
Regional Co-operation (SAARC) is an
member states through joint action in the
organisation of South Asian nations, which
agreed areas of cooperation. The SAARC
was established on 8 December 1985 for
Secretariat was established in Kathmandu
the promotion of economic and social
(Nepal) on 16th January 1987. The first
progress, cultural development within the
SAARC summit was held at Dhaka in
South Asia region and also for friendship
the year 1985. SAARC meets once in two
and co-operation with other developing
years. Recently, the 20th SAARC summit
countries. The SAARC Group (SAARC)
was hosted by Srilanka in 2018.
comprises of Bangaladesh, Bhutan, India,

Members of SAARC

India Bhutan Pakistan Nepal

Bangaladesh Maldives Sri Lanka Afghanistan

Its seven founding members are Bangladesh, Bhutan, India, the Maldives, Nepal,
Pakistan and Sri Lanka. Afgharistan joined later on 3rd April, 2007
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 2. 
Prevention of common problems
8.6.1. Objectives of SAARC associated with the member nations.

According to Article I of the Charter 3. Ensuring strong relationship among the

of the SAARC, the objectives of the member nations.
Association are as follows:
4. Removal of the poverty through various
i) To promote the welfare of the people of packages of programmes.
South Asia and improve their quality of
5. Prevention of terrorism in the region.
life;
ii) To accelerate economic growth, social 8.6.3. Achievements of SAARC
progress and cultural development in
the region; 1. 
The establishment of SAARC
Preferential Trading Agreement
iii) To promote and strengthen collective (SAPTA) and reduction in tariff and
self-reliance among the countries of non-tariff barriers on imports.
South Asia;
2. The setting up of Technical Committees
iv) 
To contribute to mutual trust, for economic cooperation among
understanding and appreciation of one SAARC countries relating to agriculture,
another’s problems; communications, education, health and
v) 
To promote active collaboration and population, rural development, science
mutual assistance in the economic, and technology, tourism, etc.
social, cultural, technical and scientific 3. 
SAARC has established a three-tier
fields; mechanism for exchanging information
vi) To strengthen co-operation with other on poverty reduction programmes
developing countries; which is passed on to member countries.
4. 
SAARC Agricultural Information
vii) 
To strengthen cooperation among Centre (SAIC) in 1988 works as a central
themselves in international forums on information institution for agriculture
matters of common interest; related resources like fisheries, forestry,
etc.
vii) To cooperate with international and
regional organisations with similar 5. 
S outh Asian Development Fund
aims and purposes. (SADF) for development projects,
human resource development
8.6.2. Functions of SAARC and infrastructural development
projects. With all these tall claims,
The main functions of SAARC are as the inter-SAARC Trade has not gone
follows. beyond three percent in the last 30
years.
1. Maintenance of the co operation in the
region
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 8.7 countries to maintain their unity and
Association of solidarity by establishing a trade block.
South East Asian Nations (ASEAN) Foreign trade is the life blood of the
ASEAN countries following globalization
ASEAN was established on 8 August and prudent macroeconomic policies.
1967 in Bangkok by the five original The ASEAN Summit of the Heads of
member countries: Indonesia, Malaysia, Governments of member countries is the
Philippines, Singapore and Thailand. highest forum for ASEAN cooperation. Its
Later Brunei Darussalam, Vietnam, Laos meetings are held once in three years. The
and Myanmar and Cambodia joined. ASEAN \ministerial meeting of Foreign
Besides ten members of the ASEAN, there Ministers is the next highest decision-
are six “dialogue partners” which have making body.
been participating in its deliberations. India’s relationship with ASEAN
They are China, Japan, India, South Korea, started in 1992 when India became a
New Zealand and Australia. The ASEAN “sectoral dialogue partner” of ASEAN.
nations are expected to benefit from the The geographic proximity of ASEAN
FTA as it will reduce tariff and non-tariff countries to India facilitates faster exports
barriers. The common historical and and lower freight costs.
cultural background made the member

8.7.1 Objectives of ASEAN (ii) To promote regional peace and stability
and adherence to the principles of the
The ASEAN Declaration states the aims United Nations Charter;
and purposes of the Association as:
(iii) 
To promote cooperation among
(i) 
To accelerate the economic growth, the members of ASEAN through
social progress and cultural the exchange of knowledge and
development in the region; experience in the field of public sector
auditing.
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 (iv) To provide a conducive environment the induction of South Africa in 2010. The
and facilities for research, training, term ‘BRIC’ was coined in 2001. The
and education among the members BRICS members are known for their
(v) To serve as a centre of information significant influence on regional affairs.
and as an ASEAN link with other Since 2009, the BRICS nations have met
international organizations. annually at formal summits. South Africa
hosted the 10th BRICS summit in July
8.7.2 Functions of the ASEAN 2018. The agenda for BRICS summit 2018
includes Inclusive growth, Trade issues,
(i) It facilitates free movement of goods, Global governance, Shared Prosperity,
services and investments within International peace and security.
ASEAN by creating a single regional
market like the European Union.

(ii) It provides free access to the marketers

of one member country to the markets
of all other member countries, thus
fostering growth in the region.

(iii) It improves business competitiveness It’s headquarters is at Shanghai,

between businesses from different China. The New Development Bank
countries and also narrow (NDB) formerly referred to as the BRICS
developmental gaps between member Development Bank was established by
countries. BRICS States. The first BRICS summit
was held at Moscow and South Africa
(iv) It paves way for market and investment hosted the Tenth Conference at
opportunities for the member nations. Johanesberg in July 2018. India had an
opportunity of hosting fourth and Eighth
(v) It fosters co-operations in many areas
summits in 2012 and 2016 respectively.
including industry and trade.

All the ASEAN economies experienced a Few Facts About The BRICS
great economic crisis in the year 1997. T
 he BRICS countries make up 21
percent of global GDP. They have
8.8 increased their share of global GDP
BRICS threefold in the past 15 years.
T
 he BRICS are home to 43 percent of
BRICS is the acronym for an the world's population.
association of five major emerging
national economies: Brazil, Russia, India, T
 he BRICS countries have combined
China and South Africa. Originally the foreign reserves of an estimated $4.4
first four were grouped as "BRIC" before trillion

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 6. It acts as a catalytic in protecting the
8.8.1. Objectives of BRICS interests of middle powers on global
forum.
1. 
To increase trade co-operation by
making an exclusive trade block. 8.8.3 Achievements of BRICS
2. To use currency other than US Dollar.
Following are some of the major
Since Dollar is a dominant currency
achievements of BRICS.
and US can control the flow of dollar,
BRICS helps in the countries operating  The establishment of the Contingent

with alternative currencies. How far Reserve Arrangement (CRA) has
have they succeeded in this respect? further deepened and consolidated
Not much. the partnership of its members in the
economic-financial area.
3. To increase regional co-operation.
 I n the sixth BRICS summit in Brazil,
4. To create a separate trade block made
the member countries, signed an
for developing countries for trade
agreement to create a development
co-operation.
bank (New Development Bank) with
headquarters at Shangai, China in 2015
8.8.2. Functions of BRICS on the lines of Asian Development
Bank and the World Bank.
1. It acts as a promoter of more legitimate
international system and also advocating  The
 economic potential and
reform of the UN Security Council. demographic development are putting
the BRICS countries, increasingly in a
2. 
This group of nations is especially leading position in setting the global
meant for South-South framework for agenda and having a greater say in the
cooperation. global governance.
3. It performs as an agent to bridge the It has to be remembered that BRICS share
increasing gap between developed and 43% of world population, but only 21% of
developing countries. For instance, the global GDP.
in the WTO, the BRICS countries are
emphasizing to promote a fair order Summary:
regarding agricultural policies. The present chapter on International
Economic Organisations discusses the role
4. It performs a commendable contribution
played by the IMF in solving the problem
for assisting developing countries in
of trade related issues and credit facilities.
gaining in areas such as an advantage in
The financial, regulatory and consultative
trade and climate change negotiations.
functions of IMF and its benefits to
5. 
It disseminates information and India have been dealt with. Further, the
exchange platform beyond economic objectives, functions and achievements
cooperation. of the World Bank and WTO have been
covered.
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 Also, the various agreements � M
 ultilateral trade agreement: It is a
implemented by the WTO such as TRIPS, multi national legal or trade agreements
TRIMS, GATS, AoA, MFA have been between countries. It is an agreement
discussed. between more than two countries but
not many.
The final part of the chapter deals
with the regional economic integration � T
 rade blocks: They are a set of
among the trade blocks such as SAARC countries which engage in international
(South Asian nations), ASEAN (South East trade together and are usually related
Asia) and BRICS and their achievements. through a free trade agreement or
other associations.
Glossary � F
 ree Trade Area: A region
encompassing a trade bloc whose
� S
 tructural Adjustment Facility:
member countries have signed a
Providing additional balance of
free-trade agreement (FTA). Such
payments assistance on concessional
agreements involve cooperation
terms to the poorer member nations to
between at least two countries to
undertake strong macroeconomic and
reduce trade barriers.
structural programmes.
� C
 ustoms Union: Free trade area
� S
 pecial Drawing Rights: International
(zero tariffs among members) with a
monetary reserve currency created
common external tariff.
by the International Monetary Fund
(IMF) that operates as a supplement to � C
 ommon Market: A group formed by
the existing money reserves of member countries within a geographical area
countries. to promote duty free trade and free
movement of labour and capital among
� T
 rade Related Intellectual Property
its members.
Rights (TRIPs): TRIPs include copy
right, trade mark, patents, geographical � E
 conomic Union: It is composed
indications, industrial designs and of a common market with a customs
invention of microbial plants. union. The participant countries have
both common policies on product
� T
 rade Related Investment Rights
regulation, freedom of movement
(TRIMs): TRIMs are related to
of goods, services and the factors of
conditions or restrictions imposed in
production and a common external
respect of foreign investment in the
trade policy.
country.

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 MODEL QUESTIONS

Part – A
Multiple choice questions

1. 
International Monetary Fund was an 6. Which of the following countries is not
outcome of a member of SAARC?
a) Pandung Conference a) Sri Lanka
b) Dunkel Draft b) Japan
c) Bretton Woods Conference c) Bangladesh
d) Doha Conference d) Afghanistan

2. International Monetary Fund is having 7. International Development Association

its headquarters at is an affiliate of
a) Washington D.C. a) IMF
b) New York b) World Bank
c) Vienna c) SAARC
d) Geneva d) ASEAN

3. IBRD is otherwise called 8. ---------- relates to patents, copyrights,

a) IMF trade secrets, etc.,
b) World Bank a) TRIPS
c) ASEAN b) TRIMS
d) International Finance c) GATS
Corporation d) NAMA
4. The other name for Special Drawing 9. The first ministerial meeting of WTO
Rights is was held at
a) Paper gold
a) Singapore
b) Quotas
b) Geneva
c) Voluntary Export Restrictions
c) Seattle
d) None of these
d) Doha
5. The organization which provides long
term loan is 10. 
ASEAN meetings are held once in
every __________ years
a) World Bank
b) International Monetary Fund a) 2
c) World Trade Organisation b) 3
d) BRICS c) 4
d) 5

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 11. 
Which of the following is not the 17. New Development Bank is associated
member of SAARC? with
a) Pakistan a) BRICS
b) Sri Lanka b) WTO
c) Bhutan c) SAARC
d) China d) ASEAN

12. SAARC meets once in ----------- years. 18. 

Which of the following does not
come under ‘Six dialogue partners’ of
a) 2
ASEAN?
b) 3
c) 4 a) China
d) 5 b) Japan
c) India
13. The headquarters of ASEAN is d) North Korea
a) Jaharta
19. 
SAARC Agricultural Information
b) New Delhi
Centre (SAIC) works as a central
c) Colombo
information institution for agriculture
d) Tokyo
related resources was founded on
14. The term BRIC was coined in a) 1985
a) 2001 b) 1988
b) 2005 c) 1992
c) 2008 d)1998
d) 2010
20. BENELUX is a form of
15. ASEAN was created in a) Free trade area
a) 1965 b) Economic Union
b) 1967 c) Common market
c) 1972 d) Customs union
d) 1997

16. The Tenth BRICS Summit was held in

July 2018 at
a) Beijing
b) Moscow
c) Johannesburg
d) Brasilia

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 Answers

1 2 3 4 5 6 7 8 9 10
c a b a a b b a a b
11 12 13 14 15 16 17 18 19 20
d a a a b c a d b d
Part B

Answer the following questions (2 marks)

21. Write the meaning of Special Drawing rights.
22. Mention any two objectives of ASEAN.
23. Point out any two ways in which IBRD lends to member countries.
24. Define Common Market.
25. What is Free trade area?
26. When and where was SAARC Secretariat established?
27. Specify any two affiliates of World Bank Group.
Part C

Answer the following questions (3 marks):

28. Mention the various forms of economic integration.
29. What are trade blocks?
30. Mention any three lending programmes of IMF.
31. What is Multilateral Agreement?
32. Write the agenda of BRICS Summit, 2018.
33. State briefly the functions of SAARC.
34. List out the achievements of ASEAN.
Part D

Answer the following questions (5 marks)

35. Explain the objectives of IMF.
36. Bring out the functions of World Bank.
37. Discuss the role of WTO in India’s socio economic development.
38. Write a note on a) SAARC b) BRICS

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 ACTIVITY
1.  he students are asked to go through the world map thoroughly to understand
T
the location of countries and its capital.
2.  he students may go to relevant websites to understand the international economic
T
organisations and its events.

References

1. C
 herunilam, Francis (2010), “International Economics”,
The McGraw Hill Publications, New Delhi.
2. J hingan, M.L., (2000), “International Economics”
Vrindha Publications Private Limited, New Delhi.
3. K
 rugman R. Paul (2003), “International Economics: Theory and Policy”,
Sixth Edition, Pearson Education, New Delhi.
4. M
 ithani, D M (1982), “International Economics”,
Himalaya Publishing House, New Delhi.
5. R
 ao, Subba, (2012), “International Business”,
Third Edition, Himalaya Publishing House, New Delhi.
6. R
 obert C. Feensta and Alan M. Taylor, (2008), “International Economics”,
Worth Publishers, New York.
7. V
 an Meerhaeghe, M.A.G. (1998), “International Economic Institutions”,
7th edition, Kluwer Academic Publishers, Dordrecht.

Website Link
http://www.worldbank.org
http://www.imf.org

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 CHAPTER

9 Fiscal Economics

“Incomings may be scant; but yet, no failures there,

If in expenditure you rightly learn to spare”.
- Thirukkural No.478

Learning Objectives

1 To understand the meaning and subject matter of public finance.

2 To understand the direct and indirect taxes.

3 To describe the functions of finance commission.

9.1
Introduction
The modern state is a welfare state. The
The term ‘Fiscal Economics’ is a
activities of the state have increased
new one; the old and popular term of the
extensively and intensively. To perform
subject is ‘Public Finance’. The subject
these activities, the state needs funds. This
Public Finance is related to the financing
chapter deals with the Public Revenue,
of the State activities and it discusses the
Public Expenditure, Public Debt, Budget,
financial operations of the Government
Federal Finance and Local Finance.
treasury. The term fiscal is derived from
Greek word which means basket and 9.2
symbolizes the public purse. Hence the Meaning of Public Finance
subject ‘Public Finance’ has been newly
termed ‘Fiscal Economics’.
Public finance is a study of the
Public Finance studies the manner financial aspects of Government. It
in which the state raises and spends is concerned with the revenue and
the resources. The state is concerned expenditure of the public authorities and
with the collective wants of the citizens. with adjustment of the one to the other.
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 9.3 1. Public Revenue

Definitions Public revenue deals with the

methods of raising public revenue such as
tax and non-tax, the principles of taxation,
“Public finance is one of those
rates of taxation, impact, incidence and
subjects that lie on the border line between
shifting of taxes and their effects.
Economics and Politics. It is concerned
with income and expenditure of public 2. Public Expenditure
authorities and with the adjustment of one
to the other”. This part studies the fundamental
-Huge Dalton principles that govern the Government
expenditure, effects of public expenditure
“Public finance is an investigation and control of public expenditure.
into the nature and principles of the state
revenue and expenditure”. 3. Public Debt
-Adam Smith Public debt deals with the methods
of raising loans from internal and
9.4
external sources.The burden, effects and
 ubject Matter / Scope of Public
S redemption of public debt fall under this
Finance head.
In Modern times, the subject ‘Public 4. Financial Administration
Finance’ includes five major sub-divisions,
viz., Public Revenue, Public Expenditure, This part deals with the study of the
Public Debt, Financial Administration different aspects of public budget. The
and Fiscal Policy. budget is the Annual master financial
plan of the Government. The various
objectives and steps in preparing a public
1. Public Revenue budget, passing or sanctioning, allocation
Scope of Public Finance

evaluation and auditing fall within

financial administration.
2. Public Expenditure
5. Fiscal Policy
Taxes, subsidies, public debt and
3. Public Debt public expenditure are the instruments of
fiscal policy.

4. Financial Administration 9.5

Public finance and Private finance

5. Fiscal Policy
Public finance deals with study
of income, expenditure, borrowing
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 and financial administration of the
9.5.2. Dissimilarities
government. Private finance is the study
of income, expenditure, borrowing and 1. Income and Expenditure adjustment
financial administration of individual
or private companies. Both public and The government adjusts the income
private finance are fundamentally similar to the expenditure while individuals adjust
in nature but different from each other their expenditure to the income. Private
on various operational aspects. The finance involves stitching coat according
similarities and dissimilarities between to cloth available whereas public finance
public and private finance have been decides the cloth according to the need for
explained below. the coat.

2. Borrowing
9.5.1. Similarities
The government can borrow from
1. Rationality internal and external sources; it can
borrow from the people by issuing bonds.
Both public finance and private
However, an individual cannot borrow
finance are based on rationality.
from himself.
Maximization of welfare and least cost
factor combination underlie both.
3. Right to print currency
2. Limit to borrowing The government can print currency.
This involves the creation, distribution
Both have to apply restraint with
and monitoring of currency. The private
regard to borrowing. The Government
sector cannot create currency.
also cannot live beyond its means. There
is a limit to deficit financing by the state 4. Present vs. future decisions
also.
3. Resource utilisation The public finance is more involved
with future planning and making long-
Both the private and public sectors term decisions. These investments could
have limited resources at their disposal. include building of schools, hospitals and
So both attempt to make optimum use of infrastructure. The private finance makes
resources. financial decisions on projects with a
short term vision.
4. Administration
The effectiveness of measures of the 5. Objective
Government as well as private depends The public sector’s main objective is
on the administrative machinery. If the to provide social benefit in the economy.
administrative machinery is inefficient The private sector aims to maximize
and corrupt it will result in wastages and personal benefit i.e. Profit.
losses.

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 6. Coercion to get revenue (i) Defence
The sources of income of a private The primary function of the
individual is relatively limited while Government is to protect the people from
those of the Government is wide. The external aggression and internal disorder.
Government can use its power and The government has to maintain adequate
authority. police and military forces and render
protective services.
7. Ability to make huge and deliberate
changes (ii) Judiciary:
The public finance has the ability Rendering justice and settlement
to make big decisions on income. For of disputes are the concern of the
example, it can effectively and deliberately government. It should provide adequate
adjust the revenue. But individuals cannot judicial structure to render justice to all
make such massive decisions. classes of citizens.

9.6 (iii) Enterprises

Functions of Modern State The regulation and control of
private enterprise fall under the purview
The modern state is a welfare state of the modern State. Ownership of
and not just police state. The state assumes certain enterprises and operating them
greater roles by creating economic and successfully are the responsibilities of the
social overheads, ensuring stability both government.
internally and externally, conserving
resources for sustainable development
and so on.
Defence
Control of
Judiciary
Monopoly

Social Justice Functions of a Enterprises

Government

Macro Economic Social Welfare

Policy
Infrastructure

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 (iv) Social Welfare 9.7
It is the duty of the state to make Public Expenditure
provisions for education, social security,
social insurance, health and sanitation
for the betterment of the people in the
country. 9.7.1. Meaning

Public expenditure refers to

(v) Infrastructure
Government spending incurred by
Modern States have to build the Central, State and Local governments of
base for the economic development of the a country.
country by creating social and economic
infrastructure. 9.7.2. Definition

Public expenditure can be defined

(vi) Macro-economic policy
as, “The expenditure incurred by public
The Government has to administer authorities like central, state and local
fiscal policy and monetary policy to governments to satisfy the collective
achieve macro-economic goals. social wants of the people is known as
public expenditure”.
(vii) Social Justice
During the process of growth of an C lassification of public
9.7.3. 
economy, certain sections of the society expenditure are as follows:
gain at the cost of others. The Government 1. Classification on the Basis of Benefit:
needs to intervene with fiscal measures to
redistribute income. Cohn and Plehn have classified the
public expenditure on the basis of benefit
(viii) Control of Monopoly into four classes:
Concentration of economic power
is another evil to be corrected by the a) Public expenditure benefiting the entire
Government. So, the state intervenes society, e.g., the expenditure on general
through control of monopolies and administration, defence, education,
restrictive trade practices to curb public health, transport.
concentration of economic power.
b) Public expenditure conferring a special
In fine, the state can play three kinds of benefit on certain people and at the
roles. same time common benefit on the
entire community, e.g. administration
i) A
 s a producer of goods and services. of justice etc.
ii) As a supplier of public goods and social
goods. c) Public expenditure directly benefiting
particular group of persons and
iii) A
 s a regulator of the system.
indirectly the entire society, e.g. social
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 security, public welfare, pension, 36.1 crore in 1951, to 121 crore in 2011.
unemployment relief etc. The growth in population requires massive
investment in health and education, law
d) Public expenditure conferring a special and order, etc. Young population requires
benefit on some individuals, e.g., increasing expenditure on education
subsidy granted to a particular industry. & youth services, whereas the aging
population requires transfer payments
2. Classification on the Basis of Function: like old age pension, social security &
health facilities.
Adam Smith classified public
expenditure on the basis of functions of
2. Defence Expenditure
government in the following main groups:
There has been enormous increase
a) Protection Functions: This group in defence expenditure in India during
includes public expenditure incurred planning period. The defence expenditure
on the security of the citizens, to protect has been increasing tremendously due to
from external invasion and internal modernisation of defence equipment. The
disorder, e.g., defence, police, courts defence expenditure of the government
etc. was ₹ 10,874 crores in 1990-91 which
b) C ommercial Functions: This group increased significantly to ₹ 2,95,511crores
includes public expenditure incurred in 2018-19.
on the development of trade and
commerce, e.g., development of means 3. Government Subsidies
of transport and communication etc. The Government of India has been
providing subsidies on a number of
c) Development Functions: This group items such as food, fertilizers, interest on
includes public expenditure incurred priority sector lending, exports, education,
for the development infrastructure and etc. Because of the massive amounts of
industry. subsidies, the public expenditure has
increased manifold.
C auses for the Increase in
9.7.4. 
Government Expenditure The expenditure on subsidies by
The modern state is a welfare state. central government in 1990-91 was ₹ 9581
In a welfare state, the government has crores which increased significantly to
to perform several functions viz Social, ₹ 2, 29,715.67 crores in 2018-19. Besides
economic and political. These activities this, the corporate sectors also receive
are the cause for increasing public subsidies (incentives) of more than ₹ 5
expenditure. lakh crores.

1. Population Growth 4. Debt Servicing

During the past 67 years of planning, The government has been borrowing
the population of India has increased from heavily both from the internal and external
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 sources, As a result, the government has to 9.8
make huge amounts of repayment towards
debt servicing. Public Revenue

The interest payment of the central

Public revenue occupies an important
government has increased from ₹ 21,500
place in the study of public finance. The
crores in 1990-91 to ₹5, 75,794crores in
Government has to perform several
2018-19.
functions for the welfare of the people.
5. Development Projects They involve substantial amount of public
The government has been expenditure which can be financed only
undertaking various development projects through public revenue. The amount of
such as irrigation, iron and steel, heavy public revenue to be raised depends on
machinery, power, telecommunications, the necessity of public expenditure and
etc. The development projects involve the people’s ability to pay.
huge investment.
9.8.1. Meaning
6. Urbanisation
The income of the government
There has been an increase in
through all sources is called public income
urbanization. In 1950-51 about 17% of
or public revenue.
the population was urban based. Now the
urban population has increased to about According to Dalton, the term
43%. There are more than 54 cities above “Public Income” has two senses — wide
one million population. The increase in and narrow. In its wider sense it includes
urbanization requires heavy expenditure all the incomes or receipts which a public
on law and order, education and civic authority may secure during any period
amenities. of time. In its narrow sense, it includes
7. Industrialisation only those sources of income of the public
authority which are ordinarily known as
Setting up of basic and heavy “revenue resources.” To avoid ambiguity,
industries involves a huge capital and long the former is termed “public receipts” and
gestation period. It is the government the latter “public revenue.”
which starts such industries in a planned
economy. The under developed countries In a narrow sense, it includes only
need a strong of infrastructure like those sources of income of the Government
transport, communication, power, fuel, which are described as “revenue resources”.
etc. In broad sense, it includes loans raised by
the Government also.
8. Increase in grants in aid to state and
union territories
9.8.2. Classification of Public Revenue.
There has been tremendous increase
in grant-in-aid to state and union Public revenue can be classified into
territories to meet natural disasters. two types.
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 Sources of 9.9.3. Characteristics of Tax
Public Revenue
1. A tax is a compulsory payment made to
the government. People on whom a tax
is imposed must pay the tax. Refusal to
pay the tax is a punishable offence.
Tax Revenue Non - Tax Revenue
2. There is no quid pro quo between a
taxpayer and public authorities. This
9.9
means that the tax payer cannot claim
Tax Revenue any specific benefit against the payment
of a tax.

9.9.1. Meaning 3. 
Every tax involves some sacrifice on
part of the tax payer.
Tax is a compulsory payment by the
4. A tax is not levied as a fine or penalty
citizens to the government to meet the
for breaking law.
public expenditure. It is legally imposed
by the government on the tax payer and in Some of the tax revenue sources are
no case tax payer can refuse to pay taxes to
 Income tax
the government.
 Corporate tax
 Sales tax
 Surcharge and
 Cess

9.9.4. Non-Tax Revenue

9.9.2 Definitions The revenue obtained by the
government from sources other than tax
“A Tax is a compulsory payment made
is called Non-Tax Revenue. The sources of
by a person or a firm to a government
non-tax revenue are
without reference to any benefit the payer
may derive from the government.” 1. Fees
-Anatol Murad Fees are another important source
of revenue for the government. A fee is
“A Tax is a compulsory contribution charged by public authorities for rendering
imposed by public authority, irrespective of a service to the citizens. Unlike tax, there
the exact amount of service rendered to the is no compulsion involved in case of fees.
tax payer in return and not imposed as a The government provides certain services
penalty for any legal offence.” and charges certain fees for them. For
- Dalton example, fees are charged for issuing of
passports, driving licenses, etc.
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 2. Fine 6. Escheats
A fine is a penalty imposed on It refers to the claim of the state to
an individual for violation of law. For the property of persons who die without
example, violation of traffic rules, payment legal heirs or documented will.
of income tax after the stipulated time etc.
9.9.5. Canons of Taxation:
3. Earnings from Public Enterprises
The Government also gets revenue The characteristics or qualities which
by way of surplus from public enterprises. a good tax should possess are described as
Some of the public sector enterprises do canons of taxation. It must be noted that
make a good amount of profits. The profits canons refer to the qualities of an isolated
or dividends which the government gets tax and not to the tax system as a whole.
can be utilized for public expenditure. A good tax system should have a proper
combination of all kinds of taxes having
4. Special assessment of betterment levy different canons.
It is a kind of special charge levied on According to Adam Smith, there are
certain members of the community who four canons or maxims of taxation. They
are beneficiaries of certain government are as follows:
activities or public projects. For example,
due to a public park or due to the Canons of Taxation
construction of a road, people in that
locality may experience an appreciation in
the value of their property or land. 1. Canon of Ability
2. Canon of Certainty
5. Gifts, Grants and Aids
3. Canon of
 A grant from one government to Convenience
another is an important source of 4. Canon of Economy
revenue in the modern days. The
government at the Centre provides
grants to State governments and the 1.Canon of Ability
State governments provide grants
to the local government to carry out The Government should impose tax
their functions. in such a way that the people have to pay
taxes according to their ability. In such
 Grants from foreign countries are case a rich person should pay more tax
known as Foreign Aid. Developing compared to a middle class person or a
countries receive military aid, food poor person.
aid, technological aid, etc. from other 2.Canon of Certainty
countries.
The Government must ensure that
there is no uncertainty regarding the
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 rate of tax or the time of payment. If the only those taxes whose collection costs
Government collects taxes arbitrarily, then are very less and cheap .
these will adversely affect the efficiency of
the people and their working ability too. 9.9.6. Direct Tax and
Indirect Tax
3.Canon of Convenience
The method of tax collection and Direct Tax
the timing of the tax payment should
suit the convenience of the people. The A direct tax is referred to as a tax
Government should make convenient levied on person’s income and wealth and
arrangement for all the tax payers to pay is paid directly to the government; the
the taxes without difficulty. burden of such tax cannot be shifted. The
tax is progressive in nature. It is levied
4.Canon of Economy according to the paying capacity of the
person, i.e. the tax is collected more from
The Government has to spend
the rich and less from the poor people.
money for collecting taxes, for example,
salaries are given to the persons who The plans and policies of the Direct
are responsible for collecting taxes. The Taxes are being recommended by the
taxes, where collection costs are more are Central Board of Direct Taxes (CBDT)
considered as bad taxes. Hence, according which is under the Ministry of Finance,
to Smith, the Government should impose Government of India.

Direct Taxes Indirect Taxes

Ultimate burden of tax Ultimate burden of tax

payment payment: purchaser

Responsibility
Responsibility to to pay tax:
pay tax shopkeeper

Example: Income Tax Example: GST

When you earn income, When you buy stuff, the
you are responsible for shopkeeper is responsible
tax payment, and you for tax payment, but he
also have the burden can collect it from you

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 3. Inconvenient
9.9.7. Merits of Direct Taxes
The tax payers find it inconvenient
1.Equity to maintain accounts, submit returns and
pay tax in lump sum.
Direct taxes are progressive i.e. rate
of tax varies according to tax base. For 4. Tax Evasion
example, income tax satisfies the canon of
equity. The burden of direct tax is so heavy
that tax-payers always try to evade taxes.
2.Certainity This ultimately leads to the generation
of black money, which is harmful to the
Canon of certainty can be ensured by
economy.
direct taxes. For example, an income tax
payer knows when and at what rate he has 9.9.9. Indirect Tax
to pay income tax.
Indirect Tax is referred to as a tax
3. Elasticity:
charged on a person who purchases the
Direct taxes also satisfy the canon of goods and services and it is paid indirectly
elasticity. Income tax is income elastic in to the government. The burden of tax can
nature. As income level increases, the tax be easily shifted to the another person. It
revenue to the Government also increases is levied on all persons equally whether
automatically. rich or poor.

4. Economy There are several types of Indirect Taxes,

such as:
The cost of collection of direct taxes
is relatively low. The tax payers pay the tax Excise Duty: Payable by the manufacturer
directly to the state. who shifts the tax burden to retailers and
wholesalers.
9.9.8. Demerits of Direct Taxes
Sales Tax: Paid by a shopkeeper or
retailer, who then shifts the tax burden to
1.Unpopular customers by charging sales tax on goods
Direct taxes are generally unpopular. and services.
It is inconvenient and less flexible.
Custom Duty: Import duties levied on
2. Productivity affected goods from outside the country, ultimately
According to many economists direct paid for by consumers and retailers.
tax may adversely affect productivity.
Citizens are not willing to earn more Entertainment Tax: Liability is on the
income because in that case they have to cinema theatre owners, who transfer the
pay more taxes. burden to cinema goers.

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 Service Tax: Charged on services like along with the price. They do not feel the
telephone bill, insurance premium such as pinch of paying tax.
food bill in a restaurant etc.
9.9.11. Demerits of Indirect Taxes
9.9.10. Merits of Indirect Taxes

(1) Higher Cost of Collection

(1) Wider Coverage
The cost of collection of indirect
All the consumers, whether they are
taxes is higher than the direct taxes. The
rich or poor, have to pay indirect taxes.
Government has to spend huge money to
For this reason, it is said that indirect
collect indirect taxes.
taxes can cover more people than direct
taxes. For example, in India everybody (2) Inelastic
pays indirect tax as against just 2 percent
paying income tax. Indirect taxes are less elastic
compared to direct taxes. As indirect taxes
(2) Equitable are generally proportional.
The indirect tax satisfies the canon
(3) Regressive
of equity when higher tax is imposed on
luxuries used by rich people.
Indirect taxes are sometimes unjust
and regressive in nature since both rich
(3) Economical
and poor persons have to pay same amount
Cost of collection is less as producers as taxes irrespective of their income level.
and retailers collect tax and pay to the
Government. The traders act as honorary (4) Uncertainity
tax collectors.
The rise in indirect taxes increase the
(4) Checks harmful consumption price and reduces the demand for goods.
The Government imposes indirect Therefore, the Government is uncertain
taxes on those commodities which are about the expected revenue collection. So
harmful to health e.g. tobacco, liquor etc. Dalton says under indirect taxes 2+2 is
They are known as sin taxes. not 4 but 3 or even less than 3.

(5) Convenient (5) No civic Consciousness

Indirect taxes are levied on As the tax is hidden in price, the

commodities and services. Whenever consumers are not aware of paying tax.
consumers make purchase, they pay tax

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 9.9.12. Comparison Chart

Basis For
Direct Tax Indirect Tax
Comparison
Indirect Tax is referred to as
Direct tax is referred to as the
the tax, levied on a person who
tax, levied on person’s income
Meaning consumes the goods and services
and wealth and is paid directly
and is paid indirectly to the
to the government.
government.
Nature Progressive Regressive
Incidence and
Falls on the same person. Falls on different persons.
Impact
Income or wealth of the Purchase/sale/manufacture of
Tax base
assessee goods and provision of services
Tax evasion is hardly possible
Evasion Tax evasion is possible. because it is included in the price
of the goods and services.
Direct tax helps in controlling Indirect taxes push up price
Inflation
the inflation. inflation.
Imposed on and collected Imposed on and collected from
Imposition and from assesses, i.e. Individual, consumers of goods and services
collection HUF (Hindu Undivided but paid and deposited by the
Family), Company, Firm etc. assesse.
Burden Cannot be shifted. Can be shifted

9.9.13. GST (Goods and  I

n simple words, Goods and Service
Service Tax) Tax (GST) is an indirect tax levied on
the supply of goods and services. This
G
ST is an Indirect Tax law has replaced many indirect tax laws
which has replaced that previously existed in India.
many Indirect Taxes in India. The
ST is one indirect tax for the entire
G
Goods and Service Tax Act was passed
country.
in the Parliament on 29th March
2017. The Act came into effect on U
nder the GST regime, the tax will be
1st July 2017; Goods & Services Tax levied at the final point of sale. In case
in India is a comprehensive, multi- of intra-state sales, Central GST and
stage, destination-based tax that is State GST will be charged. Inter-state
levied on every value addition. sales will be chargeable to Integrated
GST.
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 consumer in Karnataka. Since Goods
& Service Tax is levied at the point of
consumption, in this case, Karnataka, the
entire tax revenue will go to Karnataka
and not Tamil Nadu.

Components of GST
The component of GST are of 3 types.
They are: CGST, SGST & IGST.
CGST: Collected by the Central
Government on an intra-state sale (Eg:
Within state/ union territory)
SGST: Collected by the State Government
Single Tax to replace multiple levies, on an intra-state sale (Eg: Within state/
right from manufacturer / supplier to union territory)
consumer
IGST: Collected by the Central
Destination Based Government for inter-state sale (Eg:
Maharashtra to Tamil Nadu)
Consider goods manufactured in
Tamil Nadu and are sold to the final

In most cases, the tax structure under the new regime will be as follows:

Transaction New Regime Old Regime

Sale within CGST + VAT + Central Revenue will be shared equally
the State SGST Excise/Service tax between the Centre and the State
Sale to IGST Central Sales Tax There will only be one type of tax
another State + Excise/Service (central) in case of inter-state sales.
Tax The Center will then share the IGST
revenue based on the destination of
goods.

Nature of Sales tax, VAT and GST Advantages of GST

1. Sales tax was multipoint tax with 1. GST will mainly remove the cascading
cascading effect. effect on the sale of goods and services.
2. VAT was multipoint tax without Removal of cascading effect will directly
cascading effect. impact the cost of goods. Since tax on
3. GST is one point tax without tax is eliminated in this regime, the cost
cascading effect. of goods decreases.

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 2. 
G
 ST is also mainly technologically to induce the private sector to release
driven. All activities like registration, manpower and real resources and to finance
return filing, application for refund the purchase of these resources or to make
and response to notice need to be done welfare payments or subsidies”.
online on the GST Portal. This will – Carl S.Shoup
speed up the processes.

9.10 9.10.2. Types of Public Debt

Public Debt
i)Internal public debt

In the 18th and An internal public debt is a loan

19th centuries, the taken by the Government from the citizens
role of the state was or from different institutions within the
minimum. But since country. An internal public debt only
20th century there involves transfer of wealth.
has been enormous
increase in the The main sources of internal public debt
responsibilities are as follows:
of the state. Hence the state has to
 I
ndividuals, who purchase government
supplement the traditional revenue
bonds and securities;
sources with borrowing from individuals,
and institutions within and outside the B
anks, both private and public, buy
country. The amount of borrowing is bonds from the Government.
huge in the under developed countries to
finance development activities. The debt N
on-financial institutions like UTI,
burden is a big problem and most of the LIC, GIC etc. also buy the Government
countries are in debt trap. bonds.

9.10.1. Definitions C
entral Bank can lend the Government
in the form of money supply. The Central
“The debt is the form of promises
Bank can also issue money to meet the
by the Treasury to pay to the holders of
expenditures of the Government.
these promises a principal sum and in
most instances interest on the principal.
ii) External public debt
Borrowing is resorted to in order to provide
funds for financing a current deficit.” When a loan is taken from abroad
or from an international organisation it
– Philip E.Taylor
is called external public debt. The main
sources of External public debt are IMF,
“The receipt from the sale of financial
World Bank, IDA and ADB etc. Loan from
instruments by the government to
other countries and the Governments.
individuals or firms in the private sector,
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 Countries External Debt as on June-2018
External
Per capita
Rank Country/Region debt (USD % of GDP
US dollars
Millions)
1 USA 21,171,000 58,200 98
2 UK 8,475,956 127,000 313
3 France 5,689,745 87,200 213
4 Germany 5,398,267 65,600 141
7 Japan 3,586,817 28,200 74
13 China 1,710,625 1,200 14
21 Russia 537,458 3,700 40
22 India 529,000 380 20
(Source: World Bank Report and India’s External Debt as at the end of March 2018 – RBI
REPORT DATED 29-06-2018)

to the citizens of the country. To finance

9.10.3. Causes for the Increase in these, the State has to incur a heavy public
Public debt debt.
The causes for enormous growth
of public debt may be studied under the 3. Economic Development and Deficit
following sub-headings: The government has to undertake
many projects for economic development
1. War and Preparation of war of the country. Construction of railways,
Waging war has become one of the power projects, irrigation projects, heavy
important causes for incurring debts by industries, etc., could be thought of only
the governments. In modern times, the by means of mobilising resources in the
preparation for war and nuclear defence form of public debt. Due to heavy public
programmes take away the major share of expenditure, the governments always face
the government’s revenue and so it incurs deficit budget. Such deficits have to be
debt. financed only through borrowings.

2. Social obligations 4.Employment

Modern states are considered to be Most of the governments of modern
‘Welfare States’ and they have to undertake days face the problem of unemployment
many social obligations like public health, and it has become the duty to solve this by
sanitation, education,insurance, transport making huge public expenditure. To solve
and communications, etc., besides the unemployment problem, and to fight
providing the minimum necessaries of life recession, the government has to make

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 huge expenditures. For this the States have a new loan. Under this system a high
to resort to public debt. interest public debt is converted into a
low interest public debt. Dalton felt that
5.Controlling inflation debt conversion actually relaxes the debt
The Government can withdraw burden.
excess money from circulation, by raising (3) Budgetary Surplus
public debt and thus prevent prices from
rising. When the Government presents
surplus budget, it can be utilised for
6.Fighting depression repaying the debt. Surplus occurs when
During the depression phase, private public revenue exceeds the public
investment is lacking. The Government expenditure. However, this method is
applies compensatory public spending rarely possible.
by borrowing from internal and external (4) Terminal Annuity
sources.
In this method, Government pays off
the public debt on the basis of terminal
9.10.4. M
 ethods of Redemption of
annuity in equal annual instalments. This
Public Debt
is the easiest way of paying off the public
The process of repaying a public debt debt.
is called redemption. The Government
sells securities to the public and at the (5) Repudiation
time of maturity, the person who holds the It is the easiest way for the Government
security surrenders it to the Government. to get rid of the burden of payment of a
The following methods are adopted for loan. In such cases, the Government does
debt redemption. not recognise its obligation to repay the
(1) Sinking Fund loan. It is certainly not paying off a loan
but destroying it. However, in normal case
Under this method, the Government the Government does not do so; if done it
establishes a separate fund known as will lose its credibility.
“Sinking Fund”. The Government credits
every year a fixed amount of money to this (6) Reduction in Rate of Interest
fund. By the time the debt matures, the Another method of debt redemption
fund accumulates enough amount to pay is the compulsory reduction in the rate of
off the principal along with interest. This interest, during the time of financial crisis.
method was first introduced in England
by Walpol. (7) Capital Levy

(2) Conversion When the Government imposes

levy on the capital assets owned by an
Conversion of loans is another individual or any institution, it is called
method of redemption of public debt. It capital levy. This levy is imposed on
means that an old loan is converted into capital assets above a minimum limit on
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 a progressive scale. The fund so collected
9.11.3. Types of Budget
can be used by the Government for paying
off war time debt obligations. This is Revenue and Capital Budget
the most controversial method of debt
repayment. On the basis of expenditure on
revenue account and other accounts, a
9.11 budget can be presented in two ways:
Budget i) Revenue Budget: It consists of revenue
receipts and revenue expenditure.
The word ‘budget’ is said to have Moreover, the revenue receipts can be
its origin from the French word “Bougett” categorised into tax revenue and non-tax
which refers to ‘a small leather bag’.The revenue. Revenue expenditure can also be
budget is an annual financial statement categorised into plan revenue expenditure
which shows the estimated income and and non-plan revenue expenditure.
expenditure of the Government for the
ii) Capital Budget: It consists of capital
forthcoming financial year.
receipts and capital expenditure. In this
9.11.1. Definitions case, the main sources of capital receipts
are loans, advances etc. On the other side
“It is a document containing a capital expenditure can be categorised
preliminary approved plan of public into plan capital expenditure and non-
revenue and expenditure”. plan capital expenditure.
-Reney Stourn. iii) Supplementary Budget: During the
“The budget has come to mean the time of war emergencies and natural
financial arrangements of a given period, calamities like tsunami, flood etc, the
with the usual implication that they expenditures allotted in the budget
have been submitted to the legislature for provisions are not always enough. Under
approval”. these circumstances, a supplementary
- Bastabale budget can be presented by the
Government to tackle these unforeseen
9.11.2. Union Budget and State Budget events.
iv) Vote - on - Account: Under Article
India is a federal economy, hence 116 of the Indian Constitution, the
public budget is divided into two layers of budget can be presented in the middle of
the Government. According to the Indian the year. The reason may be political in
Constitution, the Central Government nature. The existing Government may or
has to submit annual financial statement, may not continue for the year, on account
i.e., Union Budget under Article 112 to the of the fact that elections are due, then the
Parliament and each State Government Government places a ‘lame duck budget’.
has to submit the same for the State in the This is also called ‘Vote-on-account
Legislative Assembly under Article 202. Budget’.

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 Components of Budget

Budget Receipts Budget Expenditure

Revenue Capital
Revenue Receipts Capital Receipts
Expenditure Expenditure

Tax Non - Tax Plan Non Plan Plan Non Plan

Receipts Receipts Expenditure Expenditure Expenditure Expenditure

Recovery Borrowing and Disinvestment

of Loans other Liabilities

The vote on account budget is a special justification or otherwise for the project as
provision by which the Government gets a whole in the light of the socio-economic
permission from the parliament to incur objectives which have been already set up
expenditures on necessary items till the for this project and as well as in view of
budget is finally passed in the parliament. the priorities of the society.
The legal permission of both the Houses
of the parliament for the withdrawal of vi) Performance Budget: When the
money from the Consolidated Fund of outcome of any activity is taken as the
India to meet the requisite expenses till base of any budget, such budget is known
the budget is finally approved is known as ‘Performance Budget’. For the first time
as vote-on - account budget. This type in the world, the performance budget
of budget is generally sanctioned for not was made in USA. The Administrative
more than two months. Reforms Commission was set up in
1949 in America under Sir Hooper. This
commission recommended making of
v) Zero Base Budget: The Government
a ‘Performance Budget’ in USA. In the
of India presented Zero-Base-Budgeting
Performance Budget, it is the compulsion
(ZBB first) in 1987-88. It involves
of the government to tell ‘what is done’,
fresh evaluation of expenditure in the
‘how much done’ for the betterment of the
Government budget, assuming it as a new
people. In India, the Performance Budget
item. The review has been made to provide
is also known as ‘Outcome Budget’.
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 vii) Balanced Budget Vs Unbalanced 2. Deficit Budget
Budget
Deficit budget is one where the
A. Balanced Budget estimated government expenditure is
more than expected revenue.
Balanced budget is a situation,
in which estimated revenue of the
Government’s estimated Revenue
government during the year is equal to its
<
anticipated expenditure.
Government’s proposed Expenditure.
Government’s estimated Revenue
=
9.11.4. Budgetary Procedure
Government’s proposed Expenditure.

TYPES OF BUDGET Budgetary procedure refers to the

system through which the budget is
DEFICIT BALANCED SURPLUS prepared, enacted and executed.
BUDGET BUDGET BUDGET
(A) Preparation of the Budget
+ + +
The Ministry of Finance prepares the
Central Budget every year. At the state level
EXPENSE EXPENSE EXPENSE
> = < the finance department is responsible for
REVENUE REVENUE REVENUE the Annual State Budget. While preparing
the budget, the following factors are taken
B. Unbalanced Budget into account:

The budget in which Revenue &  The macro economic targets to be

Expenditure are not equal to each other is achieved within a plan period;
known as Unbalanced Budget.  The basic strategy of the budget;
Unbalanced budget is of two types:  The financial requirements of different
1. Surplus Budget projects;
2. Deficit Budget  Estimates of the revenue expenditures
(includes defence expenditure,
1. Surplus Budget subsidy, interest payment on debt
The budget is a surplus budget when etc.);
the estimated revenues of the year are  Estimates of the capital expenditures
greater than anticipated expenditures. (includes development of railways,
Government Estimated revenue roadways, irrigations etc.);
>  Estimates of revenue receipts from tax
Estimated Government Expenditure. and non-tax revenues;

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 Estimates of capital receipts from the
  first placed before the LokSabha at the
recovery of loans, disinvestment of Centre, and before the VidhanSabha at the
public sector units, market borrowings State level. The demands of various tax
etc. proposals are included in the budget. After
the finance bill is passed, an appropriation
Estimates of the gap between revenue
 
bill is presented to give legal effect to
receipts and revenue expenditure; and
the voted demands, and to authorise the
Estimates of fiscal deficit, primary
  expenditure as per the budget. In this way,
deficit, and revenue deficit. the budgets are enacted in India.
(c) Execution of the Budget
Process in the Preparation The budget is mainly executed by
of the Budget different departments of the Government.
Budget estimates are prepared by the Proper execution of the budgetary
Ministry of Finance provisions are important for the efficient
utilisation of the allocated funds.
Based on the estimated income and
expenditure of various ministries and Parliamentary Control over the Budget
departments, sent to the Ministry of
In India,the Government Accounts are
Finance
maintained in three parts:
Prepares budget (i) Consolidated Fund
(ii) Contingency Fund
Presented by the finance minister to the (iii) Public Accounts
cabinet for approval
There are also two committees of
Budget is ready for presentation to the parliament, viz,
Parliament
(i) 
The Public Accounts Committee,
and
(B) Presentation of the Budget (ii)The Estimates Committee.

The hon’ble Minister of Finance, on These committees keep a constant vigil

behalf of the Central Government, places on the expenditure so that no Ministry
the Union Budget before Parliament on or Department exceeds the amount
the eve of a new financial year. Similarly at sanctioned to it.
state levels, the Hon’ble Finance Minister
of the respective State Government
places the State Budget before the State 9.11.5. Budgetary Deficits
Legislature.
Budget deficit is a situation where
According to the Indian Constitution, budget receipts are less than budget
all money bills must be initiated in the expenditures. This situation is also known
Lower House. All the money bills are as government deficit.
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 the real burden of the government and it
In reference to the Indian
does not include the interest burden on
Government budget, budget deficit is of
loans taken in the past. Thus, primary
four major types.
deficit reflects borrowing requirement of
(a) Revenue Deficit the government exclusive of interest
(b) Budget Deficit payments.
(c) Fiscal Deficit, and Primary Deficit (PD) = Fiscal deficit
(d) Primary Deficit (PD) - Interest Payment (IP)
(A) Revenue Deficit
9.12
It refers to the excess of the
government revenue expenditure over Federal Finance
revenue receipts. It does not consider
capital receipts and capital expenditure. Federal finance refers to the system
Revenue deficit implies that the of assigning the source of revenue to the
government is living beyond its means to Central as well as State Governments for
conduct day-to-day operations. the efficient discharge of their respective
functions i.e. clear-cut division is made
Revenue Deficit (RD) = Total Revenue regarding the allocation of resources of
Expenditure (RE) - Total Revenue revenue between the central and state
Receipts (RR), authorities.
 Division of Powers: In our Constitution,
When RE - RR > 0 there is a clear division of powers so
(B) Budget Deficit that none violates its limits and tries
to encroach upon the functions of the
Budget deficit is the difference other and functions within own sphere
between total receipts and total of responsibilities. There are three lists
expenditure (both revenue and capital) enumerated in the Seventh Schedule of
Budget Deficit = Total Expenditure – constitution. They are: the Union list,
Total Revenue the State list and the Concurrent List.
 heUnion List consists of 100 subjects
T
(C) Fiscal Deficit of national importance such as Defence,
Railways, Post and Telegraph, etc.
Fiscal deficit (FD) = Budget deficit +
T
 he State List consists of 61 subjects
Government’s market borrowings and
of local interest such as Public Health,
liabilities
Police etc.

(D ) Primary Deficit  he Concurrent List has 52 subjects

T
important to both the Union and the
Primary deficit is equal to fiscal State, such as Electricity, Trade Union,
deficit minus interest payments. It shows Economic and Social Planning, etc.

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 Central State Financial Relationship 18. 
Taxes other than stamp duties on
transactions in stock exchanges and
(I) Union Sources future markets.
1. Corporation tax 19. 
Taxes on the sale or purchase of
2. 
Currency, coinage and legal tender, newspapers and on advertisements
foreign exchange. published therein.

3. 
Duties of customs including export 20. Terminal taxes on goods or passengers,
duties. carried by railways, sea or air.
4. Duties of excise on tobacco and certain
goods manufactured or produced in (II) State Sources
India. 1. Capitation tax
5. Estate duty in respect of property other 2. 
Duties in respect of succession to
than agricultural land. agricultural land.
6. Fees in respect of any of the matters in
3. 
Duties of excise on certain goods
the Union List, but not including any
produced or manufactured in the State,
fees taken in any Court.
such as alcoholic liquids, opium, etc.
7. F
 oreign Loans.
4. Estate duty in respect of agricultural
8. Lotteries organized by the Government land.
of India or the Government of a State.
5. Fees in respect of any of the matters in
9. P
 ost Office Savings Bank.
the State List, but not including fees
10. 
Posts and Telegraphs, telephones, taken in any Court.
wireless, Broadcasting and other forms
of communication. 6. Land Revenue.

11. Property of the Union. 7. 

R ates of stamp duty in respect of
documents other than those specified
12. Public Debt of the Union.
in the Union List.
13. Railways.
8. Taxes on agricultural income.
14. R ates of stamp duty in respect of Bills
of Exchange, Cheques, Promissory 9. Taxes on land and buildings.
Notes, etc. 10. 
Taxes on mineral rights, subject to
15. Reserve Bank of India. limitations impose by Parliament
16. Taxes on income other than agricultural relating to mineral development.
income. 11. Taxes on the consumption or sale of
17. 
Taxes on the capital value of the electricity.
assets, exclusive of agricultural land of 12. Taxes on the entry of goods into a
individuals and companies. local area for consumption, use or sale
therein.
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 13. 
Taxes on the sale and purchase of (IV) 
Duties levied by the Union but
goods other than newspapers. collected and Appropriated by the
14. 
Taxes on the advertisements other states (Art.268)
than those published in newspapers.
Stamp duties and duties of excise on
15. Taxes on goods and passengers carried medicinal and toilet preparation (those
by road or on inland waterways. mentioned in the Union List) shall be
16. T
 axes on vehicles. levied by the Government of India but
17. T
 axes on animals and boats. shall be collected.

18. Taxes on professions, trades, callings (i) 

In the case where such duties are
and employments. leviable within any Union territory, by
the Government of India.
19. Taxes on luxuries, including taxes on
entertainments, amusements, betting (ii) In other cases, by the States within
and gambling. which such duties are respectively
leviable.
20. Tolls.
(v) Taxes which are Levied and Collected
(III) Taxes Levied and Collected by the by the Union but which may be
union but Assigned to the States Distributed between the Union and
(Art.269) the States (Arts.270 and 272)
1. 
Duties in respet of succession to 1. Taxes on income other than agricultural
property other than agricultural land. income.

2. Estate duty in respect of property other 2. Union duties of excise other than such
than agricultural land. duties of excise on medicinal and
toilet preparations as are mentioned
3. T
 axes on railway fares and freights. in the Union List and collected by the
Government of India.
4. 
Taxes other than stamp duties on
transactions in stock exchanges and “Taxes on income” does not include
future markets. corporation tax. The distribution of
income-tax proceeds between the
5. 
Taxes on the sale or purchase of Union and the States is made on the
newspapers and on advertisements recommendations of the Finance
published therein Commission.
6. Terminal taxes on goods or passengers
carried by railways, sea or air. 9.12.1. Principles of Federal Finance

7. Taxes on the sale or purchase of goods

In the case of federal system of finance,
other than newspapers where such sale
the following main principles must be
or purchase taxes place in the course of
applied:
inter-State trade or commerce.
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 1. Principle of Independence. that the resources of each Government
i.e. Central and State should be adequate
2. Principle of Equity.
to carry out its functions effectively. Here
3. Principle of Uniformity. adequacy must be decided with reference
4. Principle of Adequacy. to both current as well as future needs.
Besides, the resources should be elastic
5. Principle of Fiscal Access. in order to meet the growing needs and
6. P
 rinciple of Integration and unforeseen expenditure like war, floods
coordination. etc.
7. Principle of Efficiency. 5. Principle of Fiscal Access
8. Principle of Administrative Economy. In a federal system, there should
9. Principle of Accountability. be possibility for the Central and State
Governments to develop new source of
1. Principle of Independence revenue within their prescribed fields
to meet the growing financial needs. In
Under the system of federal finance, nutshell, the resources should grow with
a Government should be autonomous and the increase in the responsibilities of the
free about the internal financial matters Government.
concerned. It means each Government
should have separate sources of revenue, 6. 
Principle of Integration and
authority to levy taxes, to borrow coordination
money and to meet the expenditure. The financial system as a whole
The Government should normally enjoy should be well integrated. There should
autonomy in fiscal matters. be perfect coordination among different
layers of the financial system of the
2. Principle of Equity
country. Then only the federal system
From the point of view of equity, the will survive. This should be done in such
resources should be distributed among the a way to promote the overall economic
different states so that each state receives a development of the country.
fair share of revenue.
7. Principle of Efficiency
3. Principle of Uniformity The financial system should be well
In a federal system, each state should organized and efficiently administered.
contribute equal tax payments for federal There should be no scope for evasion and
finance. But this principle cannot be fraud. No one should be taxed more than
followed in practice because the taxable once in a year. Double taxation should be
capacity of each unit is not of the same. avoided.
8. Principle of Administrative Economy
4. Principle of Adequacy of Resources
Economy is the important criterion
The principle of adequacy means of any federal financial system. That is,
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 the cost of collection should be at the Finance Commission aims to reduce
 
minimum level and the major portion the fiscal imbalances between the
of revenue should be made available centre and the states (Vertical
for the other expenditure outlays of the imbalance) and also between the
Governments. states (horizontal imbalance). It
promotes inclusiveness.
9. Principle of Accountability
A Finance Commission is set up
 
Each Government should be once in every 5 years. It is normally
accountable to its own legislature for its constituted two years before the
financial decisions i.e the Central to the period. It is a temporary Body.
Parliament and the State to the Assembly.
The 14th Finance Commission was
 
9.13 set up in 2013. Its recommendations
History of Finance Commission were valid for the period from 1st
April 2015 to 31st March 2020.
Finance commission is a quasi-
 
The 15th Finance Commission
 
judicial body set up under Article
has been set up in November
280 of the Indian Constitution. It was
2017. Its recommendations will be
established in the year 1951, to define
implemented starting 1 April 2020.
the fiscal relationship framework
between the Centre and the state.

Finance Year of Operational

Chairman
Commission establishment duration
First 1951 K. C. Neogy 1952–57
Second 1956 K. Santhanam 1957–62
Third 1960 A. K. Chanda 1962–66
Fourth 1964 P. V. Rajamannar 1966–69
Fifth 1968 MahaveerTyagi 1969–74
Sixth 1972 K. Brahmananda Reddy 1974–79
Seventh 1977 J. M. Shelat 1979–84
Eighth 1983 Y. B. Chavan 1984–89
Ninth 1987 N. K. P. Salve 1989–95
Tenth 1992 K. C. Pant 1995–2000
Eleventh 1998 A. M. Khusro 2000–05
Twelfth 2002 C. Rangarajan 2005–10
Thirteenth 2007 Dr. Vijay L. Kelkar 2010–15
Fourteenth 2013 Dr. Y. V Reddy 2015–20
Fifteenth 2017 N. K. Singh 2020–25

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 9.13.1. F
 unctions of Finance 9.14
Commission of India Local Finance
rticle 280 (3) speaks about the
A
functions of the Finance Commission. Local finance refers to the finance
The Article states that it shall be the of local bodies in India. There is a large
duty of the Commission to make the variety of local bodies in India. We have
recommendations to the President as to: the following main four local bodies which
are functioning today in our country:
1. T
 he distribution between the Union Types of Local Bodies
and the States of the net proceeds of
taxes, which may be divided between 1. Village Panchayats
them and the allocation among the 2. District Boards or ZilaParishads
states of the respective shares of such 3. Municipalities
proceeds;
4. Municipal Corporations
2. T
 o determine the quantum of grants-
in-aid to be given by the Centre to states 1. Village Panchayats:
[Article 275 (1)] and to evolve the
principles governing the eligibility of
the state for such grant-in-aid;

Article 280 of the


Constitution mandates
the finance commission
to recommend the
distribution of the
net proceeds of taxes
between the Centre
and the states every five
years.  Establishment: The jurisdiction of
a panchayat is usually confined to one
15th Finance

Commission’s revenue village. In some cases, though
recommendations on tax not very frequently, two or more small
sharing between Centre
and States are to kick in villages are grouped under one panchayat.
form April 2020 The establishment of panchayat raj is the
3. A
ny other matter referred to the avowed policy of most states in India.
Commission by the President of India
 Functions
in the interest of sound finance. Several
a) The functions of panchayats range over
issues like debt relief, financing of
a wide area including civil, economic
calamity relief of states, additional
and so on. Thus small disputes may be
excise duties, etc. have been referred to
disposed of by panchayats on the spot.
the Commission invoking this clause.

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 b) Roads, primary schools, village district level. The territorial jurisdiction
dispensaries etc. are to be managed by of a district board is generally a revenue
panchayats. district.
c) The supply of water, both for drinking  Functions
and irrigation, falls within their field
of responsibility, and in some cases In Tamil Nadu, the Zila Parishad
farming, marketing, storage, etc. are is a co-ordinating body which exercises
entrusted to them. general supervision over the working of
Panchayat Samitis and advises them on
Sources of revenue of Village Panchayats implementation of Development Schemes.
The following are the sources of Sources of revenue of District Boards
revenue of village panchayats.
(i) Grants-in-aid from the state
(i) general property tax, government.
(ii) taxes on land, (ii) Land Cesses.
(iii) profession tax, and (iii) Toll, fees etc.
(iv) tax on animals and vehicles. (iv) Income from the property and loans
from the state governments.
Other taxes include service tax,
octroi, theatre tax, pilgrim tax, tax on (v) Grants for the centrally sponsored
marriage, tax on birth and deaths, and schemes relating to development
labour tax. As a matter of fact, taxes are work.
levied by the panchayats only with the (vi) Income from fairs and exhibitions.
sanction of the state government, and
(vii)Property tax and other taxes which
there are certain limits in respect of tax
the state governments may authorise
rates which have to be observed.
the district boards.
2. District Boards Or ZilaParishads: 3. Municipalities

 Establishment and Functions: The

 Establishment: In rural areas, district
municipalities are bodies or institutions
boards or Zila Parishads are established at
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 which are established in urban areas drainage, lighting, roads, slum clearance,
for looking after local affairs, such as, housing and town planning etc. The
sanitation, public health, local roads, rapid increase in the population of cities
lighting, water supply, cleaning of streets, has definitely added to the functions of
maintenance of parks and gardens, municipal corporations.
maintenance of hospitals, dispensaries
and veterinary hospitals, provision of Sources of revenue of Corporations
drainage, provision of primary education, (i) tax on property,
organising of fairs and exhibitions (ii) tax on vehicles and animals,
etc. However, all these functions are
(iii) tax on trades, calling and employment,
performed subject to the control of the
state government. (iv) theatre and show tax,
(v) taxes on goods brought into the cities
Sources of revenue of municipalities for sale,
(i) taxes on property (vi) taxes on advertisements,
(ii) 
taxes on goods, particularly octroi (vii) octroi and terminal tax etc.
and terminal tax
The corporations have a fair degree
(iii) personal taxes, taxes on profession, of freedom in respect of their choice and
trades and employment modification of these taxes, subject to the
(iv) taxes on vehicles and animals maximum and minimum rates laid down
by the law.
(v) theatre or show tax, and
(vi) grants-in-aid from state government.
9.15
Fiscal policy
4. Municipal Corporations
As an instrument of macro-economic
policy, fiscal policy has been very popular
among modern governments. The growing
importance of fiscal policy was due to the
Great Depression and the development of
‘New Economics’ by Keynes.

9.15.1. Meaning of Fiscal Policy

Establishment and Functions: In common parlance fiscal policy

means the budgetary manipulations
The municipal corporations have affecting the macro economic variables –
wide powers and enjoy greater freedom as output, employment, saving, investment
compared to municipalities. The municipal etc.
corporations are usually entrusted with
the functions, such as, water supply and

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 i) Taxation: Taxes transfer income from
9.15.2. Definitions the people to the Government. Taxes
“The term fiscal policy refers to a are either direct or indirect. An increase
policy under which the Government uses in tax reduces disposable income. So
its expenditure and revenue programmes taxation should be raised to control
to produce desirable effects and avoid inflation. During depression, taxes are to
undesirable effects on the national income, be reduced.
production and employment”
ii) Public Expenditure: Public
– Arthur Smithies expenditure raises wages and salaries of
“By fiscal policy is meant the use the employees and thereby the aggregate
of public finance or expenditure, taxes, demand for goods and services. Hence
borrowing and financial administration to public expenditure is raised to fight
further our national economic objectives” recession and reduced to control inflation.

– Buehler iii) Public debt: When Government

borrows by floating a loan, there is
9.15.3. Fiscal Instruments transfer of funds from the public to the
Government. At the time of interest
Fiscal Policy is implemented through
payment and repayment of public debt,
fiscal instruments also called ‘fiscal tools’
funds are transferred from Government
or fiscal levers: Government expenditure,
to public.
taxation and borrowing are the fiscal tools.

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 excess demand is due to private spending.
9.15.4. Objectives of Fiscal Policy:
Taxation reduces disposable income and
so aggregate demand.
1. Full Employment To fight depression, the Government
Objectives of Fiscal Policy

needs to increase its spending and reduce

2. Price stability taxation.

3. Economic growth 3. Economic Growth

Fiscal Policy is used to increase
4. Equitable distribution
the productive capacity of the economy.
Tax is to be used as an instrument for
5. External stability encouraging investment. Tax holidays and
tax rebates for new industries stimulate
6. Capital formation investment. Public sector investments are
to be increased to fill the gap left by private
7. Regional balance investment. When resource mobilization
through tax measures is inadequate, the
Government resorts to borrowing both
The Fiscal Policy is useful to achieve the from internal and external sources to
following objectives: finance growth projects.

1. Full Employment 4. Equitable distribution

Full Employment is the common Progressive rates in taxation help
objective of fiscal policy in both to reduce the gap between rich and poor.
developed and developing countries. Similarly progressive rates in public
Public expenditure on social overheads expenditure through welfare schemes
help to create employment opportunities. such as free education, noon meal for
In India, public expenditure on rural school children and subsidies promote the
employment programmes like MGNREGS living standard of poor people.
is aimed at employment generation.
5. Exchange Stability
2. Price Stability
Fluctuations in international trade
Price instability is caused by cause movements in exchange rate. Tax
mismatch between aggregate demand and concessions and subsidy to export oriented
aggregate supply. Inflation is due to excess units help to boost exports. Customs
demand for goods. If excess demand is duties on import of non-essential items
caused by Government expenditure in help to cut import bill. The reduction in
excess of real output, the most effective import duty on import of raw material
measure is to cut down public expenditure. and machinery enables reduction in cost
Taxation of income is the best measure if and make the exports competitive.
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 6. Capital formation investment, interest rate, consumption
and income growth.
Capital formation is essential for
rapid economic development. Tax relief
helps to increase disposable income, Glossary
savings and thereby capital formation.
Government expenditure on infrastructure Tax: Compulsory payment paid by the
development like power and transport citizens to the Government without any
encourages private investment. quid pro quo.
Quid pro quo: A favour or advantage
7. Regional balance
granted in return for something.
Fiscal incentives for industries in the Proportional Tax: Tax is imposed at the
backward regions help to narrow down same rate irrespective of tax base
regional imbalances. Public expenditure
may be used to start industrial estates so Progressive Tax: The rate of tax increases
that industrial activity is stimulated in with the increase in tax base (income)
backward regions. Regressive Tax: High rate of tax is levied
on the poor and low rate is levied to the
Summary: rich
The science of public finance deals Internal public debt: A loan taken by the
with the revenue and expenditure of the Government from the citizens or from
Centre, state and local Government. different institutions with in the country
In modern times, this subject includes External public debt: A loan is taken
five major divisions: Public revenue, from abroad or from an international
public expenditure, public debt, fiscal
organisation
administration and Fiscal Policy. Thus,
public finance plays a vital role in Fiscal Policy: Policy related with the
both developed and underdeveloped revenue and expenditure process of the
economies. In advanced or developed Government
economies, this is a problem of economic Deficit Budget: The gap between
instability due to either ‘lack of demand’ Government anticipated revenue and the
or ‘excess of demand’. In under developed targeted expenditure
countries, fiscal policy is one of the Budget: It is an annual financial statement
instruments for achieving faster economic which shows the income and expenditure
growth. of the Government
Fiscal Policy became popular after Federal Finance: The system of assigning
the Great Depression. Governments the source of revenue to the Central as
intervention was emphasised by well as State Governments.
J.M.Keynes to get the economies out of
Local Finance: Local finance refers to the
the Depression. There is close association
finance of local bodies in India
between governments spending, private

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 MODEL QUESTIONS
Part – A
Multiple choice questions

ii. 
The Constitution also provides for
1. The modern state is transferring certain tax revenues from
union list to states.
a) Laissez-faire state
b) Aristocratic state a) i only
c) Welfare state b) ii only
d) Police state c) both
d) none
2. O
 ne of the following is NOT a feature
of private finance 6. GST is equivalence of

a) B
 alancing of income and a) Sales tax
expenditure b) Corporation tax
b) Secrecy c) Income tax
c) Saving some part of income d) Local tax
d) Publicity
7. T
 he direct tax has the following merits
3. T
 he tax possesses the following except
characteristics a) equity
a) Compulsory b) convenient
b) No quid pro quo c) certainty
c) Failure to pay is offence d) civic consciousness
d) All the above
8. Which of the following is a direct tax?
4. W
 hich of the following canons of a) Excise duty
taxation was not listed by Adam smith? b) Income tax
a) Canon of equality c) Customs duty
b) Canon of certainty d) Service tax
c) Canon of convenience
 hich of the following is not a tax
9. W
d) Canon of simplicity
under Union list?
5. C onsider the following statements and a) Personal Income Tax
identify the correct ones. b) Corporation Tax
c) Agricultural Income Tax
i. 
C entral government does not have
d) Excise duty
exclusive power to impose tax which is
not mentioned in state or concurrent
list.
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 10. “Revenue Receipts” of the Government 15. M
 ethods of repayment of public debt
do not include is
a) Interest a) Conversion
b) Profits and dividents b) Sinking fund
c) Recoveries and loans c) Funded debt
d) Rent from property d) All these

11. T
 he difference between revenue 16. 
C onversion of public debt means
expenditure and revenue receipts is exchange of
a. Revenue deficit a) new bonds for the old ones
b. Fiscal deficit b) l ow interest bonds for higher
c. Budget deficit interest bonds
d. Primary deficit c) L
 ong term bonds for short term
bonds
12. 
The difference between total d) All the above
expenditure and total receipts
including loans and other liabilities is 17. 
The word budget has been derived
called from the French word “bougette”
which means
a. Fiscal deficit
b. Budget deficit a) A small bag
c. Primary deficit b) An empty box
d. Revenue deficit c) A box with papers
d) None of the above
13.The primary purpose of deficit
financing is 18. Which one of the following deficits
does not consider borrowing as a
a) Economic development
receipt?
b) Economic stability
c) Economic equality a) Revenue deficit
d) Employment generation b) Budgetary deficit
c) Fiscal deficit
14. Deficit budget means d) Primary deficit
a) A
 n excess of government’s revenue
19. Finance Commission determines
over expenditure
b) A
 n excess of government’s current a) T
 he finances of Government of
expenditure over its current India
revenue b) T
 he resources transfer to the states
c) A
 n excess of government’s total c) T
 he resources transfer to the
expenditure over its total revenue various departments
d) None of above d) None of the above

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 20. C
 onsider the following statements and identify the right ones.
i. The finance commission is appointed by the President
ii. The tenure of Finance commission is five years
a) i only
b) ii only
c) both
d) none
Answers

1 2 3 4 5 6 7 8 9 10
c d d d b a b b c d
11 12 13 14 15 16 17 18 19 20
a a a c d b a c b c

Part B
Two mark questions
21. Define public finance.
22. What is public revenue?
23. Differentiate tax and fee.
24. Write a short note on zero based budget.
25. Give two examples for direct tax.
26. What are the components of GST?
27. What do you mean by public debt?

Part C
28. Three mark questions:
29. Describe canons of Taxation.
30. Mention any three similarities between public finance and private finance.
31. What are the functions of a modern state?
32. State any three characteristics of taxation.
33. Point out any three differences between direct tax and indirect tax.
34. What is primary deficit?
35. Mention any three methods of redemption of public debt.
Part D
36. Five mark questions:
37. Explain the scope of public finance.
38. Bring out the merits of indirect taxes over direct taxes.
39. Explain the methods of debt redemption.

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 40. State and explain instruments of fiscal policy.
41. Explain the principles of federal finance.
42. Describe the various types of deficit in budget.
43. What are the reasons for the recent growth in public expenditure?

ACTIVITY
Collect various bills and tabulate different rates of GST for different
goods and services.

References

1. P
 ublic Finance – Dr.H.L.Bhatia – Vikas Publishers-2018
2. Public Finance – R.K.lekhi – Joginder Sing – Kalyani Publications-2010
3. Public Finance – AmbarGhose, Chandra Ghosh – PHI Publications -2014
4. Public FinaceTheroy and Practice – Dr. S.K.Sing – S.Chand Publication -2010

Website Link
https://edurev.in/courses/10460_Public-Finance-Notes--Videos.
https://eclass.uoa.gr/modules/document/file.php/ECON123/Lectures/Lecture%20
01%20Introduction.pdf

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 CHAPTER

10 Environmental Economics

“Environmental problems are really social problems…They begin

with the people as the cause and end with people as victims”.
–Sir Edmund Hillary

Learning Objectives

1 To understand the link between economy and environment;

2 To describe the various types of environmental pollution and their effects; and,

3 To understand the importance of sustainable development

10.1 resources – whether human, natural, or

monetary –are finite, these public policies
Introduction are most effective only when they achieve
the maximum possible benefit in the most
Environmental economics (EE) efficient way.
is the study of interactions between
human economic activity and the
natural environment. EE is the subset
of economics that is concerned with the
efficient allocation of environmental Environmental
resources. The environment provides Economics
both a direct value as well as raw material
intended for economic activity, thus
making the environment and the economy
interdependent.

EE takes into consideration issues

such as the conservation and valuation of
natural resources, pollution control, waste
management and recycling. Since
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 The key objective of EE is to identify 10.3
those particular tools or policy alternatives
that will move the market towards the most
Eco System
efficient allocation of natural resources.
An ecosystem includes all living
things (plants, animals and organisms) in
10.2 a given area, interacting with each other,
and also with their non-living
Meaning of Environment environments (weather, earth, sun, soil,
climate, atmosphere). Ecosystems are the
The term environment has been foundations of the Biosphere and they
derived from a French word “Environia” determine the health of the entire earth
means to surround. Environment means system.
“all the conditions, circumstances, and
influences surrounding and affecting the
development of an organism or group of
organisms”. It also means that the complex
of physical, chemical and biotic factors
that act upon an organism or an ecological
community ultimately determine its form
and survival.

Meaning of Environmental Economics

It is a different branch of economics

that recognizes the value of both the
environment and economic activity and
makes choices based on those values. The
goal is to balance the economic activity
and the environmental impacts by taking
into account all the costs and benefits.
In short, Environmental Economics is
an area of economics that studies the 10.4
financial impact of environmental issues Linkage between Economy and
and policies. Environment

Environmental Economics involves Man’s life is interconnected with

theoretical and empirical studies of the various other living and non-living things.
economic effects of national or local The life also depends on social, political,
environmental policies around the world. ethical, philosophical and other aspects of
economic system. In fact, the life of human
beings is shaped by his living environment.
The relationship between the economy and
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 the environment is generally explained in
the form of a “Material Balance Model’’

Environmental Quality
developed by AlenKneese and R.V. Ayres. B

Abatement Cost
The model considers the total economic
process as a physically balanced flow E
between inputs and outputs. Inputs are
bestowed with physical property of energy
which is received from the environment. A
The interdependence of economics and
0
environment is given in the figure10.1 and Size of GDP
flow diagram Figure 10.1

Natural Environment

Recycled (Rrp)

Residuals(Rp) Discharged
Raw Material (M)
Producers Goods (Rdp)
(G)

Residuals Discharged
Consumers
(Rc) (Rdc)

Recycled (Rrc)
Flow Diagram for Material Balace Approach

The first law of thermodynamics, pollutants. Production of output by firms

i.e. the law of conservation of matter from inputs resulting in discharge of solid,
and energy, emphasizes that in any liquid and gaseous wastes. Similarly, waste
production system “what goes in must results from consumption activities by
come out”. This is known as the Material households. In short, material and energy
Balance Approach or Material Balance are drawn from environment, used for
Principle. The material flow diagram production and consumption activities
implies that mass inputs must equal mass and returned back to the environment as
outputs for every process. Moreover, all wastes. In its simple form the Material
resources extracted from the environment Balance Approach can be put in form
eventually become unwanted wastes and equation.
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 M = G–(RC– RP) + (RrP + Rrc) = Rdp + Rdc

Economic Activities of Goods and

Final Residual
Service Production (G) -Consumption
Discharge from
Material and Energy and Production Residual Discharges
Production and
Inflow from Natural = from Consumption and Production =
Consumption into
World (M) activities (RC+RP) + Recycles from
Natural World
Production and Consumption
(RdC+ RdC)
(RrP + RrC)

Economy — Environment Interlinkages

Material Balance Model*

The Environment
R (Raw Material)

Production Sector
R=F+W1

Household Sector
F=W2

R=W1+W2
(Input=Output) W1 & W2 = Waste from Prod and Household Sector,
F=Final Product

Is it alright? Environment is the firms depend on nature for resources.

supplier of all forms of resources like Both households and firms send out
renewable and non-renewable, and it residuals of consumption and production
is also acting as a sink for cleaning up respectively to nature. Nature has the
of wastes. Households and firms are power to assimilate all forms of waste. But
connected to environment, and they this power is conditional. There is a limit
are interconnected too. Households and for everything. The earth has reached the

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 saturation point and it is unable to cleanup to GDP as well as depletion of natural
several forms of wastes. Remember, the resources are not accounted in the present
earth can also non-cooperate! system of National Income Enumeration.
10.5 Externalities and the environment
Environmental Goods Introduction
Environmental goods are typically In Environmental Economics, one
non-market goods, including clear air, of the most important market failures is
clean water, landscape, green transport caused by negative externalities arising
infrastructure (footpaths, cycle ways, from production and consumption of
greenways, etc.), public parks, urban parks, goods and services. Externalities are third
rivers, mountains, forests, and beaches. party effects arising from production
Concerns with environmental goods and consumption of goods and services
focus on the effects that the exploitation of for which no appropriate compensation
ecological systems have on the economy, is paid. Externalities occur outside of
the well-being of humans and other the market i.e. they affect people not
species, and on the environment. directly involved in the production and
consumption of a good or service. They
10.6 are also known as spill-over effects.
Environmental
Quality 10.6.1 Meaning of Externalities

Environmental quality is a set of Externalities refer to external effects

properties and characteristics of the or spillover effects resulting from the act
environment either generalized or local, of production or consumption on the
as they impinge on human beings and third parties. Externalities arise due to
other organisms. It is a measure of the interdependence between economic units.
condition of an environment relative to
the requirements of one or more species Definitions
and to any human need. Environmental Externality may be defined as
quality has been continuously declining “the cost or benefit imposed by the
due to capitalistic mode of functioning. consumption and production activities of
Environment is a pure public good the individuals on the rest of the society
that can be consumed simultaneously by not directly involved in these activity and
everyone and from which no one can be towards which no payment is made”.
excluded. A pure public good is one for The externalities arise from both
which consumption is non-revival and production and consumption activities
from which it is impossible to exclude a and their impact could be beneficial or
consumer. Pure public goods pose a free- adverse. Beneficial externalities are called
rider problem. As a result, resources are “positive externalities” and adverse ones
depleted. The contribution of the nature are called “negative externalities”.
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 Classification of Externalities
Consumption Production

Positive Negative Positive Negative

Private security Loud Speaker Beehives Factory emission

Public safety Noise Pollution Pollination

Positive Consumption Externality Negative Production Externality

When some residents of a locality Examples of Negative Production
hire a private security agency to patrol Externalities
their area, the other residents of the area
also benefit from better security without Negative production externalities include
bearing cost. pollution generated by a factory that
imposes costs on others
Negative Consumption Externality
When answering any question on negative
A person smoking cigarette gets may externalities consider whether the external
gives satisfaction to that person, but this costs are significant and if so, whether they
act causes hardship (dissatisfaction) to the can be measured and valued accurately
non-smokers who are driven to passive
smoking.

Positive Production Externality

The ideal location for beehives is
Air pollution Pollution from
orchards (first growing fields). While
from factories fertilizers
bees make honey, they also help in the
pollination of apple blossoms. The benefits
accrue to both producers (honey as well as
apple). This is called ‘reciprocal untraded
interdependency.
Noise pollution Industrial waste
Suppose training is given for the
workers in a company. If those trained
workers leave the company to join some
other company, the later company gets
the benefit of skilled workers without
incurring the cost of training. Collapsing fish Methane
stocks emissions

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 The emissions and effluents of a other living creatures or plants or property
factory cause air and water pollution. or environment”.
Water becomes contaminated and unfit -The Air (Prevention and Control of
for drinking e.g. Tanneries. The innocent Pollution) Act, 1981
community bears the external cost for
which it is not compensated. Types of Air pollution
10.7
Indoor Air Pollution: It refers to toxic
 
Pollution contaminants that we encounter in our
daily lives in our homes, schools and
Meaning workplaces. For example, cooking and
heating with solid fuels on open fires
Pollution is the introduction of or traditional stoves results in high
contaminants into the natural environment levels of indoor air pollution.
that causes adverse change, in the form
of killing of life, toxicity of environment, Outdoor Air Pollution: It refers to
 
damage to ecosystem and aesthetics of our ambient air. The common sources of
surrounding. outdoor air pollution are caused by
combustion processes from motor
Types of Pollution vehicles, solid fuel burning and
1. Air pollution industry.

2. Water pollution Causes of Air Pollution

3. Noise pollution
1. Vehicle exhaust smoke: Vehicles smoke
4. Land pollution happens to release high amounts of
Carbon monoxide. Millions of vehicles
10.7.1 Air Pollution are operated every day in cities, each
one leaving behind its own carbon
footprint on the environment.

2. 
 ossil fuel based power plants:
F
Fossil fuels also present a wider scale
problem when they are burned for
energy in power plants. Chemicals like
sulfur dioxide are released during the
burning process, which travel straight
Definition into the atmosphere. These types of
“Air pollution is the presence of any pollutants react with water molecules
solid, liquid, or gaseous substance in the to yield something known as acid rain.
atmosphere in such concentration as may be
or tend to be injurious to human beings or

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 3. E
 xhaust from Industrial Plants and 3. Acid rain: Harmful gases like nitrogen
Factories: Heavy machineries located oxides and sulfur oxides are released
inside big factories and industrial into the atmosphere during the burning
plants also emit pollutants into the air. of fossil fuels. Acid rain causes great
damage to human beings, animals and
4. 
 onstruction
C and Agricultural crops.
activities: Potential impacts arising
from the construction debris would 4. Eutrophication: Eutrophication is
include dust particles and gaseous a condition where high amount of
emissions from the construction nitrogen present in some pollutants
sites. Likewise, using of ammonia for which adversely affects fish, plants and
agriculture is a frequent byproduct animal species.
that happens to be one of the most 5. Effect on Wildlife: Toxic chemical
dangerous gases affecting air. present in the air can force wildlife
5. N
 atural Causes: Earth is one of species to move to new place and
the biggest polluters itself, through change their habitat.
volcanoes, forest fires, and dust storms. 6. Depletion of Ozone layer: Ozone
They are nature-borne events that exists in earth’s atmosphere and is
dump massive amounts of air pollution responsible for protecting humans
into the atmosphere. from harmful ultraviolet (UV) rays.
6. H
 ousehold activities: Household Earth’s ozone layer is depleting due
activities like cooking, heating and to presence of chlorofluorocarbons
lighting, use of various forms of and hydro chlorofluorocarbons in the
mosquito repellents, pesticides and atmosphere.
chemicals for cleaning at home and use 7. Human Health: Outdoor air pollution
of artificial fragrances are some of the is a major cause of death and disease
sources that contribute to air pollution. globally. The health effects range from
Effects of Air Pollution increased hospital admissions and
emergency room visits, to increased
1. Respiratory and heart problems: It
risk of premature death. An estimated
creates several respiratory and heart
4.2 billion premature deaths globally
ailments along with cancer. Children
are linked to ambient air pollution.
are highly vulnerable and exposed to
air pollutants and commonly suffer
from pneumonia and asthma. Every day about 93% of the
world’s children under the age of 15 (1.8
2. Global warming: Increasing
billion children) breath polluted air
temperature in the atmosphere leads
that puts their health and development
to global warming and thereby to
at serious risk – WHO
increase sea level rise and melting of
polar icebergs, displacement and loss
of habitat.
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 Remedial measures to control Air ii. Groundwater pollution: Groundwater
Pollution contamination occurs when man-
made products such as gasoline, oil
1. Establishment of industries away from
and chemicals get into the ground
the towns and cities
water. In addition, untreated waste
2. Increasing the length of the Chimneys from septic tanks, toxic chemicals from
in industries underground storage tanks and leaky
3. Growing more plants and trees landfills contaminate groundwater.
4. Use of non-conventional fuels like iii. Microbiological pollution: In many
Biogas, CNG and LPG. communities around the world, people
5. Use of Mass Transit System (Public drink untreated water (straight from
Transport) a pond,river or stream). Sometimes
there is natural pollution caused by
10.7.2 Water Pollution micro-organism like viruses and
bacteria. This natural pollution causes
Definition
both aquatic and human illness.
“The introduction (directly or iv. Oxygen depletion pollution:
indirectly) of substances or energy into When oxygen levels in the water are
the marine environment (including depleted, relatively harmless aerobic
estuaries) results in deleterious effects to micro-organisms die and anaerobic
living resources, hazards to human health, micro-organisms begin to thrive.
hindrance to marine activities. Some anaerobic micro-organisms are
- United Nations, 1971 harmful to people, animals and the
environment as they produce harmful
toxins such as ammonia and sulfides.
Causes of Water Pollution
Water pollution is caused due to
several reasons. Here are the few major
causes of water pollution:
1. Discharge of sewage and waste water:
Sewage, garbage and liquid waste of
Types of Water Pollution households, agricultural runoff and
i. Surface water pollution: Surface effluents from factories are discharged
water includes natural water found into lakes and rivers. These wastes
on the earth’s surface, like rivers, contain harmful chemicals and toxins
lakes, lagoons and oceans. Hazardous which make the water poisonous for
substances coming into contact with aquatic animals and plants.
this surface water, dissolving or mixing 2. Dumping of solid wastes: The
physically with the water can be called dumping of solid wastes and litters in
surface water pollution. water bodies cause huge problems.
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 Discharge of industrial sastes:
3.  are dumped and in which locations. Many
Industrial waste contains pollutants water bodies near urban areas are highly
like asbestos, lead, mercury, grease polluted. This is the result of both garbage
oil and petrochemicals, which are dumped by individuals and dangerous
extremely harmful to both people and chemicals legally or illegally dumped by
environment. manufacturing industries, health centers
and markets.
Oil Spill: Sea water gets polluted due
4. 
to oil spilled from ships and tankers Death of aquatic animals: The main
i.  
while travelling. The spilled oil does problem caused by water pollution is
not dissolve in water and forms a thick that it kills organisms that depend on
sludge polluting the water. these water bodies. Dead fish, crabs,
birds and sea gulls, dolphins, and
Acid rain: Acid rain is pollution of
5.  many other animals often wind up on
water caused by air pollution. When beaches, killed by pollutants in their
the acidic particles caused by air habitat.
pollution in the atmosphere mix with
water vapor, it results in acid rain. Disruption of food-chains: Pollution
ii.  
disrupts the natural food chain as well.
Global warming: Due to global
6.  Pollutants such as lead and cadmium
warming, there is an increase in water are eaten by tiny animals. Later, these
temperature as a result aquatic plants animals are consumed by fish and the
and animals are affected. food chain continues disrupted at all
higher levels.
Eutrophication: Eutrophication is an
7. 
Diseases: The discharge of untreated
iii. 
increased level of nutrients in water
and under-treated effluent contributes
bodies. This results in bloom of algae
to severe ecological degradation.
in water. It also depletes the oxygen in
The indiscriminate human activities
water which negatively affects fish and
such as open defecation, solid waste
other aquatic animal population.
dumping, discharge of drainage water
Effects of Water Pollution are responsible for the pathogenic
bacteria water-borne diseases like
Water pollution adversely affects the Hepatitis-A, Typhoid, Malaria,
health and life of man, animals and plants Dysentery, Jaundice, Dengue fever,
alike. Polluted water is also harmful for Viral fever and Worm infections.
agriculture as it adversely affects the crops
and the soil fertility. Pollution of sea water Destruction
iv.  of Ecosystems:
damages the oceanic life. The effects Ecosystems can be severely destroyed
can be catastrophic, depending on the by water pollution. Many areas are
kind of chemicals, concentrations of the now being affected by careless human
pollutants. The effects of water pollution pollution, and this pollution is coming
are varied and depend on what chemicals back to hurt humans in many ways.

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 Remedial measures to control Water Types of Noise Pollution
Pollution
Atmospheric Noise: Atmospheric
i.  
C omprehensive

1.  water management noise or static is caused by lighting
plan. discharges in thunderstorms and
other natural electrical disturbances
C onstruction of proper storm drains
2.  occurring in the atmosphere.
and settling ponds.
Industrial Noise: Industrial noise
ii. 
Maintenance of drain line.
3. 
refers to noise that is created in the
4. 
Effluent and sewage treatment plant. factories. Sound becomes noise it
5. 
Regular monitoring of water and waste becomes unwanted. Heavy industries
water. like ship building, iron and steel
have long been associated with Noise
Stringent actions towards illegal

6. 
Induced Hearing Loss (NIHL).
dumping of waste into the water bodies.
iii. Man made Noise: The main sources of
10.7.3 Noise Pollution man-made noise pollution are ships,
aircraft, seismic exploration, marine
construction, drilling and motor boats.
Causes of Noise Pollution

Poor urban planning: Improper urban

i.  
planning will cause more nuisances
among the city travelers.

S ounds from motor vehicles: Sounds

ii. 
from motor vehicles can cause
temporary hearing loss.
iii. Crackers: Enormous Crackers are used
during some occasions. Such activities
Definition create a very louder noise to the level of
Noise pollution is unwanted or excessive harming the public. Sometimes, they
sound that can have deleterious effects on may even cause deafness to children
human health and environmental quality. and aged.
Noise pollution is commonly generated by Factory machinery: The industrial
iv. 
many factories. It also comes from highway, noise caused by continuous operation
railway and airplane traffic and from of mills, machines and pneumatic
outdoor construction activities. drills, is unbearable nuisance to the
-Jerry A. Nathanson and workers.
Richard E. Berg, 2018

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 Effects of Noise Pollution
10.7.4 Land Pollution
a. Hearing Loss: Chronic exposure to
noise may cause noise-induced hearing
loss. Older people are exposed to
significant occupational noise and
thereby reduced hearing sensitivity.

b. Damage Physiological and

Psychological health: Unwanted
noise can damage physiological
and psychological health. For
Definition
example, annoyance and aggression,
hypertension, and high stress levels.
The land pollution is defined as, “the
c. Cardiovascular effects: High noise degradation of land because of the disposal
levels can contribute to cardiovascular of waste on the land”. Any substance (solid,
problems and exposure to blood liquid or gaseous) that is discharged,
pressure. emitted or deposited in the environment in
such a way that it alters the environment
d. Detrimental effect on animals causes land pollution
and aquatic life: Noise can have
-Protection of the Environment Operations
a detrimental effect on animals,
Act 1997
increasing the risk of death.
Types of Land Pollution
e. Effects on wildlife and aquatic
animals: It creates hormone imbalance, i. Solid waste: It includes all kinds of
chronic stress, panic and escape rubbish like paper, plastic containers,
behavior and injury. bottles, cans, food, used cars, broken
electronic goods, municipal waste and
Remedial measures to control Noise
hospital waste.
Pollution
ii. Pesticides and Fertilizers: Many
1. Use of noise barriers
farming activities engage in the
2. Newer roadway for surface transport application of fertilizers, pesticides
and insecticides for higher crop yield
3. Traffic control
which pollute land.
4. Regulating times for heavy vehicles
iii. Deforestation: Humans depend on
5. Installations of noise barriers in the trees for many things including life.
work place Trees absorb carbon dioxide from
6. Regulation of Loudspeakers the air and release Oxygen, which is
needed for life. Forest helps replenish

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 soils and help retain nutrients being C onstruction activities: Due to
vi. 
washed away. Deforestation is led to urbanization, large amount of
land pollution. construction activities are taking place.
This has resulted in large waste articles
Causes of Land Pollution like wood, metal, bricks, plastic. These
i.  Deforestation and soil erosion: are dumped at the outskirts of urban
Deforestation carried out to create dry areas that lead to land pollution.
lands is one of the major concerns.
Land that is once converted into a dry vii. N
 uclear waste: The leftover
or barren land, can never be made radioactive materials, harmful and
fertile again, whatever the magnitude toxic chemicals affect human health.
of measures to convert it. They are dumped beneath the earth to
avoid any casualty.
Agricultural activities: With growing
ii. 
human and pet animal population, Effects of Land Pollution
demand for food has increased
considerably. Farmers often use 1.  Soil pollution: Soil pollution is another
highly toxic fertilizers and pesticides form of land pollution, where the
to get rid off insects, fungi and bacteria upper layer of the soil is damaged. This
from their crops. However the is caused by the overuse of chemical
overuse of these chemicals, results in fertilizers, and pesticides. This leads
contamination and poisoning of land. to loss of fertile land. Pesticides kill
not only pests and also human beings.
iii. M
 ining activities: During extraction
and mining activities, several land 2.  Health Impact: The land when
spaces are created beneath the surface. contaminated with toxic chemicals
and pesticides lead to problem of skin
L andfills: Each household produces
iv.  cancer and human respiratory system.
tones of garbage each year due to The toxic chemicals can reach our
changing economic lifestyle of the body through foods and vegetables.
people. Garbage like plastic, paper,
cloth, wood and hospital waste get 3. C
 ause for Air pollution: Landfills and
accumulated. Items that cannot be waste dumping lead to air pollution.
recycled become a part of the landfills The abnormal toxic substances spread
that cause land pollution. in the atmosphere cause transmit
respiratory diseases among the masses.
v.  Industrialization: Due to increasing
consumerism more industries were 4. E
 ffect on wildlife: The animal
developed which led to deforestation. kingdom has suffered mostly in the
Research and development paved past decades. They face a serious threat
the way for modern fertilizers and with regards to loss of habitat and
chemicals that were highly toxic and natural environment. The constant
led to soil contamination. human activity on land is leaving
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 it polluted, forcing these species to its atmosphere. Average temperatures
move farther away. Sometimes several around the world have risen by 0.75ºC
species are pushed to the verge of (1.4ºF) over the last 100 years. About
extinction or disappear due to no two thirds of this increase has occurred
conducive environment. since 1975. Carbon dioxide, methane,
Chlorofluoro Carbon, nitrous oxides are
Remedial measures to control Land the green house gases warming the earth’s
Pollution surface. So it is also called green house
effect. The CO2 is the most important of
1. Making people aware about the concept the green house gases contributing to 50%
of a Reduce, Recycle and Reuse of global warming. The burning of fossil
2. Buying biodegradable products fuel, and other biomass, deforestation
result in CO2. In the past, when the Earth
3. Minimizing the usage of pesticides experienced increases in temperature it
4. Shifting cultivation was the result of natural causes but today
it is being caused by human activities.
5. Disposing unwanted garbage properly
either by burning or by burying under Global warming adversely affects
the soil. agriculture, horticulture and eco system.
6. Minimizing the usage of plastics. Reduced rainfall, higher temperature
and increased pest/weed growth hamper
10.8 farming. Threats to health arise due to
increase in disease carrying vectors such
Global Warming
as mosquitoes resulting in malaria, dengue
fever, encephalitis and yellow fever.

An increase in the global average

surface air temperature of such magnitude
will bring about alarming changes in
rainfall patterns and other climatic
conditions, resulting in serious ecological
disequilibrium.

10.9
Climate Change

The climate change refers to seasonal

changes over a long period with respect to
Global warming is the current the growing accumulation of greenhouse
increase in temperature of the Earth’s gases in the atmosphere. Recent studies
surface (both land and water) as well as have shown that human activities since
the beginning of the industrial revolution.
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 have contributed to an increase in the from factories, cars or heating boilers
concentration of carbon dioxide in the contact with the water in the atmosphere.
atmosphere by as much as 40%, from about These emissions contain nitrogen oxides,
280 parts per million in the pre-industrial sulphur dioxide and sulphur trioxide
period, to 402 parts per million in 2016,
which in turn has led to global warming.

Several parts of the world have

already experienced the warming of
coastal waters, high temperatures, a
marked change in rainfall patterns, and
an increased intensity and frequency of
storms. Sea levels and temperatures are
expected to be rising.
10.10 which when mixed with water becomes
sulfurous acid, nitric acid and sulfuric
Acid Rain acid. This process also occurs by nature
through volcanic eruptions. It can have
Acid rain is one of the consequences harmful effects on plants, aquatic animals
of air pollution. It occurs when emissions and infrastructure.

Sources of E-Waste:

Home: Hospitals: Government: Private Sectors

 PC  PC  PC (Restaurants,
 Television  Monitors  FAX machine Industries)
 Radio  ECG device  Xerox machine  PC
 Cell phones  Boilers
 Microscope  Scanner
 Washing
  Mixer
machine  Incubator  Fan
 Tube lights Signal
 
 Microwave oven
Generators
 CD player  Air conditions
 Incubator
 Fan
 Electric Iron

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 10.11 10.12
Sustainable Development
e-Wastes

Meaning
Sustainable development is concerned
with the welfare of not only present
generation but also future generation. It
aims at not only satisfying the luxury wants
of the upper class i.e. rich but also the basic
necessities of the poor like food, sanitation,
health care, education etc. The present
Electronic waste which is commonly generation should not exhaust the resources
referred as “e-waste” is the new byproduct left by the past generation, but it should leave
of the Info Tech society. It is a physical waste the same for the sake of future generation.
in the form of old discarded, end of life This is called inter – generational equity.
electronics. It includes a broad and growing
range of electronic devices from large Definitions
household appliances such as refrigerators, “Sustainable development is
air conditioners, cellular phones, computers development that meets the needs of the
and other electronic goods". Similarly, e-waste present without compromising the ability of
can be defined as the result when consumer, future generations to meet their own needs”
business and household devices are disposed -World Commission on Environment
or sent for re-cycling (example, television, and Development, 1987-
computers, audio-equipments, VCR, DVD,
telephone, Fax, Xerox machines, wireless “The alternative approach (to
devices, video games, other household sustainable development) is to focus on
electronic equipments). natural capital assets and suggest that they
should not decline through time.”
Solid Waste
-Pearce, Markandya and
Solid Waste is basically discharge of Barbier, 1989-
useless and unwarranted materials as a
result of human activity. Most commonly, 10.12.1 Sustainable
they are composed of solids, semisolids or Development
liquids. Solid wastes consist of the discards Goals (SDGs)
of households, hospital refuse, dead animals, It is crucial to
debris from construction site, ashes, harmonize three core
agricultural wastes and industrial wastes etc. elements such as economic
When waste is not removed from the streets growth, social inclusion and environmental
and public places in time it poses severe protection. A set of 17 goals for the World’s
public-health and hygiene hazards. future can be achieved before 2030 with

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 1 NO
POVERTY 2 ZERO
HUNGER 3 GOOD HEALTH
AND WELL-BEING 4 QUALITY
EDUCATION 5 GENDER
EQUALITY

6 CLEAN WATER
AND SANITATION 7 AFFORDABLE AND
CLEAN ENERGY 8 DECENT
ECONOMIC GROWTH 9 AND INFRASTRUCTURE 10 INEQUALITIES
WORK AND INDUSTRY, INNOVATION REDUCED

11 SUSTAINABLE CITIES
AND COMMUNITIES 12 RESPONSIBLE
CONSUMPTION

THE GLOBAL GOALS

For Sustainable Development
AND PRODUCTION

13 CLIMATE
ACTION 14 LIFE
WATER
BELOW
15 LIFE
ON LAND STRONG INSTITUTIONS 17 FOR THE GOALS
16 PEACE AND JUSTICE PARTNERSHIPS

three unanimous principles fixed by United 8. P

romote inclusive and sustainable
Nations such as Universality, Integration economic growth, employment and
and Transformation. decent work for all
1. End Poverty in all its forms everywhere 9. B
 uild resilient infrastructure, promote
2. E
nd hunger, achieve food security sustainable industrialization and foster
and improved nutrition and promote innovation.
sustainable agriculture 10. Reduce inequality within and among
3. E
 nsure healthy lives and promote well- countries
being for all at all ages 11. Make cities inclusive, safe, resilient and
4. E
 nsure inclusive and quality education sustainable
for all and promote lifelong learning 12. 
Ensure sustainable consumption and
5. A
 chieve gender equality and empower production pattern
women and girls 13. Take urgent action to combat climate
6. E
 nsure access to water and sanitation for change and its impacts
all 14. 
Conserve and sustainably use the
7. E
nsure access to affordable, reliable, oceans, seas and marine resources
sustainable and modern energy for all
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 15. Sustainably manage forests, combat 10.14
desertification, halt and reverse land
degradation, halt biodiversity loss Organic Farming
16. Promote just, peaceful and inclusive
Organic farming is a system of
societies
agricultural production which relies on
17. Revitalize the global partnership for animal manure, organic waste, crop rotation,
sustainable development legumes and biological pest control. It
avoids use of synthetic fertilizer, pesticides
10.13 and livestock additives. Organic inputs have
certain benefits, such as enriching soil for
Green Initiatives microbes.

Organic production is a holistic system

10.13 designed to optimize the productivity and
fitness of diverse communities within the
agro-ecosystem, including soil organisms,
plants, livestock and people. The principal
goal of organic production is to develop
enterprises that are sustainable and
harmonious with environment. The general
Green Initiatives principles of organic farming are:
1. Protect the environment, minimize
Today, number of organizations, soil degradation and erosion, decrease
businesses and people across the globe pollution, optimize biological
that are striving for sustainability and productivity and promote a sound state
more eco-friendly lifestyles is increasing. of health.
They are passionate towards protecting 2. Maintain long-term soil fertility by
the Earth – the only life support system optimizing conditions for biological
we have. Hence, we should bring about activity within the soil
change through political lobbying, citizen 3. Maintain biological diversity within the
action and consumer pressure. And we system
should take peaceful direct action to
protect this fragile planet and promote 4. Recycle materials and resources to
the solutions for a green and peaceful the greatest extent possible within the
future. Since the globe warming is a globe enterprise
problem, the polluters, namely developed
countries, should be made to pay for the
pollution control efforts.

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 GREEN LEAF
MANURES

VERMI COMPOST CROP ROTATION

ORGANIC
FARMING
MANURES BIOLOGICAL MANAGEMENT

BIOFERTILIZERS ANIMAL HUSBANDRY

Alkali Farming

Nearly 50 percent of the irrigated land in the arid and semi-arid regions has some
degree of soil salinization problems. The occurrence of accumulation of excess salt/
acid in the root zone, results in a partial or complete loss of soil productivity and such
soil is defined as ‘Problem (alkali, saline & acid) Soils’ and exist mainly in arid and
semi-arid regions.

The alkali soils are predominantly located in the Indo-Gangetic plains encompassing
States of Punjab, Haryana, Uttar Pradesh, Bihar and partly in States like, Chhattisgarh,
Rajasthan, Andhra Pradesh, Gujarat, Maharashtra, Karnataka, Andhra Pradesh,
Madhya Pradesh and Tamil Nadu.

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 5. Provide attentive care that promotes the
health and meets the behavioural needs of
livestock
6. 
Prepare organic products, emphasizing
careful processing, and handling methods
in order to maintain the organic integrity
and vital qualities of the products at all
stages of production.
7. 
Rely on renewable resources in locally
organized agricultural systems.
A seed ball before the storm
10.15 A seed ball (or seed bomb) is a seed that
Tree Plantation has been wrapped in soil materials, usually a
mixture of clay and compost, and then dried.
Trees contribute to their environment Essentially, the seed is ‘pre-planted’ and can
by providing oxygen, improving air quality, be sown by depositing the seed ball anywhere
climate amelioration, conserving water, suitable for the species, keeping the seed
preserving soil and supporting wildlife. safely until the proper germination window
During the process of photosynthesis, trees arises. Seed balls are an easy and sustainable
take in carbon dioxide and produce the way to cultivate plants that provide a larger
oxygen we breathe. So trees are considered window of time when the sowing can occur.
to be the lungs of the earth. Natural forests Summary
and tree plantations improve the water cycle The introductory part of this chapter
in diminishing runoff and improving the deals with human activity and natural
replenishment of the water table. environment. The concept of environmental
10.16 economics is the subset of economics that
Seed Ball is concerned with the efficient allocation
of environmental resources. Further, it
discusses the linkage between economy
and environment with the help of material
balance model developed by Alen Kneese
and R.V. Ayres.
The second part is concerned with
different type’s pollutions like air, water, noise
and land pollution and its cause, effects and
various reduction strategies. Again, it dealt
with the important aspects of global warming,
A pile of seed balls climate change, acid rain, e-waste and solid
waste which are responsible for environmental
degradation. Finally, it also reflects the
importance of sustainable development and

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 its goals which are striving to achieve through � A
 ir Pollution : The presence of
mass programs like green initiatives, organic contaminant or pollutant substances in
farming, tree plantation, seed ball and alkali the air that do not disperse properly and
farming. However, today the problems are interfere with human health or welfare or
mounting in the form of industrial pollution, produce harmful environmental effects.
atmospheric emission, soil erosion and land � W
 ater Pollution : The presence of harmful
degradation, deforestation and irreversible or objectionable material to damage water
loss of biodiversity due to increasing greed quality.
of the rich people. The underlying cause of � L
 and Pollution : Land pollution is the
environmental degradation in countries like deposition of solid or liquid waste materials
India is failure of market and institutions, a on land or underground in a manner that
factor which has not been adequately focused can contaminate the soil and groundwater,
on corrective actions. Also, pollutions are threaten public health and cause unpleasant
cross-border problems. Unless all the countries conditions and nuisances.
simultaneously attempt to overcome the
� G
 lobal warming : The increase in
problem, global warming cannot be stopped.
temperature of the Earth’s surface, due to
The rich countries which have been the cause
green house gases.
for global warming, should be brought in to
pay for the damages caused by them. � C
 limate Change : Climate change refers
to any significant change in temperature,
Glossary precipitation, or wind patterns that occur
over several decades or longer.
� E
 nvironment : Surroundings in which � A
 cid Rain : The result of sulphur dioxide
an organization operates, including air, (SO2) and nitrogen oxides (NOx)
water, land, natural resources, flora, fauna, reacting in the atmosphere with water and
humans, and their interrelations. returning to earth as rain, fog or snow.
� E
 cology : The relationship of living things � S
 olid Wastes : Non-liquid, non-soluble
to one another and their environment, or materials, ranging from municipal garbage
the study of such relationship. to industrial wastes that contain complex,
� E
 co System : The interacting system of a and hazardous, substances. Solid wastes
biological community and its nonliving include sewage sludge, agricultural refuse,
environmental surroundings. demolition wastes, and mining residues.
� E
 xternalities : A situation in which an � S
 ustainable Development : Development
individual or firm takes an action but that meets the needs of the present
does not bear all the costs (negative generation without compromising the
externality) or receive all the benefits ability of future generations to meet their
(positive externality) costs or benefits that own needs.
fall on third parties. � O
 rganic Farming : System of farming
� P
 ollution : Residual discharges which uses animal manure, organic waste
of contaminants in to the natural and legumes reducing, the use of chemical
environment to the air or water. fertilizers and pesticides.

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 MODEL QUESTIONS
Part – A
Multiple choice questions

1. T
 he term environment has been 6. I n a pure public good, consumption is
derived from a French word-----------. -----------------
a. Environ a. Rival
b. Environs b. Non-rival
c. Environia c. Both
d. Envir d. None of the above

7. O
 ne of the most important market
2. The word biotic means environment
failures is caused by ------------
a. living a. Positive externalities
b. non-living b. Negative externalities
c. physical c. Both
d. None of the above d. None of the above

3. Ecosystem is smallest unit of 8. T

 he common source of outdoor air
pollution is caused by combustion
a. Ionosphere
processes from the following----------
b. Lithosphere
c. Biosphere a. Heating and cooking
d. Mesosphere b. Traditional stoves
c. Motor vehicles
4. W
 ho developed Material Balance d. All the above
Models?
9. T
 he major contributor of Carbon
a. Thomas and Picardy monoxide is
b. AlenKneese and R.V. Ayres
a. Automobiles
c. Joan Robinson and J.M. Keynes
b. Industrial process
d. J oseph Stiglitz and Edward
c. Stationary fuel combustion
Chamberlin
d. None of the above
5. Environmental goods are --------------
10. W
 hich one of the following causes of
a. Market goods global warming?
b. Non-market goods a. Earth gravitation force
c. Both b. Oxygen
d. None of the above c. Centripetal force
d. Increasing temperature

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 11. W
 hich of the following is responsible 16. W
 hich of the following is main cause
for protecting humans from harmful for deforestation?
ultraviolet rays? a. Timber harvesting industry
a. UV-A b. Natural afforestation
b. UV-C c. Soil stabilization
c. Ozone layer d. Climate stabilization
d. None of the above
17. E
 lectronic waste is commonly
12. G
 lobal warming also refers to as referred as ----------
a. Ecological change a. solid waste
b. Climate Change b. composite waste
c. Atmosphere change c. e-waste
d. None of the above d. hospital waste

13. W
 hich of the following is the 18. A
 cid rain is one of the consequences
anticipated effect of Global warming? of ------------Air pollution
a. Rising sea levels a. Water Pollution
b. Changing precipitation b. Land pollution
c. Expansion of deserts c. Noise pollution
d. All of the above
19. S ustainable Development Goals and
14. T
 he process of nutrient enrichment is targets are to be achieved by -------
termed as a. 2020
a. Eutrophication b. 2025
b. Limiting nutrients c. 2030
c. Enrichment d. 2050
d. Schistosomiasis
20. A
 lkali soils are predominantly located
15. P
 rimary cause of Soil pollution is in the ------------ plains?
---------------- a. Indus-Ganga
a. Pest control measures b. North-Indian
b. Land reclamation c. Gangetic plains
c. Agricultural runoff d. All the above
d. Chemical fertilizer
Answers

1 2 3 4 5 6 7 8 9 10
c a c b b b b b a d
11 12 13 14 15 16 17 18 19 20
c d b a d a c a c d

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 Part - B
Answer the following questions in one or two sentences

21. State the meaning of environment.

22. What do you mean by ecosystem?
23. Mention the countries where per capita carbondioxide emission is the highest
in the world.
24. What are environmental goods? Give examples.
25. What are the remedial measures to control noise pollution?
26. Define Global warming.
27. Specify the meaning of seed ball.

Part-C
Answer the following questions in one paragraph.

28.Brief the linkage between economy and environment.

29.Specify the meaning of material balance principle.
30. Explain different types of air pollution.
31.What are the causes of water pollution?
32. State the meaning of e-waste.
33. What is land pollution? Mention the causes of land pollution.
34.Write a note on a) Climate change and b) Acid rain

Part-D
Answer the following questions in about a page.

35. 
Briefly explain the relationship between GDP growth and the quality of
environment.
36. Explain the concepts of externality and its classification
37. Explain the importance of sustainable development and its goals.

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 ACTIVITY
Who should pay more for correcting the present trend of damaging
the environment? Developed countries or developing countries? Why?

References

1. K
 arpagam M. (1993). Environmental Economics, Sterling Publishers, New Delhi.
2. S ankaran S. (1994). Environmental Economics, Margham, Chennai.
3. 
Sacratees J. and Karthigarani (2008). Environment Impact Assessment, APH
Publishing Corporation, New Delhi.
4. Garge, M.R. (Ed.) (1996). Environmental Pollution and Protection, Deep and Deep
Publications, New Delhi.
5. L
 odha S.L (Ed.) (1991). Economics of Environment, publishers, New Delhi.
6. T
 he Hindu Survey of Environment: Annual Reports.

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 CHAPTER

11 Economics of Development and

Planning

A good plan may fail due to faulty implementation. But a faulty plan
cannot succeed through good implementation.
“Plan your work for today and every day, then work your plan.”
-Margaret Thatcher

Learning Objectives

1 To understand the process, features and determinants of economic

development.

2 To study the case for and against planning and to compare the various types
of planning.

3 To describe the functions of NITI Aayog.

11.1 and formulating theories and models

Meaning of Development and of development and growth. The Under
Underdevelopment Developed Countries (UDCs) were
once the colonies of England and other
Introduction European countries. After becoming free
and independent, there was an awakening
The concept "development" refers to to march towards economic development.
the structural changes towards betterment.
Until the World War II, interest was rarely Approaches to Economic
shown on the problems of the present day Development
third World Countries. After the Second
World War, economists started devoting There are two main approaches to
their attention towards analyzing the the concept of development viz i) the
problems of underdeveloped countries traditional approach and ii) the new
welfare oriented approach.
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 1. Traditional TheApproach: Features of an Underdeveloped
traditional approach defines development Economy
strictly in economic terms. The increase
in GNP is accompanied by decline in share Introduction
of agriculture in output and employment
while those of manufacturing and service The term 'underdeveloped country' is
 
sectors increase. It emphasizes the relative.
importance of industrialization. It was
assumed that growth in GNP per capita The World bank in its world
 
would trickle down to people at the Development Report classified
bottom. various countries on the basis of Gross
National Income (GNI) Per Capita.
2. New Welfare oriented Approach:
During 1970s, economic development World Development Report
was redefined in terms of reduction of
poverty, ‘inequality’ and unemployment
within the context of a growing economy. Low Middle High
Income Income Income
In this phase, ‘Redistribution with Growth’ Countries Countries Countries
became the popular slogan. GNI Per GNI Per GNI Per
Capita of Capita Capita of
$906 And Ranging $11,116 Or
To quote Michael P. Todaro, below Between $906 more
And $11, 115
“Development must, therefore, be
conceived as a multidimensional process
involving major changes in social
structures, popular attitudes and national Meaning of Underdevelopment
institutions as well as the acceleration of The term underdevelopment refers
growth, the reduction of inequality and to that state of an economy where levels
the eradication of absolute poverty”. of living of masses are extremely low due
to very low levels of Percapita income,
Underdevelopment resulting from low levels of productivity
and high growth rate of population.
The UDCs are characterized by
predominance of primary sector i.e. 11.2
agriculture, low per capita income,
Economic Growth Vs Economic
widespread poverty, wide inequality in
Development
distribution of income and wealth, over
population, low rate of capital formation, 1. State of Development
high rate of unemployment, technological
Generally speaking, economic
backwardness, dualism etc.
development refers to the problems of
underdeveloped countries and economic
growth to those of developed countries.

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 2. Nature and Level of Change Quantitative Quantitative as
aspects well as Qualitative
Development is a discontinuous and i.e increase in per aspects
spontaneous change while growth is a capita income
gradual and steady change in the long run.

3. Scope of Change
Vs
Growth simply means more output.
But development refers to efficiency in Economic Growth VS. Economic
production i.e. output per unit of input. Development
It also implies changes in composition 4. Extent of change
of output and in allocation of resources,
Economic development (wider
reduction of poverty, inequality and
concept than economic growth) is taken
unemployment.
to mean growth plus structural change.

Differences between Economic Growth and Economic Development

Economic Growth Economic Development
Deals with the problems of Developed
Deals with the problems of UDCs
countries
Change is discontinuous and
Change is gradual and steady
spontaneous
Means not only more output but also
Means more output
its composition
Concerns Quantitative aspects
Quantitative as well as Qualitative
i.e. increase in per capita income
Wider concept
Narrow
Development = Growth + Change

11.3 income of those located abroad),

Measurement of Economic minus income of non-residents located
Development in that country. GNP is one measure of
the economic condition of a country,
Economic development is measured under the assumption that a higher
on the basis of four criteria GNP leads to a higher quality of living,
all other things being equal.
� G
ross National Product (GNP): GNP
is the total market value of all final � G
NP per capita: This relates to
goods and services produced within a increase in the per capita real income
nation in a particular year, plus income of the economy over the long period.
earned by its citizens (including This indicator of economic growth

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 emphasizes that for economic improvement in health, literacy and
development the rate of increase in real standard of living.
per capita income should be higher
than the growth rate of population. � Social Indicators: Social indicators
are normally referred to as basic and
� Welfare: Economic development is collective needs of the people. The
regarded as a process whereby there direct provision of basic needs such
is an increase in the consumption of as health, education, food, water,
goods and services by individuals. sanitation and housing facilities check
From the welfare perspective, economic social backwardness.
development is defined as a sustained

11.4
Determinants of Economic Development
Economic development is not determined by any single factor. Economic development
depends on Economic, Social, Political and Religious factors. We can simply classify it
into Economic and Non-economic factors

11.5
Economic and Non-Economic Factors

Determinants of Economic Development

Economic Factors Non-Economic Factors

1.Human Resource
1. Natural Resource 2.Technical Know-how
2. Capital Formation 3.Political Freedom
3. Size of the Market 4.Social Organization
4. Structral Change 5.Corruption free administration
5. Financial System 6.Desire for Development
6. Markatable surplus 7. Moral, ethical and social values
7. Foreign Trade 8. Casino Capitalism
8. Economic System 9. Patrimonial Capitalism

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 structure of the economy. Any economy
11.5.1. Economic Factors
of the country is generally divided into
1. Natural Resource: The principal three basic sectors: Primary sector
factor affecting the development of an such as agricultural, animal husbandry,
economy is the availability of natural forestry, etc; Secondary sector such as
resources. The existence of natural industrial production, constructions
resources in abundance is essential and Tertiary sector such as trade,
for development. A country deficient banking and commerce. Any economy
in natural resources may not be in which is predominantly agricultural
a position to develop rapidly. But a tends to remain backward.
country like Japan lacking natural
5. Financial System: Financial system
resources imports them and achieve
implies the existence of an efficient
faster rate of economic development
and organized banking system in the
with the help of technology. India with
country. There should be an organized
larger resources is poor.
money market to facilitate easy
availability of capital.
2. C apital Formation: Capital formation
is the main key to economic growth. 6. Marketable Surplus: Marketable
Capital formation refers to the net surplus refers to the total amount of farm
addition to the existing stock of capital output cultivated by farmers over and
goods which are either tangible like above their family consumption needs.
plants and machinery or intangible This is a surplus that can be sold in the
like health, education and research. market for earning income. It raises the
Capital formation helps to increase purchasing power, employment and
productivity of labour and thereby output in other sectors of the economy.
production and income. It facilitates The country as a result will develop
adoption of advanced techniques of because of increase in national income.
production. It leads to better utilization
of natural resources, industrialization 7. Foreign Trade: The country which
and expansion of markets which are enjoys favorable balance of trade and
essential for economic progress. terms of trade is always developed.
It has huge forex reserves and stable
3. Size of the Market: Large size of the exchange rate.
market would stimulate production,
increase employment and raise the 8. E conomic System: The countries
National per capita income. That is which adopt free market mechanism
why developed countries expand their (laissez faire) enjoy better growth rate
market to other countries through compared to controlled economies. It
WTO. may be true for some countries, but not
for every country.
4. Structural Change: Structural change
refers to change in the occupational
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 4. S ocial Organization: People show
11.5.2. Non- Economic Factors
interest in the development activity
‘Economic Development has only when they feel that the fruits of
much to do with human endowments, development will be fairly distributed.
social attitudes, political conditions and Mass participation in development
historical accidents. Capital is a necessary programs is a pre-condition for
but not a sufficient condition of progress. accelerating the development
– Ragnar Nurkse. process. Whenever the defective
social organization allows some
1. Human Resources: Human resource groups to appropriate the benefits of
is named as human capital because of growth. majority of the poor people
its power to increase productivity and do not participate in the process of
thereby national income. There is a development. This is called crony
circular relationship between human capitalism.
development and economic growth.
5. 
C orruption free administration:
A healthy, educated and skilled labour
Corruption is a negative factor in
force is the most important productive
the growth process. Unless the
asset. Human capital formation is the
countries root-out corruption in their
process of increasing knowledge, skills
administrative system, the crony
and the productive capacity of people.
capitalists and traders will continue
It includes expenditure on health,
to exploit national resources. The tax
education and social services. If labour
evasion tends to breed corruption and
is efficient and skilled, its capacity to
hamper economic progress.
contribute to growth will be high. For
example Japan and China. 6. 
Desire for development: The pace
of economic growth in any country
2. Technical Know-how: As the scientific depends to a great extent on people’s
and technological knowledge advances, desire for development. If in some
more and more sophisticated techniques country, the level of consciousness is
steadily raise the productivity levels in low and the general mass of people has
all sectors. Schumpeter attributed the accepted poverty as its fate, then there
cause for economic development to will be little scope for development.
innovation.
7. Moral, ethical and social values: These
3. Political Freedom: The process of determine the efficiency of the market,
development is linked with the political according to Douglas C. North. If
freedom. Dadabhai Naoroji explained people are not honest, market cannot
in his classic work ‘Poverty and Un- function.
British Rule in India’ that the drain of 8. 
Casino Capitalism : If People spend
wealth from India under the British larger propotion of their income and
rule was the major cause of the increase time on entertainment liquor and other
in poverty in India. illegal activities, productive activities
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 may suffer, according to Thomas their parents, the children would not
Piketty. work hard, because the children do not
know the value of the assets. Hence
9. Patrimonial Capitalism : If the assets productivity will be low as per Thomas
are simply passed on to children from Piketty.
11.6
Vicious Circle of Poverty

The Vicious Circle of Poverty

Low Per
Capita
Income

Low Low Level of Low Level of

Productivity Saving Demand

Low Levels of
Investment in
Physical And
Human Capital

There are circular relationships of forces tending to act and react upon one
known as the ‘vicious circles of poverty’ another in such a way as to keep a poor
that tend to perpetuate the low level of country in a state of poverty. For example,
development in Less Developed Countries a poor man may not have enough to eat;
(LDCs). Nurkse explains the idea in these being underfed, his health may be weak;
words: “It implies a circular constellation being physically weak, his working capacity
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 is low, which means that he is poor, which simultaneously the workers employed in
in turn means that he will not have enough various industries will become consumers
to eat and so on. A situation of this sort of each other’s products and will create
relating to a country as a whole can be demand for one another. The balanced
summed up in the proposition: “A county growth i.e. simultaneous investment in
is poor because the country is poor”. large number of industries creates mutual
demand. Thus, through the strategy of
The vicious circle of poverty operates balanced growth, vicious circle of poverty
both on the demand side and the supply operating on the demand side of capital
side. formation can be broken.

On the supply side, the low level of 11.7

real income means low savings. The low
Planning
level of saving leads to low investment and
to deficiency of capital. The deficiency
of capital, in turn, leads to low levels of Meaning
productivity and back to low income. Planning is a technique, a means to
Thus the vicious circle is complete from an end being the realization of certain
the supply side. pre-determined and well-defined aims
and objectives laid down by a central
The demand-side of the vicious planning authority. The end may be to
circle is that the low level of real income achieve economic, social, political or
leads to a low level of demand which, in military objectives.
turn, leads to a low rate of investment and
hence back to deficiency of capital, low Definitions
productivity and low income.
Economic Planning is “collective
11.6.1. Breaking the Vicious Circle of control or suppression of private activities
Poverty of production and exchange”.
-Robbins-
The vicious circle of poverty is
associated with low rate of saving and “Economic Planning in the widest
investment on the supply side. In UDCs the sense is the deliberate direction by persons
rate of investment and capital formation in-charge of large resources of economic
can be stepped up without reduction in activity towards chosen ends”.
consumption. For this, the marginal rate
Dalton-
of savings is to be greater than average
rate of savings.
11.7.1. Economic Planning in India
To break the vicious circle on
Consists of economic decisions,
the demand side, Nurkse suggested
schemes formed to meet certain pre-
the strategy of balanced growth. If
determined economic objectives and
investment is made in several industries
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 a road map of directions to achieve 2. 
Jawaharlal Nehru (1938): set-up
specific goals within specific period of “National Planning Commission” by a
time. The current thinking of economic committee but due to the changes in the
planning is fairly new, somewhat rooted political era and second World War, it
in Marxist socialism. In the 20th century, did not materialize.
intellectuals, theorists, thinkers from
Europe put forward the idea of state 3. Bombay Plan (1940): The 8 leading
involvement to stop capitalism and the industrialists of Bombay presented
inequality of society. “Bombay Plan”. It was a 15 Year
Investment Plan.
Soviet Union adopted economic
planning for the first time in 1928 4. S. N Agarwal (1944) gave the “Gandhian
that enabled the country to turn into Plan” focusing on the agricultural and
an industrial superpower. The idea of rural economy.
economic planning was strengthened
during the Great Depression in 1930s. 5. 
M.N. Roy (1945) drafted ‘People’s
The outbreak of the World War II also Plan”. It was aiming at mechanization
required adequate and suitable planning of agricultural production and
of economic resources for the effective distribution by the state only.
management after the effects of post war
economy. 6. 
J.P. Narayan (1950) advocated,
“Sarvodaya Plan” which was inspired
After Independence, in 1948, a by Gandhian Plan and with the idea of
declaration of industrial policy was Vinoba Bhave. It gave importance not
announced. The policy suggested only for agriculture, but encouraged
the creation of a National Planning small and cottage industries in the plan.
Commission and the elaboration of the
policy of a mixed economic system. On After considering all the plans, in
January 26, 1950, the Constitution came the same year Planning Commission
into force. In logical order, the Planning was set up to formulate Five Year Plan in
Commission was created on March 15, India by Jawaharlal Nehru. He was the
1950 and the plan era began on April 1, first Chairman of Planning Commission,
1951 with the launch of the first five year Government of India.
plan (1951-56). The evolution of planning
in India is stated below: 11.7.2. Case for planning

1. 
Sir M. Vishveshwarya (1934): a The economic planning is justified
prominent engineer and politician made on the following grounds.
his first attempt in laying foundation
for economic planning in India in 1934 1. To accelerate and strengthen market
through his book, “Planned Economy mechanism: The market mechanism
of India”. It was a 10 year plan. works imperfectly in underdeveloped
countries because of the ignorance and
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 unfamiliarity with it. A large part of the also essential to supply the raw material
economy comprises the non-monetized needs of the industrial sector.
sector. The product, factor, money
and capital markets are not organized ii) Development of Infrastructure: The
properly. Therefore the planned agriculture and industrial sectors
economy will be a better substitute for cannot develop in the absence of
free economy. economic and social overheads. The
building of canals, roads, railways,
2. 
To remove unemployment: Capital power stations, etc., is indispensable
being scarce and labour being for agricultural and industrial
abundant, the problem of providing development. Infrastructure involves
gainful employment opportunities to huge capital investment long gestation
an ever-increasing labour force is a period and low rate of return. The state
difficult task. The need for planning alone can provide strong infrastructural
in underdeveloped countries is bases through planning.
further stressed by the necessity of
removing widespread unemployment iii) 
Development of Money and
and disguised unemployment in such Capital Markets: The expansion
economies. of the domestic and foreign trade
requires not only the development
3. 
To achieve balanced development: of agricultural and industrial sectors
In the absence of sufficient enterprise along with social and economic
and initiative, the planning authority overheads but also the existence of
is the only institution for planning the financial institutions. Money and
balanced development of the economy. capital markets are not adequate in
For rapid economic development, underdeveloped countries. This factor
underdeveloped countries require the acts as an obstacle to the growth of
development of the agricultural and industry and trade. So planning alone
industrial sectors, the establishment can provide sound money market and
of social and economic overheads, the capital market.
expansion of the domestic and foreign
trade sectors in a harmonious way. 4. To remove poverty and inequalities:
Planning is the only path open to
i) 
Development of Agriculture and underdeveloped countries, for raising
Industrial Sectors: The need for national and per capita income,
developing the agriculture sector along reducing inequalities and poverty and
with the industrial sector arises from increasing employment opportunities.
the fact that agriculture and industry Has it happened in India in the last 65
are interdependent. Reorganization of years?
agriculture releases surplus labour force
which can be absorbed by the industrial Hence, Arthur Lewis says, “Planning
sector. Development of agriculture is is more necessary in backward countries

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 to devise ways and means and to make 2. Elimination of Initiative
concerted efforts to raise national income” Under centralized planning, there
will be no incentive for initiatives and
11.7.3. Case against planning innovations. Planning follows routine
The failure of market mechanism procedure and may cause stagnation in
invited state intervention in economic growth. The absence of initiatives may
activities through planning. The affect progress in following ways.
prime goals of economic planning are
a. The absence of private ownership and
stabilization in developed countries
profit motive discourages entrepreneurs
and growth in LDCs. But the economic
from taking bold decisions and risk
planning also is not free from limitations.
taking. Attractive profit is the incentive
It may retard private initiatives, hamper
for searching new ideas, new lines and
freedom of choice, involve huge cost of
new methods. These are missing in a
administration and stop the automatic
planned economy.
adjustment of price mechanism. The
arguments against planning are discussed b. As all enjoy equal reward under planned
below. economy irrespective of their effort,
efficiency and productivity, nobody is
1. Loss of freedom interested in undertaking new and risky
The absence of freedom in decision ventures.
making may act as an obstacle for
c. The bureaucracy and red tapism which
economic growth. Regulations and
are the features of planned economy,
restrictions are the backbone of a planned
cripple the initiative as they cause
economy. The economic freedom
procedural delay and time loss. The
comprises freedom of consumption,
ease of doing business is disrupted. It is
freedom of choice of occupation,
because of this, even socialist countries
freedom to produce and the freedom
like Russia and China offer incentives
to fix prices for the products. Under
to private enterprises.
planning, the crucial decisions are made
by the Central Planning Authority. The 3. High cost of Management
consumers, producers and the workers
enjoy no freedom of choice. Therefore, No doubt the fruits of planning such
Hayek explains in his book ‘Road to as industrialization, social justice and
Serfdom’ that centralized planning leads regional balance are good. But the cost
to loss of personal freedom and ends in of management of the economic affairs
economic stagnation. The decisions by outweighs the benefits of planning. Plan
the Government are not always rational. formulation and implementation involve
But, freedom to private producers will be engagement of an army of staff for data
misused; profit will be given top priority, collection and administration. As Lewis
welfare will be relegated. remarks, “The better we try to plan, the

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 more planners we need”. Inadequate and excess demand can also happen in the
data, faulty estimations and improper market oriented economy. Infact it has
implementation of plans result in wastage happened in many expitalistic economies,
of resources and cause either surplus or including the US.
shortages.
The arguments against planning are
4. Difficulty in advance calculations mostly concerned with centralized and
totalitarian planning. The democratic
Price mechanism provides for the planning, planning by inducement and
automatic adjustment among price, decentralized planning especially under
demand and supply in a Laissez Faire mixed economies give equal role for
economy. The producers and consumers private sector and public sector. Planned
adjust their supply and demand based economy appears to be more efficient
on price changes. There is no such operationally than a market economy.
mechanism in a planned economy. So the question is not one of plan or no
Advance calculations in a precise manner plan but one of the type of plan. The
are impossible to make decisions regarding right mix of market mechanism and state
the consumption and production. It is also intervention in right proportion will
very difficult to put the calculations into promise accelerated economic growth
practice under planning. Excess supply accompanied by stability and social
justice.
11.8
Types of planning

Types of Planning

Planning by
Democratic Short, Medium Functional
Direction
Vs and Vs
Vs
Totalitarian Long term Structural
Inducement

Centralized Indicative Financial Comprehensive

Vs Vs Vs Vs
Decentralized Imperative Physical Partial

Economic planning is a process

under which attempts are made to achieve are different types of planning which
desired targets of economic development differ in ideology and the procedure in
within a specified period of time. There execution.

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 1. Democratic Vs Totalitarian: planning authority. This authority
formulates a central plan, fixes objectives,
targets and priorities for every sector of
the economy. In other words, it is called
‘planning from above’.

A form of rule in which the government

attempts to maintain 'total' control
over society, including all aspects of the
public and private lives of its citizens Centralization Vs Decentralization

Democratic planning implies planning Under decentralized planning local

within democracy. People are associated organizations and institutions formulate,
at every step in the formulation and adopt, execute and supervise the plan
implementation of the plan. A democratic without interference by the central
plan is characterized by the widest authorities. In other words, it is called
possible consultations with the various ‘planning from below’.
state governments and private enterprises
at the stage of preparation. The plan 3. Planning by Direction Vs Inducement:
prepared by the Planning Commission is Under planning by direction, there is a
not accepted as such. It can be accepted, central authority which plans, directs
rejected or modified by the Parliament of and orders the execution of the plan in
the country. accordance with pre-determined targets
and priorities.
Under totalitarian planning, there
is central control and direction of all Under planning by inducement,
economic activities in accordance with the people are induced to act in a certain
a single plan. Consumption, production, way through various monetary and fiscal
exchange, and distribution are all measures. If the planning authority
controlled by the state. In authoritarian wishes to encourage the production of
planning, the planning authority is a commodity, it can give subsidy to the
the supreme body. It decides about the firms. Thus, planning by inducement
targets, schemes, allocations, methods is able to achieve the same results as
and procedures of implementation of the under planning by direction but with less
plan. sacrifice of individual liberty.

2. Centralized Vs Decentralized: Under 4. Indicative Vs Imperative Planning:

centralized planning, the entire planning Indicative planning is peculiar to the
process in a country is under a central mixed economies. It has been in practice

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 in France since the Monnet Plan of 1947- drawn up, its implementation is a matter
50. In a mixed economy, the private of enforcement. The USSR President
sector and the public sector work together. Stalin used to say, ‘Our plans are our
Under this plan, the outline of plan is instructions’. There is complete control
prepared by the Government. Then it over the entire resources by the state.
is discussed with the representatives There is no consumer sovereignty. The
of private management, trade unions, Government policies and procedures are
consumer groups, finance institutions rigid. China and Russia follow imperative
and other experts. The essential function planning.
of planning is coordination of different
economic units. The state provides all 5. Short, Medium and Long term
types of facilities to the private sector. Planning: Short-term plans are also known
The private sector is expected to fulfill the as ‘controlling plans’. They encompass the
targets and priorities. The state does not period of one year, therefore, they are also
force the private sector but just indicate known as ‘annual plans’.
the areas of operation and targets to be
fulfilled. In short, the planning procedure The medium-term plans last for the
is soft and flexible. period of 3 to 7 years. But normally, the
medium term plan is made for the period
Under imperative planning, the of five years. The medium-term planning
state is all powerful in preparation and is not only related to allocation of financial
implementation of the plan. Once a plan is resources but also physical resources.

Planning

Long - term Medium - term Short - term

over 10 year 3 - 7 years upto 1 year

Long - term Medium - term Short - term

planning is planning is planning concerns
considered for considered for a the plans in a
a time period time period of 5 time period of 1
over 10 years - years - tactical year - operational
strategic planning. planning. planning.

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 Long-term plans last for the period 13th August, 2014. The Prime Minister is
of 10 to 30 years. They are also known the Chairperson of NITI Aayog and Union
as ‘perspective plans’. The basic philosophy Ministers will be Ex-officio members.
behind long-term planning is to bring The Vice- Chairman of the NITI Aayog
structural changes in the economy. is the functional head and the first Vice-
Chairman was Arvind Panangariya.
6. Financial Vs Physical Planning:
Financial planning refers to the technique 11.9.1. Functions of NITI Aayog
of planning in which resources are
allocated in terms of money while physical 1. 
C ooperative and Competitive
planning pertains to the allocation of Federalism: To enable the States to have
resources in terms of men, materials and active participation in the formulation
machinery. of national policy.
7. Functional Vs Structural Planning: 2. Shared National Agenda: To evolve
Functional planning refers to that a shared vision of national development
planning which seeks to remove economic priorities and strategies with the active
difficulties by directing all the planning involvement of States.
activities within the existing economic 3. Decentralized Planning: To restructure
and social structure. the planning process into a bottom-up
The structural planning refers to model.
a good deal of changes in the socio- 4. Vision and Scenario Planning: To
economic framework of the country. This design medium and long-term strategic
type of planning is adopted mostly in frameworks towards India’s future.
under developed countries.
5. Network of Expertise: To mainstream
8. Comprehensive Vs Partial Planning: external ideas and expertise into
General planning which concerns itself government policies and programmes
with the major issues for the whole through a collective participation.
economy is known as comprehensive 6. Harmonization: To facilitate
planning whereas partial planning is to harmonization of actions across different
consider only the few important sectors of layers of government, especially when
the economy. involving cross-cutting and overlapping
11.9 issues across multiple sectors; through
communication, coordination,
NITI Aayog
collaboration and convergence amongst
all the stakeholders.
NITI Aayog (National Institution
for Transforming India) was formed on 7. Conflict Resolution: To provide
January 1, 2015 through a Union Cabinet platform for mutual consensus to inter-
resolution. NITI Aayog is a policy think- sectoral, inter-departmental, inter-state
tank of the Government of India. It as well as centre-state issues for all speedy
replaced the Planning Commission from execution of the government programmes.

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 NITI Aayog is based on the
7 Pillars of Effective Governance

fulfills aspirations
Pro-People of society as well
as individuals
in anticipation of
and response to Pro-Activity
citizen needs

involvement of
Participation
Citizenry

women in all Empowering

aspects
SC, ST, OBC,
Inclusion minorities, gareeb,
of all
gaon, kisaan

of opportunity
for the youth
Equality

making govt
Transparency visible and
responsive

8. Coordinating Interface with the 10. Capacity Building: It enables to

World: It will act nodal point to harness provide capacity building and technology
global expertise and resources coming up-gradation across government,
from International organizations for benchmarking with latest global trends
India’s developmental process. and providing managerial and technical
know-how.
9. Internal Consultancy: It provides
internal consultancy to Central and State 11. Monitoring and Evaluation: It will
governments on policy and programmes. monitor the implementation of policies
and progammes and evaluate the impacts.

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 Initiatives like Atal Innovation systems depending upon the extent of
Mission, Ayushmaan Bharat approach Government control. It is totalitarian and
towards water conservation measures highly centralized in socialist countries,
and the draft bill to establish the National democratic and indicative in countries
Medical Commission to replace the like France. The NITI Aayog is the
Medical Council of India have all been new planning body replacing Planning
conceptualized in NITI Aayog. Commission in India.

NITI Aayog is also bringing about Glossary

a greater level of accountability. It has
established a development monitoring and � G
 rowth : Economic growth refers to
evaluation office which collects data on the an increase in real GDP , which means
performance of various ministries. Using an increase in the value of national
such data, the Aayog makes performance output/national expenditure.
based ranking of states to foster a spirit
� D
 evelopment : The systematic use of
of competitive federalism. The success
scientific and technical knowledge
of NITI Aayog can be evaluated after a
to meet specific objectives and
substantial period of time
requirements.
Summary � S ocial Indicators : The basic needs for
development such as health, education,
The first part of this chapter deals sanitation, water, food etc.
with economic development which gained
� C
 apital accumulation : The process of
importance during the 20th Century.
addition to the existing stock of capital
The concept of development and growth
are used inter-changeably. However, � F
 inancial Planning : Techniques
there are mild differences between the of planning in which resources are
two. The pace of economic development allocated in terms of money
depends on several factors which are � P
 hysical Planning : Techniques of
classified under economic and non- planning in which resources are
economic factors. Economic development allocated in terms of men, materials
is retarded by several obstacles of which and machinery
the Vicious Circle of Poverty is the prime
� P
 erspective Planning : Long term
one. The second part is concerned with
planning i.e. for a period of 15 or more
economic planning. The failure of market
mechanism brought the birth of planning. � U
 nderdevelopment :
Planning started in USSR and spread to Underdevelopment is low level of
countries like India and most of the mixed development characterized by low
economies. There are strong arguments real per capita income, widespread
in favour of planning and some arguments poverty, lower level of literacy, low
against planning. There are various types life expectancy, underutilization of
of planning under different economic resources etc.

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  uman Capital : Education and
� H � P
 lanning : It is the process of thinking
training that make human beings more about the activities required to achieve
productive. directed goals.
� V
 icious Circle of Poverty : Circular � C
 entralized Planning : Centralized
relationships that tend to perpetuate planning means the power of planning
the low level of development in Less and decision making are exclusively in
Developed Countries. the hands of top management.

MODEL QUESTIONS
Part-A
Multiple Choice Questions

1. "Redistribution with Growth" became c) Increase in output

popular sloga]er which approach? d) None of the above
a) Traditional approach
b) New welfare oriented approach 6. The supply side vicious circle of poverty
c) Industrial approach suggests that poor nations remain poor
d) None of the above because

2. Which is not the feature of economic a) Saving remains low

growth? b) Investment remains low
a) Concerned with developed nations c) There is a lack of effective
b) Gradual change government
c) Concerned with quantitative aspect d) a and b above
d) Wider concept 7. Which of the following plan has focused
3. 
Which among the following is a on the agriculture and rural economy?
characteristic of underdevelopment? a) People’s Plan
a) Vicious circle of poverty b) Bombay Plan
b) Rising mass consumption c) Gandhian Plan
c) Growth of Industries d) Vishveshwarya Plan
d) High rate of urbanization
8. 
Arrange following plans in correct
4. 
The non-economic determinant of
chronological order
economic development
a) Natural resources a) People’s Plan
b) Human resource b) Bombay Plan
c) Capital formation c) Jawaharlal Nehru Plan
d) Foreign trade d) Vishveshwarya Plan
5. Economic growth measures the ------- Answer choices
-------- a) (i) (ii) (iii) (iv)
a) Growth of productivity b) (iv) (iii) (ii) (i)
b) Increase in nominal income
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 c) (i) (ii) (iv) (iii) 15. Planning Commission was set up in
d) (ii) (i) (iv) (iii) the year ---------------
a) 1950 b) 1951
9. M.N. Roy was associated with --------- c) 1947 d) 1948
------------ e) Gandhian Plan
a) Congress Plan
b) People’s Plan 16. 
Who wrote the book ‘The Road to
c) Bombay Plan Serfdom’?
d) None of the above a) Friedrich Hayek
b) H.R. Hicks
10. Which of the following country adopts c) David Ricardo
indicative planning? d) Thomas Robert Malthus
a) France
b) Germany 17. P
 erspective plan is also known as ----
c) Italy a) Short-term plan
d) Russia b) Medium-term plan
c) Long-term plan
11. Short-term plan is also known as----- d) None of the above
--------------
a) Controlling Plans 18. 
NITI Aayog is formed
b) De-controlling Plans through------------------------
c) Rolling Plans a) Presidential Ordinance
d) De-rolling Plans b) A
 llocation of business rules by
President of India
12. Long-term plan is also known as ----- c) Cabinet resolution
---------------- d) None of the above
a) Progressive Plans
b) Non-progressive Plans 19. Expansion of NITI Aayog?
c) Perspective Plans a) N
 ational Institute to Transform
d) Non-perspective Plans India
b) National Institute for Transforming
13. 
The basic philosophy behind long- India
term planning is to bring------------ c) N
 ational Institution to Transform
changes in the economy? India
a) Financial d) N ational Institution for
b) Agricultural Transforming India
c) Industrial
d) Structural 20. The Chair Person of NITI Aayog is

14. Sarvodaya Plan was advocated by----- a) Prime Minister

------------- b) President
a) Mahatma Gandhi c) Vice – President
b) J.P. Narayan d) Finance Minister
c) S. N Agarwal
d) M.N. Roy
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 Answers

1 2 3 4 5 6 7 8 9 10
b d a b c d c b b a
11 12 13 14 15 16 17 18 19 20
a c d b a a c c d a

Part-B
Answer the following questions in one or two sentences.
21. Define economic development
22. Mention the indicators of development.
23. Distinguish between economic growth and development
24. What is GNP?
25. Define economic planning.
26. What are the social indicators of economic development?
27. Write a short note on NITI Aayog.
Part-C
Answer the following questions in one paragraph.
28. Elucidate major causes of vicious circle of poverty with diagram
29. What are the non-economic factors determining development?
30. How would you break the vicious circle of poverty?
31. Trace the evolution of economic planning in India.
32. Describe the case for planning.
33. Distinguish between functional and structural planning.
34. What are the functions of NITI Aayog?
Part-D
Answer the following questions in about a page.
35. Discuss the economic determinants of economic development.
36. Describe different types of Planning.
37. Bring out the arguments against planning.

References

1. J hingan M.L. (2011). The Economics of Development and Planning, 40th Edition,
Vrinda Publications (P) Ltd.
2. T
 odaro M.P and Smith S.C, (2011). Economic Development , Addison Wesley,
New York
3. V
 aidehi Shriram Daptardar (2015): India: Economic Policies and Performances –
1947-48 to 2015-16, New Century Publications, New Delhi.

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 CHAPTER

12 Introduction to Statistical
Methods and Econometrics

“Statistics is the grammar of science.”

- Karl Pearson

Learning Objectives

1 To describe some statistical techniques that may be useful to analyze

economic issues.

2 To give a brief introduction to the subject of econometrics and its

applications

12.1
Etymology and Milestones of Father of statistics
Statistics in Global Level The fundamental
principles of statistics
The term statistics originated in the were developed by
West and was known by various names, the biologist, Ronald
such as ‘status’ in Latin, ‘statistik’ in fisher who lived in
German, ‘statisque’ in French. It is said England during the
that Gottfried Achenwall used the word last century. His
Ronald Fisher
‘statistik’ in 1749 to describe the political studies in statistics
science of different countries. All these led to the synthesis of evolution and
names in short mean to describe the modern genetics.
political state.

The first book to have statistics as its The monumental contribution to

title was ‘Contributions to vital Statistics’ the subject of statistics can be attributed
by Francis GP Neison in 1845. It was to to R.A. Fisher (1890-1962) who was able
prepare a systematic study of birth and to apply statistics to a variety of fields
death related data. such as Biometry, Genetics, Psychology,
Education, Agriculture and others.

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 Besides he is also known as the pioneer form it denotes collection of numerical
of estimation theory, analysis of variance, figures and facts. In the narrow sense it
and design of experiments. Hence he is has been defined as the science of counting
known as the father of Statistics. and science of averages.
12.2
Definitions of Statistics
Evolution of Statistics in India
Statistics as a science of estimates
and probabilities
Evidence
- Boddington
from history
proves that during Statistics may be defined as the
the reign of collection, organisation, presentation,
Chandra Gupta analysis and interpretation of numerical
Maurya, there data
existed a system - Croxton & Cowden
of maintaining
vital statistics, 12.4
Prof. P.C.Mahalanobis i n c l u d i n g Characteristics and Functions of
registration of Statistics
births and deaths. Such records can be
found in Kautilya’s Arthashastra even
i) Statistics are an aggregate of facts.
before 300B.C. The book “Ain-e-Akbari”
For example, numbers in a calendar
(1596-97) mentions the statistical and
pertaining to a year will not be called
administrative surveys conducted during
statistics, but to be included in statistics
Akbar’s rule. P.C.Mahalanobis is known as
it should contain a series of figures with
the founder of modern statistics and also
relationships for a prolonged period.
as father of Statistics in India. Since 2007
29th of June every year is celebrated as ii) Statistics are numerically enumerated,
Statistics Day to commemorate his birth estimated and expressed.
anniversary.
iii) Statistical collection should be
12.3 systematic with a predetermined
purpose: The purpose of collection
Definitions of Statistics
of statistics should be determined
beforehand in order to get accurate
The term ‘Statistics’ is used in two information.
senses: as singular and plural. In singular
form it simply means statistical methods. iv) Should be capable of being used as a
Statistics when used in singular form technique for drawing comparison:
helps in the collection, presentation, It should be capable of drawing
classification and interpretation of data to comparison between two different sets
make it easily comprehensible. In its plural of data by tools such as averages, ratios,
rates, coefficients etc.
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 Statistics and Firms
Functions of Statistics
 Statistics presents facts in a definite Statistics is widely used in many firms
form. to find whether the product is conforming
to specifications or not.
 It simplifies mass of figures.
 It facilitates comparison. Statistics and Commerce
 It helps in formulating and testing. Statistics are life blood of successful
 It helps in prediction. commerce. Market survey plays an
important role to exhibit the present
 It helps in the formulation of suitable
conditions and to forecast the likely
policies.
changes in future.

12.5 Statistics and Education

Nature of Statistics Statistics is necessary for the

formulation of policies to start new course,
Different Statisticians and according to the changing environment.
Economists differ in views about the There are many educational institutions
nature of statistics, some call it a science owned by public and private engaged in
and some say it is an art. research and development work to test the
past knowledge and evolve new knowledge.
Tipett on the other hand considers These are possible only through statistics.
Statistics both as a science as well as an
art. Statistics and Planning:

12.6 Statistics is indispensable in planning.

In the modern world, which can be termed
Scope of Statistics as the “world of planning”, almost all
the organisations in the government are
Statistics is applied in every sphere of seeking the help of planning for efficient
human activity – social as well as physical working, for the formulation of policy
– like Biology, Commerce, Education, decisions and execution of the same. In
Planning, Business Management, order to achieve the above goals, various
Information Technology, etc. advanced statistical techniques are used
for processing, analyzing and interpreting
Statistics and Economics data. In India, statistics play an important
Statistical data and techniques role in planning, both at the central and
are immensely useful in solving many state government levels, but the quality of
economic problems such as fluctuation in data highly unscientific.
wages, prices, production, distribution of
income and wealth and so on.

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 Statistics and Medicine It is well known that mathematical and
physical sciences are exact. But statistical
In Medical sciences, statistical
laws are not exact and statistical laws
tools are widely used. In order to test the
are only approximations. Statistical
efficiency of a new drug or to compare the
conclusions are not universally true. They
efficiency of two drugs or two medicines,
are true only on an average.
t - test for the two samples is used. More
and more applications of statistics are at
3. Statistics table may be misused:
present used in clinical investigation.
Statistics must be used only by experts;
Statistics and Modern applications otherwise, statistical methods are the
most dangerous tools on the hands of the
Recent developments in the fields inexpert. The use of statistical tools by
of computer and information technology the inexperienced and untrained persons
have enabled statistics to integrate their might lead to wrong conclusions.
models and thus make statistics a part
of decision making procedures of many 4. Statistics is only one of the
organisations. There are many software methods of studying a problem: Statistical
packages available for solving simulation method does not provide complete
problems. solution of the problems because problems
are to be studied taking the background
12.7
of the countries culture, philosophy,
Limitations of statistics religion etc., into consideration. Thus the
statistical study should be supplemented
Statistics with all its wide application by other evidences.
in every sphere of human activity has its 12.8
own limitations. Some of them are given Types of Statistics
below.
There are two major types of
1. Statistics is not suitable to the statistics named as Descriptive Statistics
study of qualitative phenomenon: and Inferential Statistics.
Since statistics is basically a science and
deals with a set of numerical data. It is Descriptive Statistics
applicable to the study of quantitative The branch of statistics devoted to
measurements. As a matter of fact, the summarization and description of
qualitative aspects like empowerment, data is called Descriptive Statistics
leadership, honesty, poverty, intelligence
Inferential Statistics
etc., cannot be expressed numerically
and statistical analysis cannot be directly The branch of statistics concerned
applied on these qualitative phenomena. with using sample data to make an
inference about a population of data is
2. Statistical laws are not exact: called Inferential Statistics.

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 Descriptive
Statistics
Statistics
Inferential
Type of Statistics Statistics

Major differences between Descriptive Statistics and Inferential Statistics

S.No Descriptive statistics Inferential statistics

1. It describes the population under study. It draws conclusion for the population
based on the sample result.
2. It presents the data in a meaningful way It uses hypotheses, testing and
through charts, diagrams, graphs, other predicting on the basis of the outcome.
than describing in words.
3. It gives the summary of data. It tries to understand the population
beyond the sample.
12.9 A characteristic is qualitative in nature
Data when its observations are defined
and noted in terms of the presence or
Data is the information about facts absence of a certain attribute in discrete
or numbers collected to be examined and numbers. These data are further
used to help with decisions. Data are the classified as nominal and rank data. Eg.
basic raw materials of statistics. Gender, Community, honesty…

In statistics, data are classified into (i) Nominal data are the outcome
two broad categories: 1.Quantitative data of classification into two or more
and Qualitative data. categories of items or units comprising
a sample or a population according
1. Quantitative data are those that to some quality characteristic.
can be quantified in definite units Classification of students according
of measurement. These refer to to their sex (as males and females),
characteristics whose successive Workers according to their skill (as
measurements yield quantifiable skilled, semi-skilled, and unskilled),
observations. Eg. Age, income, number and of employees according to their
of firms etc level of education (as matriculates,
undergraduates, and post-graduates).
2. Qualitative data refer to qualitative
(ii) Rank data, on the other hand, are the
characteristics of a subject or an object.
result of assigning ranks to specify
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 order in terms of the integers 1,2,3, ..., (i) Primary data: Those data which do
n. Ranks may be assigned according not already exist in any form, and thus
to the level of performance in a test, have to be collected for the first time
a contest, a competition, an interview, from the primary source(s). By their
or a show. The candidates appearing very nature, these data are fresh and
in an interview, for example, may be first-time collected covering the whole
assigned ranks in integers ranging population or a sample drawn from it
from I to n, depending on their
(ii) S econdary data: They already exist in
performance in the interview.
some form: published or unpublished
Sources of Collection of data in an identifiable secondary source.
Based on the data sources, data could They are, generally, available from
be seen as of two types, viz., secondary published source(s), though not
data and primary data. The two can be necessarily in the form actually
defined as under: required. Eg. Data from CSO, NSSO,
RBI….
Primary
Data
Quantitative
Data
Secondary
Based on
Data
characteristics
Qualitative
Data Primary
Data Data
Primary
Secondary
Data
Based on Data
Sources
Secondary Classifications Of Data
Data

12.10 Meaning of Average

Arithmetic mean or mean ( )  “A measure of central tendency is a
typical value around which other
Central value is called a measure of figures congregate.”
central tendency or an average or a
measure of locations. There are five “
 An average stands for the whole
averages. Among them mean, median and group of which it forms a part yet
mode are called simple averages and the represents the whole.”
other two averages geometric mean and
“
 One of the most widely used set
harmonic mean are called special averages.
of summary figures is known as
measures of location.”

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 The mean of a variable is defined as
the sum of the observations divided by the X̅ = A + ∑d
n
number of observations. If the variable
31
x assumes n values x1, x2 … xn then the = 68 +
5
mean, , is given by summing of all x values
divided by the number of x values. = 68 + 6.2

X1+X2+X3+X4+⋯+Xn 1 n = 74.2
X̅ = = ∑ = X,
n n i 1 i 12.11
This formula is for ungrouped or raw data. Standard Deviation (σ)

Example 1: Calculate the mean for given The measures of central tendency
data 2,4,6,8,10. serve to locate the center of the distribution,
∑X but they do not reveal how the items are
Direct Method X̅ =
n spread out on either side of the center. This
Where ∑X = Sum of values characteristic of a frequency distribution
N = No. of items is commonly referred to as dispersion.
The degree of variation is evaluated by
Solution: various measures of dispersion. There
2+4+6+8+10 30 are two kinds of measures of dispersion,
X̅ = = =6 namely
5 5
Short- cut method:
1. Absolute measure of dispersion
The formula for finding mean, 2. Relative measure of dispersion
X̅ = A + ∑d
n Absolute measure of dispersion
Where A= the assumed mean or any value indicates the amount of variation in a set
of X of values in terms of units of observations.
d = deviations of each value from assumed
Relative measures of dispersion
mean.
are free from the units of measurements
Example 2: A student’s marks in 5 subjects
of the observations. They are pure
are 75,68,80,92,and 56. Find
numbers. They are used to compare the
his average mark.
variation in two or more sets, which are
Solution: having different units of measurements of
observations.
X d=X-A
75 7 Standard Deviation is one of
68 → A 0 the methods of Absolute measure of
80 12 dispersion. Karl Pearson introduced the
92 24 concept of standard deviation in 1893.
56 -12 Standard deviation is also called Root-
Total 31 Mean Square Deviation. The reason is
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 that it is the square–root of the mean of
the squared deviation from the arithmetic ∑x2 ∑(x-x̅ )2
𝜎 = � n � or � n �
mean. It provides accurate result. Square
of standard deviation is called Variance. ∑x2 ∑(x-x̅ )2
= Variance =
n n
Definition:
When the sample size is less than 30,
It is defined as the positive square- ∑(x-x̅ )2
variance = ;
root of the arithmetic mean of the square n–1
of the deviations of the given observation When n = number of observations.
from their arithmetic mean. Example 1: Calculate the standard
deviation from the following data by
The standard deviation of the Actual Mean Method: 25, 15, 23, 42, 27,
population is denoted by the Greek letter σ 25, 23, 25, and 20.
(sigma) The standard deviation of sample
is denoted as 's'. Solution: Deviations from actual mean.

Calculation of Standard deviation- Sl. No Values (X) X –X̅ (X –X̅ )2

Individual Series:
1 25 25-25=0 0
There are two methods of calculating
2 15 15-25=10 100
Standard deviation in an individual series.
3 23 23-25= -2 4
a) Deviations taken from Actual mean 4 42 42-25=17 289
b) Deviation taken from Assumed mean 5 27 27-25=2 4
∑(x-x̅ )2 6 25 25-25=0 0
Standard Deviation = � �
n
7 23 23-25=-2 4
Where, x ̅ = mean value of distribution
n = number of observations. 8 25 25-25=0 0

Steps: 9 20 20-25=-5 25

1. Find out the actual mean of given data N=9 225 0 426
(X̅ ) 225
X̅ = =25
2. Find out the deviation of each value 9
from the mean (x ⁼ X –X̅ )
𝜎 = �∑(x-x̅ )2� =
426
= 47.33
3. S quare the deviations and take the total n 9
of squared deviations ∑x2 𝜎 = 6.88 Answer
4. Divided the total ∑x2 by the number of Example 2: Calculate the standard
observation � x2 �
∑ deviation for the following data by
n assumed mean method: 43, 48, 65, 57, 31,
 he square root of � x2� is standard
∑ 60, 37, 48, 78, 59
5. T
n
deviation.
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 Solution: Deviation from assumed mean 12.12
Sl. No (X) d=X-A (A=57) d2 Correlation (Υ)
1 43 -14 196
2 48 -9 81 Introduction
3 65 8 64 Correlation is a statistical device
4 57 0 0 that helps to analyse the covariation of
5 31 -26 676
two or more variables. Sir Francis Galton,
is responsible for the calculation of
6 60 3 9
correlation coefficient.
7 37 -20 400
8 48 -9 81
Types of Correlation
9 78 21 441 Correlation is
10 59 2 4 classified in several
N=10 ∑d = -44 ∑d2=1952 different ways. Three of
the most important ways
1952 -44 2
of classifying correlation
𝜎 = =
10 10 Karl Pearson are:
= 195.2-19.36 = 175.84 = 13.26,
Answer = 13.26

Types of Correlation

Based upon the constancy

Based on the direction Based upon the number
of the ratio of change
of change of variables of variables studied
between the variables

Positive Negative Linear Non-linear

Correlation Correlation Correlation Correlation

Simple Multiple Partial

Correlation Correlation Correlation

Type I: B
 ased on the direction of change of variables
Correlation is classified into two types as Positive correlation and Negative Correlation
based on the direction of change of the variables.

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 Positive Correlation: P is the price of the goods,
The correlation is said to be positive Pc is the price of competitive goods
if the values of two variables move in the Ps is the price of substituting goods
same direction. t is the taste and preference
y is the income.
Ex 1: If income and Expenditure of
a Household may be increasing or Partial Correlation:
decreasing simultaneously. If so, there is If there are more than two variables
positive correlation. Ex. Y= a + bx but only two variables are considered
keeping the other variables constant,
Negative Correlation: then the correlation is said to be Partial
The Correlation is said to be negative Correlation
when the values of variables move in the Type III: Based upon the constancy of
opposite directions. Ex. Y= a – bx the ratio of change between the
Ex 1: Price and demand for a commodity variables
move in the opposite direction. Correlation is divided into two types
as linear correlation and Non-Linear
Type II: 
Based upon the number of correlation based upon the Constancy of
variables studied. the ratio of change between the variables.
There are three types based upon the
Linear Correlation: Correlation is said to
number of variables studied as
be linear when the amount of change in
a) Simple Correlation one variable tends to bear a constant ratio
b) Multiple Correlation to the amount of change in the other.
c) Partial Correlation Ex. Y= a + bx

Simple Correlation: Non Linear: The correlation would be

non-linear if the amount of change in
If only two variables are taken one variable does not bear a constant
for study then it is said to be simple ratio to the amount of change in the other
correlation. variables.
Multiple Correlations: Ex. Y= a + bx2
Methods of Studying Correlation:
If three or more than three variables
are studied simultaneously, then it is The various methods of ascertaining
termed as multiple correlation. whether two variables are correlated or
not are:
Ex: Determinants of Quantity demanded 1. Scatter diagram Method
2. Graphic Method
Qd= f (P, Pc, Ps, t, y)
3. Karl Pearson’s Co - efficient of
Where Qd stands for Quantity correlation and
demanded, f stands for function. 4. Method of Least Squares.
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 Of these, the first two are based on portrays the relationship between these
the knowledge of diagram and graphs, two variables graphically.
whereas the others are mathematical
Advantages of Scatter Diagram method
methods.
(1) It is very simple and non- mathematical
1. Scatter Diagram Method: method
(2) 
it is not influenced by the size of
Scatter diagram is a graph of observed
extreme item.
plotted points where each point represents
the values of X and Y as a coordinate. It (3) 
It is the first step in resting the
relationship between two variables.

Disadvantages of Scatter diagram method

It cannot establish the exact degree of correlation between the variables, but provides
direction of correlation and depicts it is high or low.

Scatter Diagram
Perfect Positive Perfect Negative Low Degree of Positive Low Degree of
y Correlation y Correlation y Correlation y Negative Correlation

o xo x o x o x

High Degree of High Degree of

y Positive Correlation y Negative Correlation y No Correlation y No Correlation

o xo xo x o x

2. Graphic method

In this method, the individual values of two variables are plotted on the graph sheet
and draw the curves of both the variables say x and y. If both X and Y are moving in the
same direction either upward or downward, then the correlation is said to be positive. If
the curves of X and Y move in the opposite direction; then the correlation is said to be
negative.

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 Public vs Private Investments Public Private

45
35
%year-on-year

25
15
5
-5
-15
-25
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Financial year Source: Central Statistical Organisation

3. K
 arl Pearson’s Where dx refers to deviations of x
Coefficient of series from assumed mean A (X-A), dy
Correlation refers to deviations of y series from an
Karl Pearson’s assumed mean θ (Y-B)
Method is popularly ∑dxdy = Sum of product of the deviations
known as Pearson’s x and y series from their
coefficient of correlation denoted by the assumed means.
symbol ‘r’. The coefficient of correlation ‘r’ ∑dx 2 = Sum of the squares of the deviations
measures the degree of linear relationship
of x series from an assumed mean
between two variables say X and Y. The
∑dy 2= Sum of the squares of the deviations
Formula for computing Karl Pearson’s
Coefficient of correlation is: of y series from an assumed mean
N∑XY − (∑X) (∑Y) ∑dx = sum of the deviation of x series
1) r =
N∑X2 − (∑X)2 N∑Y2 − (∑Y)2 from an assumed mean of x

‘r’ is calculated by Direct Method ∑dy = sum of the deviation of y series

without taking deviation of terms either from an assumed mean of y
from actual mean or assumed mean.
Procedure for Computing the
2) r is calculated by taking the Deviation
Correlation Coefficient: (For Direct and
from actual mean.
Deviation from actual mean method).
∑xy
r= where x= (x-x̅ ), y = (y-y̅ ) Step-1 Calculate the mean of two
 
∑x2 ∑y2
series ‘X’ ‘Y’
3) ‘r’ is calculated by taking assumed mean
Step-2 Calculate the deviations ‘X’ and
 
N ∑dxdy − (∑dx ) (∑dy ) Y in two series from their respective
r=
N ∑dx 2 − (∑dx )2 N ∑dy 2 − (∑dy )2 mean.
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 ∑xy
Step-3 Square each deviations of ‘X’
  1 r=
∑x2 ∑y2
and ‘Y’ then obtain the sum of the
Squared deviation, That is and N∑XY − (∑X) (∑Y)
r=
Step-4 Multiply each deviation under
  N∑X2 − (∑X)2 N∑Y2 − (∑Y)2
X with each deviation under Y and
obtain the product of ‘xy’. Then obtain where x= (x-x̅ ), y = (y-y̅ )
the sum of the product of X,Y. Then
obtain the sum of the product of x,y 2. Assumed Mean Deviation Method
is ∑xy.
N ∑dxdy − (∑dx ) (∑dy )
Step-5 Substitute the value in the
  r=
formula. N ∑dx 2 − (∑dx )2 N ∑dy 2 − (∑dy )2

Formula of Karl Pearson’s Coefficient 2. Indirect Method

of Correlation - Ungrouped Data.
dx= (x-x̅ ) and dy = (y-y̅ )
r is free from origin
Direct Method Indirect Method
r is free from unit of measurement -1≤r≤+1
Actual Mean
Using the
deviation Direct Method:
Variables as it is
method
Example 1: Calculate Karl Pearson’s Coefficient of correlation from the following data
and interpret its value:
Price :X 10 12 14 15 19
Supply:Y 40 41 48 60 50
Solution: L
 et us take Price as X and supply as Y

Computation of Pearson’s Correlation Coefficient

Price: X Supply: Y XY X2 Y2
10 40 400 100 1600
12 41 492 144 1681
14 48 672 196 2304
15 60 900 225 3600
19 50 950 361 2500
∑x = 70 ∑y = 239 ∑xy = 3414 ∑x2 = 1026 ∑y2=11685

N∑XY − (∑X) (∑Y) (5 x 3414) − (70 x 239)

r= r=
N∑X2 − (∑X)2 N∑Y2 − (∑Y)2 (5 x 1026) − (70) 2 5x11685 − (239) 2

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 340
r = 17,070 − 16,730 r= =+0.621
230 ¥ 1304 547.65
Price of the product and supply for the product is positively correlated. When price
of the product increases then the supply for the product also increases.
Actual Mean Method:
Ex-1: Estimate the coefficient of correlation with actualmean method for the following
data.
Age of Cars in years 3 6 8 9 10 6
Cost of Annual Maintains (in 000 ₹) 1 7 4 6 8 4
Solution:
∑xy
r= where x= x-x̅ , y = y-y̅
∑x2 ∑y2

x-x̅ y-y̅
S.No x (x-x̅ )2 =x2 Y (y-y̅ )2=y2 xy
x - 7=x Y –5=y
1 3 -4 16 1 -4 16 16
2 6 -1 1 7 2 4 -2
3 8 +1 1 4 -1 1 -1
4 9 2 4 6 1 1 2
5 10 3 9 8 3 9 9
6 6 -1 1 4 -1 1 +1
42 42
x̅ =7 0 32 y̅ =7 0 32 25
6 6
∑x2 = 32 ∑y2 = 32 ∑xy = 25

Applying in Formula
∑xy 25 25
r= = = = 0.781
∑x2 ∑y2 32 ¥ 32 32

r = 0.781, The Car is getting old in years the cost of maintenance is also increasing. The
age of Car and its maintenance are positively correlated.
Assumed Mean Deviation Method
Ex 1: Find the Karl Pearson coefficient of Correlation between X and Y from the following
data:
X: 10 12 13 16 17 20 25
Y: 19 22 26 27 29 33 37
Solution:
Formula for Assumed Mean Deviation method.

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 N ∑dxdy − (∑dx ) (∑dy )
r=
N ∑dx 2 − (∑dx )2 N ∑dy 2 − (∑dy )2

S.No X Y (X-A)=dx (Y-A)=dy dx2 dy2 Dxdy

1 10 19 -6 -8 36 64 48
2 12 22 -4 -5 16 25 20
3 13 26 -3 -1 9 1 3
4 16 27 0 0 0 0 0
5 17 29 1 2 1 4 2
6 20 33 4 6 16 36 24
7 25 37 9 10 81 100 90
N=7 ∑X=113 ∑Y=193 ∑(X-A)=1 ∑(Y-A)=4 ∑dx =159 ∑dy =230 ∑dxdy=187
2 2

∑X 113 1 12.13
x̅ = = =16
N 7 7 Regression
∑Y 193 4
y̅ = = =27
N 7 7 Evolution of Regression

Take the assumed values A = 16 & B = 27 The term

therefore dx = X – A ⇒ X – 16 and ‘Regression’ was first
coined and used in
dy = Y- A ⇒ Y – 27 1877 by Francis Galton
while studying the
N ∑dxdy − (∑dx ) (∑dy ) relationship between
∴r = Francis Galton
the height of fathers
N ∑dx 2 − (∑dx )2 N ∑dy 2 − (∑dy )2 and sons. The average height of children
7×187−1×4 born of parents of a given height tended
= to move or “regress” toward the average
7×159−(1)2 7×230−(4)2
height in the population as a whole.
1309−4 Galton’s law of universal regression was
=
1112 1610 − 16 confirmed by his friend Karl Pearson, who
collected more than a thousand records of
1305 heights of members of family groups. The
= = 1305
literal meaning of the word “regression” is
1112 1594 (33.34) (39.92)
“Stepping back towards the average”.

Regression is the study of the

= 1305 = 0.9865 r = 0.986
1330.9 relationship between the variables.
If Y is the dependent variable and X
There exists a positive high correlation is independent variable, the linear
between X and Y relationship between the variable is called
the regression equation of Y on X, The

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 regression equation is used to estimate the value of Y corresponding to the known value
of X. The line describing this tendency to regress or going back was called by Galton a
“Regression Line”.

Difference between Correlation and Regression

S.No Correlation Regression

Correlation is the relationship between Regression means going back and it
two or more variables, which vary with is a mathematical measure showing
1
the other in the same or the opposite the average relationship between two
direction variables
Both the variables X and Y are random Both the variables may be random
2
variables variables
It finds out the degree of relationship It indicates the cause and effect
3 between two variables and not the cause relationship between the variables and
and effect relationship. establishes functional relationship.
It is used for testing and verifying the Besides verification it is used for the
4 relation between two variables and gives prediction of one value, in relation to
limited information the other given value.
The coefficient of correlation is a relative Regression coefficient is also relative
measure. The range of relationship lies measure. If we know the value of the
5
between –1 and +1 independent variable, we can find the
value of the dependent variable
There may be spurious correlation In regression there is no such spurious
6
between two variables. regression
It has limited application, because it It has wider application, as it studies
7 is confined only to linear relationship linear and nonlinear relationship
between the variables between the variables
It is not very useful for further It is widely used for further mathematical
8
mathematical treatment. treatment

Two Regression lines gives the best estimate to the value of one
variable for any specific value of the other
X on Y => X = a + by
variable.
Y on X => Y = a + bx
To fit Regression equations X on Y
Regression line is the line which gives and Y on X the following examples are
the best estimate of one variable from the given
value of any other given variable. The line
gives the average relationship between Ex 1: Fit two regression equation
the two variables in mathematical form. X on Y and Y on X for the following data.
The line of regression is the line which
X̅ =12, Y̅ =10, σy= 0.2, σx =0.1 and r = 0.85
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 Solution
12.14
The equation of the regression line of X Introduction To Econometrics
on Y is
(X-X̅ ) = r × σx ×(Y-Y̅ ) Origin Of Econometrics
σy
Given X̅ = 12, Y̅ =10 Economists tried to support their
r = 0.85, σx = 0.1 and σy = 0.2 ideas with facts and figures in ancient
times. Irving Fisher is the first person,
Then substituting the values in formula developed mathematical equation in the
quantity theory of money with help of
(X-12) = 0.85 × (0.1/0.2) × (Y-10)
data. Ragnar Frisch, a Norwegian
(X-12) = 0.85 × (0.5) × (Y-10) economist and statistician named the
X = 0.425 ×(Y-10)+ 12 integration of three subjects such that
X = 0.425Y- 4.25+12 mathematics, statistical methods and
X = 0.425Y+7.75 economics as Econometrics” in 1926.
X on Y
Answer X = 0.425Y + 7.75
Ragnar Anton Kittil
The equation of the regression line of Y Frisch Noble Memorial
on X is Prize in 1969
Ragnar Frisch
(Y-Y̅ ) = r × σy ×(X-X̅ )
σx
The term econometrics is formed
Given X̅ = 12, Y̅ =10
from two words of Greek origin,
r = 0.85, σx = 0.1 and σy = 0.2 ‘oukovouia’ meaning economy and
‘uetpov’ meaning measure. Econometrics
Then substituting the values in formula emerged as an independent discipline
(Y-10) = 0.85 × (0.2/0.1) × (X–12) studying economic phenomena.
(Y-10) = 0.85 × (2) × (X–12) Econometrics may be considered as
Y = 1.7 × (X–12) + 10 the integration of economics, Statistics
Y = 1.7X–20.4+10 and Mathematics.
Y = 1.7X–10.4 Econometrics is an amalgamation
Y on X of three subjects which can be easily
Answer Y = 1.7X–10.4 understood by following Venn diagram
and picture representation.
Economics + Mathematics= Mathematical Economics
Mathematical Economics+ Statistical Data & Its Technique = Econometrics
{Economics + Statistics + Mathematics}+Empirical Data = Econometrics

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 Definitions
In the words of Arthur S. Goldberger, “Econometrics may be defined as the social
science in which the tools of economic theory, mathematics and statistical inference are
applied to the analysis of economic phenomena”.
Gerhard Tinbergen points out that “Econometrics, as a result of certain outlook
on the role of economics, consists of application of mathematical statistics to economic
data to lend empirical support to the models constructed by mathematical economics
and to obtain numerical results”.
H Theil“Econometrics is concerned with the empirical determination of economic
laws”
In the words of Ragnar Frisch “The mutual penetration of quantitative econometric
theory and statistical observation is the essence of econometrics”.

Econometrics means economic measurement. Econometrics deals with the

measurement of economic relationships.

Mathematical Economic
Economics Statistics
Economics

Statistics
Mathematics

Econometrics Mathematical
Statistics

Objectives Of Econometrics
The general objective of Econometrics is to give empirical content to economic theory.
The specific objectives are as follows:

1. It helps to explain the behaviour of a forthcoming period that is forecasting economic

phenomena.

2. It helps to prove the old and established relationships among the variables or between
the variables

3. It helps to establish new theories and new relationships.

4. It helps to test the hypotheses and estimation of the parameter.

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 Flow Chart of Anatomy / Methodology
of Econometrics

Economics Anatomy of Econometric Modeling

Economic theory

Mathematical model of the theory

Mathematics Statistics
Economic model of the theory

Data

Estimation of econometric model

Hypothesis Testing

Forecasting or prediction
Amalgamation of
above Three Subjects is Using the model for control or
policy purpose
Econometrics Difference between the Econometric
model with Mathematical models and
Methodology Of Econometrics statistical models
1. Models in Mathematical Economics
Broadly speaking, traditional or
are developed based on Economic
classical econometric methodology
Theories, while, Econometric Models
consists of the following steps.
are developed based on Economic
1) Statement of the theory or hypothesis Theories to test the validity of Economic
Theories in reality through the actual
2) Specification of the mathematical data.
model of the theory
2. Regression Analysis in Statistics does
3) Specification of the econometric model not concentrate more on error term
of the theory while Econometric Models concentrate
more on error terms
4) Obtaining the data
Statistics Regression:
5) Estimation of the parameters of the
Yi = β0 + β1Xi
econometric model
Econometrics Regression:
6) Hypothesis testing
Yi = β0 + β1Xi+ Ui
7) Forecasting or prediction
(with more than 2 variables) or
8) Using the model for control or policy
Y = β0 + β1X1 + β2X2 + β3X3+Ui
purposes.

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 Systematic Part: β0 + β1Xi or explained 4. 
The Covariances of any Ui with any
part and Random Part: Ui unexplained other Uj are equal to zero
part in a regression. Ui represents the
role of omitted variables in specifying a 5. 
"U" is independent of explanatory
regression relationship of Y on X. Hence, variable (s)
the Ui cannot and should not be ignored. 6. 
Explanatory variables are measured
Assumptions of the Linear Regression without error.
Model 7. 
The explanatory variables are not
The Linear regression model is based perfectly linearly correlated.
on certain assumptions
8. T
 he variables are correctly aggregated.
1. S ome of them refer to the distribution
of the random variable . 9. The relationship is correctly identified
and specified.
2. S ome of them refer to the relationship
between Ui and the explanatory 10. Parameters are linear.
variables (x1, x2, x3 given in the above 12.15
example).
Official Statistics
3. S ome of them refer to the relationship
between Ui the explanatory variables Official Statistics are statistics
themselves. published by government agencies or
Assumptions about the distribution other public bodies such as international
of the values of are called stochastic organizations. They provide quantitative
assumptions of ordinary least squares or qualitative information on all major
(OLS). Assumptions relating to the areas of citizens’ lives. Official Statistics
relationship between Ui and explanatory make information on economic and social
variables and relating to the relationship development accessible to the public,
among the explanatory variables are called allowing the impact of government
other assumptions. policies to be assessed, thus improving
accountability.
Assumptions
The Ministry of Statistics and
1. "U" is a random real variable. That is Programme Implementation (MOSPI)
"U" may assume positive, negative or came into existence as an Independent
zero values. Hence the mean of the "U" Ministry in 1999 after the merging
will be zero. of the Department of Statistics and
the Department of Programme
2. The variance of "U" is constant for all
Implementation.
values of "U"

3. T
 he "U" has a normal distribution. The Ministry has two wings, Statistics
and Programme Implementation.

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 The Ministry

Programme
Statistics (NSO) Implementation

CSO NSSO Twenty point Infrastructure MP Local area

monitoring and Development
programme project monitoring scheme

SDRD FOD DPD CPD

The Statistics Wing called the CSO is located in the Sardar Patel
National Statistical Office (NSO) consists Bhawan, Parliament Street, New Delhi.
of the Central Statistical Office (CSO), The Industrial Statistics Wing of CSO is
the Computer Centre and the National located in Kolkata. The Computer Centre
Sample Survey Office (NSSO). also under the CSO is located in R K
Puram, New Delhi.
Central Statistical Office (CSO)
National Sample Survey Organisation
The Central Statistical Office is one (NSSO)
of the two wings of the National Statistical
The National Sample Survey
Organisation (NSO). It is responsible for
Organisation, now known as National
co-ordination of statistical activities in the
Sample Survey Office, is an organization
country and for evolving and maintaining
under the Ministry of Statistic of the
statistical standards. Its activities include
Government of India.It is the largest
compilation of National Accounts;
organisation in India, conducting regular
conduct of Annual Survey of Industries
socio-economic surveys. It was established
and Economic Censuses, compilation of
in 1950. NSSO has four divisions:
Index of Industrial Production as well
as Consumer Price Indices. It also deals 1. Survey Design and Research Division
with various social statistics, training, (SDRD)
international cooperation, Industrial
Classification, etc. 2. Field Operations Division (FOD)

The CSO is headed by a Director- 3. Data Processing Division (DPD)

General who is assisted by 5 Additional 4. Co-ordination and Publication Division
Director-Generals looking after the (CPD)
National Accounts Division, Social
Statistics Division, Economic Statistics The Programme Implementation
Division, Training Division and the Wing has three Divisions, namely,
Coordination and Publication Division.
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 (i) Twenty Point Programme Summary
(ii) Infrastructure Monitoring and Project First Part deals with meaning of
Monitoring statistics, nature, type and scope. Brief
(iii) 
Member of Parliament Local Area information about the data, data source
Development Scheme. and its kinds are given in the second part.
The third part of this chapter explains
Besides these three wings, there is correlation ‘r’ which measures the strength
National Statistical Commission created and direction of the linear association
through a Resolution of Government between two quantitative variables x and
of India (MOSPI) and one autonomous y. The fourth section depicts regression.
Institute, viz., Indian Statistical Institute The last part of this chapter introduces
declared as an institute of National Econometrics. Next the organizational
importance by an Act of Parliament. structure of Indian statistical system is
given in a gist.

MODEL QUESTIONS
Part – A
Multiple choice questions

1. 
The word ‘statistics’ is used as 4. 
The data collected by questionnaires
__________. are_____________.

(a) Singular. (a) Primary data.

(b) Plural (b) Secondary data.
(c) Singular and Plural. (c) Published data.
(d) None of above. (d) Grouped data.

2. Who stated that statistics as a science of 5. A measure of the strength of the linear
estimates and probabilities. relationship that exists between two
variables is called:
(a) Horace Secrist.
(a) Slope
(b) R.A Fisher.
(b) Intercept
(c) Ya-Lun-Chou
(c) Correlation coefficient
(d) Boddington
(d) Regression equation
3. S ources of secondary data are
6. 
If both variables X and Y increase
___________.
or decrease simultaneously, then the
(a) Published sources. coefficient of correlation will be:
(b) Unpublished sources.
(a) Positive
(c) n
 either published nor
(b) Negative
unpublished sources.
(c) Zero
(d) Both (A) and (B)
(d) One
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 7. 
If the points on the scatter diagram (b) Regression
indicate that as one variable increases (c) Residual
the other variable tends to decrease the (d) Slope
value of r will be:
12. If Y = 2 - 0.2X, then the value of Y
(a) Perfect positive intercept is equal to
(b) Perfect negative
(c) Negative (a) -0.2
(d) Zero (b) 2
(c) 0.2X
8. The value of the coefficient of correlation (d) All of the above
r lies between:
(a) 0 and 1 13. In the regression equation Y = β0+β1X,
(b) -1 and 0 the Y is called:
(c) -1 and +1 (a) Independent variable
(d) -0.5 and +0.5 (b) Dependent variable
9. T
 he term regression was used by: (c) Continuous variable
(d) none of the above
(a) Newton
(b) Pearson 14. In the regression equation Y = β0+β1X,
(c) Spearman the X is called:
(d) Galton
(a) Independent variable
10. The purpose of simple linear regression (b) Dependent variable
analysis is to: (c) Continuous variable
(d) none of the above
(a) Predict one variable from another
variable 15. E
 conometrics is the integration of
(b) Replace points on a scatter
(a)Economics and Statistics
diagram by a straight-line
(b) Economics and Mathematics
(c) Measure the degree to which two
(c)
Economics, Mathematics and
variables are linearly associated
Statistics
(d) Obtain the expected value of the (d) None of the above
independent random variable for
a given value of the dependent 16 .Econometric is the word coined by
variable (a) Francis Galton
(b) RagnarFrish
11. A process by which we estimate the (c) Karl Person
value of dependent variable on the (d) Spearsman
basis of one or more independent
variables is called:
(a) Correlation

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 17. 
The raw materials of Econometrics 19. 
The term Uiis introduced for the
are: representation of
(a) Data (a) Omitted Variable
(b) Goods (b) Standard error
(c) Statistics (c) Bias
(d) Mathematics (d) Discrete Variable
20. E
 conometrics is the amalgamation of
18. T
 he term Uiin regression equation is
(a) 3 subjects
(a) Residuals (b) 4 subjects
(b) Standard error (c) 2 subjects
(c) Stochastic error term (d) 5 subjects
(d) none

Answers

1 2 3 4 5 6 7 8 9 10
c d d a c a c c d a
11 12 13 14 15 16 17 18 19 20
b b b a c b a c a a

Part-B

Answer the following in one or two sentences

21. What is Statistics?
22. What are the kinds of Statistics?
23. What do you mean by Inferential Statistics?
24. What are the kinds of data?
25. Define Correlation.
26. Define Regression.
27. What is Econometrics?

Part-C
Answer the following questions in one paragraph:
28. What are the functions of Statistics?
29. F
 ind the Standard Deviation of the following data:
14, 22, 9, 15, 20, 17, 12, 11 (Answer: = 4.18)
30. State and explain the different kinds of Correlation.
31. Mention the uses of Regression Analysis.
32. Specify the objectives of econometrics.
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 33. Differentiate the economic model with econometric model.
34. Discuss the important statistical organizations (offices) in India.

Part-D
Answer the following questions

35. Elucidatethe nature and scope of Statistics.

36. Calculate the Karl Pearson Correlation Co-efficient for the following data
Demand of Product X : 23 27 28 29 30 31 33 35 36 39
Sale of Product Y: 18 22 23 24 25 26 28 29 30 32
Answer: r=0.9955)
37.Find the regression equation Y on X and X on Y for the following data:
Y: 45 48 50 55 65 70 75 72 80 85
X: 25 30 35 30 40 50 45 55 60 65
(Answer: Y = 0.787X + 7.26, and X =0.87Y + 26.65)
38. Describe the application of Econometrics in Economics.

ACTIVITY
1. Check, Count and make a data set of the number of pages of
your subject books of Economics, Commerce, History, Tamil
and English

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 References

1. A
 garwal.D.R (2003)“Statistics for Economists” Vrinda Publications (P) Ltd New
Delhi,
2. C
 hristopher Dougherty (2007), Introduction to Econometrics, Oxford University
Press, 3rd edition, Indian Edition.
3. Greene W.H., (2003) Econometric analysis , 5ed., Prentice Hall,
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 ujarati.N and Sangeetha (2012) Basic Econometrics, McGraw Hill, Indian
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 upta.S.P, Gupta.M.P (1998) “Business Statistic” Sultan Chand & Sons. 16th
revised) enlarge edition.
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Company Ltd., New Delhi.
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LtdKundli
10. Maddala G.S. 1992 , Introduction to econometrics , 2ed., Macmillan
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Revised Edition, Himalaya Publishing House.
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 TERMINOLOGY

Accelerator முடுக்கி
Balance of trade அயல்நாட்டு வாணிப நிலை
Balance of payments அயல்நாட்டு செலுத்து நிலை
Budget வரவு செலவு திட்டம்
Budgetary deficit நிதிநிலை பற்றாக்குறை
Commercial Banks வணிக வங்கிகள்
Central Bank மத்திய வங்கி
Credit creation கடன் உருவாக்கம்
Cash Reserve Ratio ர�ொக்க இருப்பு வீதம்
Capitalism முதலாளித்துவம்
Capital formation மூலதனத் உருவாக்கம்
Capital மூலதனம்
Consumption function நுகர்வுச் சார்பு
Comparative cost advantage ஒப்பீட்டு செலவு நன்மை
Customs union சுங்க வரி ஒன்றியம்
Common market ப�ொதுச் சந்தை
Capital accumulation மூலதனத் திரட்சி
Casino capitalism சூதாட்ட முதலாளித்துவம்
Crony capitalism சலுகைசார் முதலாளித்துவம்
Credit control கடன் கட்டுப்பாடு
Credit Rationing கடன் பங்கீடு
Correlation co-efficient உடன் த�ொடர்பு கெழு
Development மேம்பாடு
Disposable income செலவிடக் கூடிய வருமானம்
Deflation பணவாட்டம்
Disinflation மித பணவீக்கம்
Demonetization பண மதிப்பிழப்பு
Devaluation நாணய மதிப்பு குறைப்பு
Developing countries வளரும் நாடுகள்
Developed countries வளர்ந்த நாடுகள்
Demand deposit தேவை வைப்பு
Economics ப�ொருளியல்
Exchange rate மாற்று விதம்
Exchange control மாற்று வீத கட்டுபாடு

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 Economic union ப�ொருளாதார கூட்டு
Eco system சுற்று சூழல்
Econometrics ப�ொருளாதார அளவியல்
Face value முக த�ோற்ற மதிப்பு
Foreign country அயல் நாடு
ப�ொது நிதிக் க�ொள்கை, அரச�ோடு
Fiscal policy த�ொடர்புடையது
Finance commission நிதிக் குழு
Fiscal deficit நிதிப்பற்றாக்குறை
Free Trade Area தலையிடா வாணிப பகுதி
Firm நிறுவனம்
Growth வளர்ச்சி
சுங்க வரி மற்றும் வாணிபம் த�ொடர்பான
General agreement on tariffs and trade ப�ொது ஒப்பந்தம்
Goods and services Tax சரக்கு மற்றும் சேவைவரி
Industry த�ொழில்
Investment முதலீடு
Intrinsic value அகமதிப்பு
Inflation பணவீக்கம்
Induced investment ஊக்குவிக்கப்பட்ட முதலீடு
International economics பன்னாட்டு ப�ொருளியல்
International monetary fund பன்னாட்டு பணநிதியம்
Indicative planning சுட்டிக்காட்டும் திட்டம்
Imperative planning கட்டாய திட்டமிடல்
Incidence of Taxation வரி பளு அல்லது வரிச்சுமை
IDBI தேசிய த�ொழில் வளர்ச்சி வங்கி
தலையிடாக் க�ொள்கையைக் க�ொண்டுள்ள
Laissez – Faire capitalist economy முதலாளித்துவ ப�ொருளாதாரம்
Liquidity ர�ொக்கத்தன்மை அல்லது நீர்மைத்தன்மை
Macro economics பேரினப் ப�ொருளாதாரம்
Mixed economy கலப்புப் ப�ொருளாதாரம்
Marginal propensity to consume இறுதிநிலை நுகர்வு விருப்பம்
Marginal propensity to save இறுதிநிலை சேமிப்பு நாட்டம்
Multiplier பெருக்கி
Multilateral Trade Agreement பன்முக வாணிப ஒப்பந்தம்
Monetary policy பணக் க�ொள்கை
Moral suasion அறிவுறுத்தல்
Measure of central Tendency மையப�ோக்கு அளவியல்
Measure of dispersion பரவல் (அல்லது) சிதறல்
National Income தேசிய வருமானம்
Negative externalities எதிர்மறை புறவிளைவுகள்

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 தேசிய வேளாண் மற்றும் கிராமப்புற
NABARD வளர்ச்சி வங்கி
Omitted variable விடுபட்ட மாறிகள்
Personal income தனிநபர் வருமானம்
Per capita income தலைவீத வருமானம்
Proportional Tax விகிதாச்சார வரி
Progressive Tax வளர்வீத வரி
Public Debt ப�ொதுக்கடன்
Positive externalities நேர்மறை புறவிளைவுகள்
Patrimonial capitalism பேரிடர் முதலாளித்துவம்
Planning commission திட்டக் குழு
Primary data முதனிலை புள்ளி விவரம்
RRB வட்டார கிராம வங்கி
Regression Coefficients உடன் த�ொகை கெழு
Subjective factors மனஇயல் காரணிகள்
Stagflation தேக்க வீக்கம்
Speculation ஊக வாணிகம்
Special Drawing Rights சிறப்பு எடுப்பு உரிமை
Sustainable development நிலைத்த மேம்பாடு
Social justice சமூக நீதி
Statutory liquidity Ratio சட்ட பூர்வ இருப்பு வீதம்
Statistics புள்ளியியல்
Secondary data இரண்டாம் நிலை புள்ளி விவரம்
Terms of Trade நிபந்தனை
Trade Blocs வர்த்தக குழுமங்கள்
Tax evasion வரி ஏய்ப்பு
Tax avoidance வரி தவிர்ப்பு
Time deposit கால வைப்பு
Underdeveloped Countries பின்தங்கிய நாடுகள்
Undeveloped Countries வளர்ச்சி குறைந்த நாடுகள்
Vicious circle of poverty வறுமையின் நச்சுச் சுழல்
World Bank உலக வங்கி
World Trade Centre உலக வர்த்தக மையம்
World Trade Organisation உலக வர்த்தக அமைப்பு

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 Economics – XII
List of Authors and Reviewers

Reviewers
Dr. L.Venkatachalam Dr. George V. Kallarackal Dr. S. Iyyam Pillai
Professor, Madras Institute of Developmental Former HOD, Economics Department Former Professor, Dept. of Economics
Studies, Chennai. CMS College, Kottayam, Kerala. Bharathidasan University, Trichy.

Domain Experts
Dr. R. Bernadshaw Dr. S. Theenathayalan
Former Professor, Dept. of Economics, Head, Department of Economics,
NMSSVN College, Nagamalai, Madurai. The Madura College, Madurai.

Subject Coordinator
J. Sornalatha
Post Graduate Assistant, Government Muslim Hr. Sec School.
Chennai-600002.

Authors

Dr. J. Socrates Dr. K. Sadasivam

Head, Department of Economics, Associate Professor, School of Economics,
Manonmaniam Sundaranar University, Tirunelveli. Madurai Kamaraj University, Madurai-625 021.
Dr. R. Albert Christopher Dhas Dr. M. Chitra
Associate Professor, Dept. of Economics, Assistant Professor, School of Economics,
The American College, Madurai. Madurai Kamaraj University, Madurai.
Dr. R.Vaheedha Banu Dr. K Kaliyamurthy,
Assistant Professor, MSS WAKF Board College, Madurai. HOD,Urumu Dhanalakshmi College,Kattur, Trichy.
Dr. S.Shanthi Getzie, K. Karnan
HOD, Bishop Heber College, Post Graduate Assistant, Government Girls Higher Secondary School,
Trichy. Tirumangalam, Madurai.
Stephen Elangovan K. Alamarselvan
Post Graduate Assistant, Post Graduate Assistant, Government Boys Higher Secondary School,
TVS Matric Higher Secondary School, Madurai. Bhuvanagiri, Cuddalore.
B. Shunmugam
Post Graduate Assistant
Natarajan Dhamayanthi Higher Secondary School, Nagapattinam.

Qr Code Management Team

Art & Design Team J.F. Paul Edwin Roy, B.T. Asst,
P.U.M.S -Rakkipatty, Veerapandi, Salem.

Layout & Illustrations A. Devi Jesintha, B.T. Asst,

V2 Innovations, Chennai-86. G.H.S, N.M. Kovil, Vellore
M. Murugesan, B.T. Asst,
In-House QC P.U.M.S. Pethavelankottagam, Muttupettai, Thiruvarur.
Mathan Raj R
Jerald Wilson
Reajesh Thangappan ICT- Co-ordinators
D. Vasuraj
Cover Design P.GT. & H.O.D., (Maths),
KRM Public School, Chennai.
Kathir Arumugam

Co-ordination
Ramesh Munisamy This book has been printed on 80 G.S.M.
Elegant Maplitho paper.
Typist
Printed by offset at:
M. Madhavi
SCERT.

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