MANAGERIAL

ECONOMICS
MEANING
 Managerial economics refers to the
application of economic principles and
methodologies to the decision making
process within a business firm organization.
 The focus of managerial economics evolves
round identifying and solving the decision
making problems which a manager faces in a
given business environment. It lies on the
borderline of management and economics. It
is primarily an applied branch of knowledge.
DEFINITIONS
 Henry and Haynes point out that managerial
economics is economics applied in decision
making. It is a special branch of economics.
That bridges the gap between abstract
theory and managerial practice.
 Joel dean views that the purpose of
managerial economics is to show how
economic analysis can be used in formulating
business policies.
FUNDAMENTAL NATURE OF
MANAGERIAL ECONOMICS
 A close interrelationship between
management and economics has led to the
development of managerial economics.
Management is the guidance, leadership and
control of the efforts of a group of people
towards some common objective. On the
other hand, economics, in broadest sense, is
what economists do. Economists are
primarily engaged in analyzing and providing
answers to manifestations of the most
fundamental problem, scarcity.
CONTD……..
 Scarcity of resources results because of two
fundamental facts of life:
1. Human wants are virtually unlimited and
insatiable.
2. Economic resources to satisfy these human
demands are limited.
Thus, we cannot have everything we want, we
must make choices.
Thus, managerial economics is the study of
allocation of resources available to a firm
among the various alternative activities of that
unit.
CHARACTERISTICS
 ME is micro economic in character. The unit
of study is a firm and its problems are
studied in it.
 ME is normative in character. It is
prescriptive rather than descriptive. It tells
the businessmen how best to achieve the
objectives of the firms under the given
circumstances.
 ME mostly uses the theory of the firm and
profit theories.
CONTD…..
 Besides micro economics concept, macro
economic concepts like, business cycles,
national income accounting, tax policy of the
government, price control measures, etc. are
highly used in ME to understand the external
forces effecting the business.
 ME bridges the gap between the purely
abstract analytical problems and the
pragmatic policies that management must
face. It offers powerful tools and approaches
for managerial policy making.
ECONOMICS VS. MANAGERIAL
ECONOMICS
 Economics is the systematic study of the
society as a whole. It studies as to how the
resources are allocated. It analyses the
interaction in markets of many individual
choices.
 ME is the systematic study of a particular
enterprise. It studies as to how resources are
allocated in a firm. It studies the purposive
decisions by the managers of the enterprise.
WHAT WE HAVE TO STUDY!!!
 The following areas generally are found
under the ambit of ME:
1. Demand analysis and forecasting.
2. Production and cost analysis.
3. Pricing decisions, policies and practices.
4. Profit analysis.
5. Capital management.
FUNDAMENTAL PRINCIPLES
 Economic theory has contributed the
following basic principles to ME, which are of
immense use. They are:
1. The incremental concept.
2. The time perspective concept.
3. The discounting concept.
4. The opportunity cost concept.
5. The equi marginal principle.
THE INCREMENTAL CONCEPT
 Incremental reasoning amounts to estimating
the impact of decision alternatives on costs
and revenue by comparing the resultant
change in the total revenue with the change in
the total cost.
 A business decision is considered as profitable
only if:
1. It increases the revenue more than the costs.
2. It adds to revenue more than costs.
3. It reduces costs more than revenue.
4. It lowers some cost more than revenues.
THE TIME PERSPECTIVE
PRINCIPLE
 Managerial economists are concerned with
the short run and long run effects of decision
on revenues as well as costs. The important
practical problem in decision making analysis
is to maintain the right balance between the
long run, short run and intermediate run
perspectives. The management usually
begins with a short run approach to the costs
and revenues and then carries out a series of
analysis extending the time perspective.
THE DISCOUNTING PRINCIPLE
 The decision problems make it imperative
that the concept of discounting is applied to
future costs and returns. Because of the time
value of money costs and revenue that occur
at different times must be adjusted to their
equivalent values at some common time
before a comparison to determine the
profitability is made. The method of
compounding and discounting are used to
find the time value of money.
THE OPPORTUNITY COST
CONCEPT
 Opportunity costs are the costs of displaced
alternatives. The opportunity cost of a
decision is meant the sacrifice of alternatives
required by the decision. If a scarce resource
is put to particular use, other uses of the
resources must be given up. The net revenue
that could be produced in the next best use
of the resource is called the opportunity cost
of the resource for the use actually made.
THE EQUI MARGINAL PRINCIPLE
 The equi marginal concept tells us that an input
should be allocated in such a way that the value
added by the last unit is the same in all the
cases. The available input should be used in all
the activities, in such a way that the value added
by the marginal input should be the same.
 If the value of the marginal product is greater in
one activity he will shift labour from low
marginal uses. This will increase the total value
of the product taken together. The optimum is
reached when the value of the marginal product
is equal in all activities.
CONCEPT OF RISK
 Risk refers to the amount of variability
among the outcomes associated with a
particular strategy. When there are many
possible outcomes with different money
returns, there is said to be substantial risk.
For ex. When an unproven oilfield is drilled
possibly there may be two results. One is
that if oil is found, the well will be
financially worth millions. If no oil is found,
the well will be worth nothing.
DECISION MAKING
 From the alternative courses of action and
choosing the best or optimal courses of
action from among the several alternatives is
decision making. Decision making implies the
need for optimizing behavior of the firm.
CONTD…..
 According to Herbert Simon the principle of
economics identifies with following areas of
decision making in the following areas:
1. Finding occasions for making decisions.
2. Identifying possible courses of action.
3. Evaluating the revenues and costs
associated with each course of action.
4. Choosing the particular course that best
meets the goal or objective of the firm.
DEMAND ANALYSIS
 Demand in economics means effective
demand, which can be defined as a desire
backed by willingness and ability to pay for a
particular product. Thus for a demand to be
effective, three factors are important:
1. Desire to buy.
2. Willingness to buy.
3. Ability to buy.
DEMAND VS WANT
 Want can be defined as a desire to buy a
particular product. But for the want to
become a demand, it must be backed by the
ability to pay for the product. For ex. A
person may have a desire to buy a car. This
desire can be termed as a want. This
becomes a demand, only when he has the
ability to pay for the car.
FACTORS DETERMINING
DEMAND
 Population.
 Income and wealth.
 Consumers tastes, preferences, customs and
habit.
 Price of the related goods.
 Future expectation about the price of the
product.
 Advertisement expenditure.
 Price of the product.
 Demonstration effect.
 Consumer credit facility.
THE LAW OF DEMAND
 There is an inverse correlation between price
and demand. Whenever a price changes for a
commodity, the demand for the commodity
also changes. When the price of a commodity
declines, the demand for the same increases.
On the contrary, if the price of the commodity
increases, the quantity demanded decreases.
Thus there is a cause and effect relationship
between price and demand of the commodity.
 This cause and effect relationship between the
price and the quantity demanded is called the
Law of Demand.
DEMAND SCHEDULE
 There are two types of demand schedule:
1. Individual demand schedule
2. Market demand schedule
INDIVIDUAL DEMAND SCHEDULE
 Individual demand schedule indicates how an
individual consumer will buy commodities at
various prices.
 The graphical presentation of Individual
demand schedule will depict Individual
demand curve.
MARKET DEMAND SCHEDULE
 Market demand schedule is formulated to
indicate the various prices at which the
consumers in the whole market will buy
different quantities of goods.
 The graphical presentation of Market demand
schedule will depict market demand curve.
CAUSES FOR THE OPERATION
OF LAW OF DEMAND
1. Substitution effect.
2. Income effect.
3. Arrival of new consumers.
4. Operation of law of diminishing marginal
utility.
EXCEPTIONS TO THE LAW OF
DEMAND
1. Prestige value.
2. Giffens paradox.
3. Speculative demand.
4. Expectation of further changes in price.
5. Money market speculations.
TYPE OF DEMAND
 Income demand.
 Cross demand.
 Direct demand.
 Derived demand.
 Joint demand.
 Composite demand.
INCOME DEMAND
 At various levels of income, the consumers
demand different quantities of goods. For
better types of goods like butter, ghee etc.
The larger the income larger will be the
demand. Costly goods are demanded only
when the consumers get more income. These
are known as superior goods. On the other
hand,basic necessaries like salt, kerosene
etc. every one has to buy them. with the rise
in income, there is no increase in the
demand of these products. Such goods are
known as inferior goods.
CROSS DEMAND
 Cross demand refers to various amount of a
commodity, which are demanded at different
prices of another related commodity. In cross
demand, we relate the quantity demanded of
one commodity, with the price of another
commodity. For ex. The demand for petrol
may increase not because the price of petrol
has fallen but because the prices of cars has
fallen.
DIRECT DEMAND
 Demand for all such goods which are directly
consumed by the consumers, is known as
direct demand. For ex. Demand for car,
eatables etc.
DERIVED DEMAND
 Demand for all such goods which are not
directly consumed by the consumers but are
used in the preparation of such goods which
are used directly by the consumers, is known
as derived demand. For ex. Demand for
petrol, demand for sugar.
JOINT DEMAND
 Many commodities like tea have a joint
demand. Tea comprises of tea leaves, milk,
sugar, etc., the demand for all of them taken
together is a joint demand.
COMPOSITE DEMAND
 Many industries demand coal, for ex.,
railways, factories, etc. here the demand for
coal is called composite demand.
ELASTICITY OF DEMAND
 Every demand has elasticity. A small change
in price of a commodity may lead to a big
change in demand. Similarly a big change in
price may not lead to proportionately big
changes in demand. Therefore, it is seen
that goods are either more sensitive or less
sensitive to price changes. The concept of
elasticity of demand measures the
proportionate change in quantity demanded
as a result of proportionate change in price.
CONTD……
 The concept of elasticity of demand refers to
the responsiveness of quantity demanded of
a good to a change in price. It tries to
quantify the relationship between the
demand of the commodity and the price of
the commodity.
EOD VS. LOD
 Elasticity of demand is different from the
Law of demand. The law of demand states
that when the price increases, demand of a
good decreases. But the law does not tell us
to what extent the price changes and to
what extent the demand changes as a result
of change in the prices.
TYPES OF ELASTICITY
1. Elastic demand.
2. Inelastic demand.
3. Unitary elastic demand.
4. Perfectly elastic demand.
5. Perfectly inelastic demand.
ELASTIC DEMAND
 When there is a small change in price and if
there is a big change in demand, this
situation is called elastic demand. For ex.
When there is a 10% change in the price and
because of this there is 40% change in
demand, this phenomenon is known as
elastic demand.
INELASTIC DEMAND
 When there is a big change in price, and as a
result of this there is a little change in
demand, this situation is known as inelastic
demand. For ex. When there is a 50% change
in the price and as a result of this there is
only 10% change in the demand of a product,
this phenomenon is known as inelastic
demand.
UNITARY ELASTIC DEMAND
 When the change in price of a product is
exactly equal to the resultant change in the
demand of the commodity, this situation is
known as unitary elastic demand. For ex.
When price increases by 10% and as a result
the demand decreases by exactly 10%, this
phenomenon is known as unitary elastic
demand.
PERFECTLY ELASTIC DEMAND
 When a small change in price creates a huge
change in demand of a commodity, this
situation is known as a perfectly elastic
demand. For ex. When price increases by 5%
and as a result the demand decreases by
50%, it is a case of perfectly elastic demand.
PERFECTLY INELASTIC DEMAND
 When there is a change in the price of a
commodity but as a result there is no change
in the demand of the commodity, this
situation is known as perfectly inelastic
demand. For ex. When price increases by 10%
but there is no change in the demand of the
product because of this, it indicates
perfectly inelastic demand.
DEMAND FORECASTING
 Demand forecasting means an estimation of
the level of demand that might be realized in
future under given circumstances. By
forecasting demand we intend to making an
objective assessment of the future course of
demand. However in a world of uncertainty
future conditions can never be predicted
accurately. Yet the businessmen needs to
plan and take decisions making the best
possible judgment about future
development. For this purpose demand
forecasting comes handy to us.
TECHNIQUES OF FORECASTING
 The techniques of forecasting methods for
the demand of a product are of two
categories:
1. Survey methods.
2. Statistical methods.
SURVEY METHODS
1. Opinion survey method.
2. Consumer interview method.
3. Complete enumeration method.
4. Sample survey.
5. End use method.
6. Experts opinion survey.
STATISTICAL METHODS
1. Measures of central tendency.
2. Correlation.
3. Regression.
4. Index number.
5. Graphical methods.
CRITERIA FOR A GOOD
FORECASTING METHOD
1. Accuracy.
2. Plausibility.
3. Durability.
4. Flexibility.
5. Availability.
6. Economy.
MEANING OF PRODUCTION
 The factors of production, land, labour,
capital and entrepreneurship are called
factor inputs. When these factors are used in
certain proportions depending upon the
method of production chosen by the firm a
certain quantity of product comes into
existence. This quantity of product known as
output comes out of the process of
production. The technical relationship
between the factor inputs and outputs is
known as production function.
CONCEPT
 Production implies transformation of inputs
the factors bought by a firm into output.
Production is a transformation of physical
inputs into physical output. The functional
relationship between physical inputs and
physical outputs of a firm is called
production function.
HOW TO DETERMINE
PRODUCTION FUNCTION?
 The production function is determined by the
state of technology. When technology
improves, a new production function comes
into being. The new technology has greater
flow of outputs from the same quantity of
inputs or still smaller quantity of inputs.
Algebraically the production function can be
written as:
 Q = F(L,K,D)
 Where L = Labour, K = capital, D = Land
VARIOUS CONCEPTS REGARDING
PRODUCTS
1. Total product: Total product of a factor is
the amount of total output produced by a
given amount of the factor, other factors
held constant.
2. Average product: Average product of a
factor of production is the total output
produced per unit of factor employed.
3. Marginal product: Marginal product of a
factor is the addition to the total
production by the employment of extra unit
of a factor.
THE LAW OF VARIABLE
PROPORTIONS
 The law of variable proportions or non
proportional returns occupies an important
place in the theory of production. It states
how the output behaves in a production
function when one factor input is constant
and the employment of other factor input is
varied.
CONTD…..
 According to samuelson, “an increase in
some inputs relative to other fixed inputs
will in a given state of technology, cause
output to increase; but after a point the
extra output resulting from the same
additions of extra inputs will become less
and less.
CONTD……
 This law examines the production function
with one factor variable, keeping the
quantities of other factors constant, when
the total output or production of a
commodity is increased by adding units of a
variable input. While the quantities of other
inputs are held constant, the increase in
total production becomes after some point
smaller and smaller. This is known as the law
of diminishing returns.
THREE STAGES OF
PRODUCTION
1. 1 stage – increasing returns.
2. 2 stage – constant returns.
3. 3 stage – negative returns.
1 STAGE INCREASING RETURNS
 At this stage average product per man
increases. Marginal product and total product
also increases. At this stage total product to
a point increases at an increasing rate.
2 STAGE CONSTANT RETURNS
 At stage 2, the total product continues to
increase at a diminishing rate until it reaches
the maximum point, where the second stage
ends. At this stage both the marginal product
and the average product are diminishing but
remain positive. At the end of the second
stage, marginal product of the variable
becomes zero. This stage is known as the
stage of diminishing returns as both the
average and marginal products of the
variable factor continuously fall during this
stage.
3 STAGE NEGATIVE RETURNS
 In stage 3, the total product declines and
therefore, the total product curve slopes
downwards. The marginal product of the
variable factor is negative and it goes below
X axis. Hence this stage is called the stage of
negative returns.
THEORY OF COSTS
 Cost analysis is very important for the
business manager because he has to balance
cost against revenue in an optimal manner
with a view to earning a satisfactory level of
profits. The term cost of production may be
used in three different senses; production of
goods and services is possible only at a cost,
the producer will like to minimize his cost
and all costs are not added for accounting
purposes.
DETERMINANTS OF COST
1. Output level.
2. Prices of factors of production.
3. Productivities of factors of production.
4. Technology.
OUTPUT AND COST
 Total cost varies directly with output. The
more output a firm produces, the higher will
be its production cost and vice versa. This is
because increased production requires
increased use of raw materials, labour, etc;
and if the increase is substantial, even fixed
inputs like plant and equipment and
managerial staff have to be increased.
PRODUCTIVITIES OF FACTORS
OF PRODUCTION AND COST
 Productivity of a factor of production means
the contribution of a unit of that factor is
output. The higher the productivity of an
input factor, the smaller the quantum of that
factor, other factors remaining the same,
that one needs, to produce a given output
and vice versa. Thus, production cost varies
inversely with the productivities of factors of
production.
TECHNOLOGY AND COST
 Technology is a significant force underlying
production. Technological progress is
conducive to increased production while
technological stagnation may impede
production. By definition, technological
improvement leads to an increase in the
efficiency or productivity of factors of
production, which in turn, causes a reduction
in production cost. Thus, cost varies
inversely with technological progress.
COST OUTPUT RELATIONS
 A cost output function is a relationship
between the value of production input that
are used by the firm in each period and the
corresponding ratio of the output attained.
The costs are divided into long run costs and
short run costs.
DIFFERENT CONCEPTS OF COST
1. Variable cost: costs incurred by a firm in
connection with the use of variable factors
are called the variable costs in economics.
2. Fixed cost: costs incurred by a firm in
connection with the use of fixed factors are
called fixed cost.
3. Marginal cost: Marginal cost is the addition
made to total cost when one more unit of
the commodity is produced.
CONTD……..
 Opportunity cost or alternative cost: such
costs are cash outflows prevented by taking
one course of action instead of another. They
include returns which the entrepreneur could
have earned in an alternative use of his
services and capital.
 Explicit costs: such costs are those expenses
which are actually paid by the firm. In other
words, these are paid out costs. These
appear in the accounting records of the firm.
CONTD…….
 Implicit costs: such costs are imputed costs.
They are theoretical costs and they are not
recognized by the accounting system.
Imputed costs are defined as costs which are
not actually incurred, but would have been
incurred in the absence of self employment of
owned factors.
 Incremental costs: Incremental cost is the
addition resulting from a change in the level
or nature of business activity like addition of
a new product line, changing the channel of
distribution, etc.
CONTD…….
 Sunk cost: Sunk cost is one which is not
affected or altered by varying the nature or
level of business activity. It will remain the
same whatever the level of activity.
 Past cost: past costs are actual costs incurred
in the past and are generally contained in the
financial accounts. If they are regarded as
excessive, management can indulge in
postmortem, just to find out the factors
responsible for the excessive costs, if any,
without being able to do anything for
reducing them.
CONTD……..
 Future cost: future cost are costs that are
reasonably expected to incur in some future
period or periods. Their actual incurrence is
a forecast and their management is an
estimate.
 Short run cost: short run cost is that vary
with output when fixed plant and capital
equipment remain the same.
 Long run cost: long run cost are which vary
with output when all input factors including
plant and equipment vary.
CONTD……..
 Direct cost: A direct or traceable cost is one,
which can be identified easily and
indisputably with units of operation.
 Indirect cost: indirect costs are those that
are not traceable to any plant, department
or operation or to any individual final
product.
 Controllable cost: The executive may define
a controllable cost as one, which is
reasonably subject to regulation.
MARKET STRUCTURE
 In economics the term market does not refer
to the sale of several commodities. It does
not refer to a place also. In economics
market, refers to the sale or purchase of
single commodity. For ex. Tea market.
 A market in economic terms means:

1. Sale of single commodity.

2. Buyers and sellers for that commodity.
3. Close touch between the buyers and
sellers.
FACTORS DETERMINING THE
STRUCTURE OF A MARKET.
1. Number of firms in a industry.
2. Goods homogeneous or differentiated.
3. Knowledge about market and technology.
4. Freedom of entry into industry and exit
from industry.
OBJECTIVES OF A FIRM
 Profit maximization.
 Sales maximization.
 Utility maximization.
TYPES OF MARKETS
 Under market conditions, two markets are
said to prevail in the economy:
1. Perfect competition.
2. Imperfect competition.

Imperfect competition market has three

types of markets:
3. Monopoly market.
4. Monopolistic market.
5. Oligopoly market.
PERFECT COMPETITION
 Perfect competition is said to prevail where there is a
large number of producers producing a homogeneous
product. The maximum output, which an individual
firm can produce, is relatively very small to the total
demand of the industry product so that a firm cannot
affect the price by varying its supply or output. With
many firms and homogeneous product under perfect
competition no individual firm is in such position to
influence the price of the product and therefore the
demand curve facing it will be a horizontal straight
line at this level of the prevailing price of the
product in the market, that is price elasticity of
demand for a single firm will be infinite.
CHARACTERISTICS
1. Larger number of buyers and sellers and
their size is small.
2. Homogeneous product.
3. Perfect knowledge.
4. Perfect mobility.
5. There is no entry ban on the firms.
6. There is no transport and selling costs in
this market.
7. Equal cost throughout the market.
PRICE DETERMINATION?
 In this market the price of the commodity is
determined by the industry. The industry
determines the price of the commodity at
the point where the market demand and
supply of the commodity becomes equal to
each other.
MONOPOLY
 Monopoly refers to a market situation in
which there is one producer and seller for
the commodity. Monopoly is an extreme form
of market structure.
 Prof. chamberlin points out that monopoly
refers to seller’s control over supply in such
a way so as to create a monopolistic
situation. There is no close substitutes for
the product. Mono means single and poly
means seller. It is a single seller market.
TYPES OF MONOPOLY
 On the basis of ownership:
1. Private monopoly.
2. Public monopoly.
CONTD…..
 On the basis of price differentiation:
1. Simple monopoly.
2. Discriminating monopoly.
CONTD……..
 On the basis of emergence:
1. Natural monopoly.
2. Legal monopoly.
CHARECTERISTICS
1. Single seller and large number of buyers.
2. There is no substitute in the market.
3. Entry ban.
4. Controlled supply.
5. Independent price policy.
6. There is no difference between firm and
industry.
7. Price determination.
8. Abnormal profits.
9. There are no selling costs.
10. Different average and marginal revenue curve.
PRICE DETERMINATION?
 A monopolist determines that price of his
product at which he will get maximum profit.
He will be in equilibrium when he produces
that amount of his product at which his total
profit will be maximum.
MONOPOLISTIC COMPETITION
 The monopolistic market is a market, which
prevails in between the both, perfect
competition and monopoly and has the
elements of both the markets.
 According to Prof. Chemberlin monopolistic
competitive market is a blending of the
elements of perfect competition and
monopoly.
CHARACTERISTICS
1. Large number of sellers.
2. Product differentiation.
3. No entry ban with product differentiation.
4. Importance of selling costs.
5. Group behavior.
PRICE DETERMINATION
 A monopolistic firm faces more problems
than a perfect competitive market. The
equilibrium of a monopolistic firm depends
upon three areas or we can say that in this
market the firm has to take the following
three decisions:
1. Price decision.
2. About the production quantity.
3. Advertisement costs.
CONCEPT OF SUPPLY
 Supply is the willingness and ability of
producers to make a specific quantity of
output available to consumers at a particular
price over a given period of time.
 Individuals control the inputs, or resources,
necessary to produce goods. And hence, in
one sense, supply is the mirror image of
demand.
LAW OF SUPPLY
 Supply refers to the various quantities
offered for sale at various prices. According
to the Law of Supply, more of a good will be
supplied the higher its price, other things
constant or less or less of a good will be
supplied the lower its price, other things
remaining constant.
MARKET SUPPLY
 As with market demand, market supply is the
summation of all individual supplies at a
given price. The market supply curve is the
horizontal sum of the individual supply
curve.
MONETARY POLICY
 Monetary policy is an important aspect of
overall macro economic policy. To influence
economic conditions or to achieve economic
objectives, monetary authorities employ
various techniques.
 Monetary policy can be defined as the
deliberate effort by the central bank to
influence economic activity by variations in
the money supply, in availability of credit or
in the interest rates consistent with specific
national objectives.
OBJECTIVES OF MONETARY
POLICY
1. Price stability.
2. Exchange stability.
3. Full employment.
4. Maximum output.
5. High rate of growth.
INSTRUMENTS OF MONETARY
POLICY
1. Open market operation.
2. Bank rate policy.
3. Reserve requirement changes.
4. Selective credit controls.
OPEN MARKET OPERATIONS
 Open market operations refer to the buying
or selling of securities by the central bank.
Buying and selling of securities by the central
bank affects directly the money supply in
circulation and commercial banks cash
reserves. When the central bank sells
securities, it reduces the quantity of money
and credit as well. when the central bank
follows an expansionary monetary policy, it
buys securities from the market. This
increases money in circulation and banks
cash reserves.
BANK RATE POLICY
 Bank rate policy is one of the oldest methods
of credit control. The bank rate is the rate of
interest at which the central bank
rediscounts approved bills of exchange. This
policy is based on the assumption that
market rates change in response to the bank
rates. This relationship between the bank
rate and market rate exists only in developed
money markets.
RESERVE REQUIREMENT
CHANGES
 The central bank stipulates the statutory
limits of cash reserve requirements for
commercial banks. It asks banks to maintain
a minimum percentage of their deposits as
reserves. When reserve requirements are
increased, the amount of demand deposits
that banking system can support will be
reduced and which in turn, reduces the
money supply or vice versa.
SELECTIVE CREDIT CONTROL
 Selective credit controls are qualitative methods
to regulate credit. They are different from
quantitative methods of monetary management
because they are directed towards particular uses
of credit rather than the total volume of credit
outstanding.
 Various selective credit control methods are:

1. Rationing of credit.
2. Direct action.
3. Changes in the margin requirement.
4. Regulation of consumer credit.
5. Moral suasion.
PROBLEMS IN MONETARY
POLICY
1. Lags in monetary policy.
2. Pressure of financial intermediaries.
3. Contradictions in objectives.
4. Underdeveloped nature of money and
capital markets.
FISCAL POLICY
 Fiscal policy involves designing the tax
structure, determining tax revenue and
handling public expenditure in such a way
that the objective of full employment is
achieved. It seeks to do this by maintaining
an equilibrium between the effective
demand and supply of goods and regulating
public expenditure and revenue. Fiscal policy
can be used to minimize the effects of
business cycles and to maintain stable price
levels.
OBJECTIVES OF FISCAL POLICY
1. Mobilization of resources.
2. Economic development and growth.
3. Reduction of disparities of income.
4. Expansion of employment.
5. Price stability.
CONSTITUENTS OF FISCAL
POLICY
1. Public expenditure.
2. Taxation.
3. Public borrowing.
PUBLIC EXPENDITURE
 The emergence of welfare states that were
set up with the aim of promoting socio
economic welfare has led to an increase in
government spending. Other factors that
have contributed to the growth of public
expenditure are:
1. Rising defense expenditure.
2. Rise in price level.
3. Economic planning.
4. Basic infrastructure.
5. Population growth.
TAXATION
 Taxation is the most important source of
government revenue for both developed and
developing countries. The tax structure
should be designed in such a way that the
government can raise the maximum revenue
without affecting investment in the private
sector.
PUBLIC BORROWING
 After taxes, public borrowing is the next
important source of revenue for the
government. Public borrowing is different
from taxes in the sense that all borrowings
from the public have to be repaid. Public
borrowing is a common tool for mobilizing
resources in developing countries.
LIMITATIONS OF FISCAL POLICY
1. Lags in fiscal policy.
2. Problems in tax policy.
3. Burden of public debt.
LINK BETWEEN FP AND MP
 Fiscal policy is an important instrument in
the hands of the government to meet its
financial requirements and relates to the
management of finance by the government.
Monetary policy, on the other hand, refers to
the policies pursued by the RBI to regulate
the growth of money and credit in the
economy.
CONTD………
 However, the two policies are
interdependent that fiscal policies of the
government determine the directions of the
monetary policy and the fiscal policies have
to be devised depending on the monetary
control required.
INFLATION
 Inflation refers to the rate of change in the
overall price level of goods and services that
we typically consume.
 Inflation is good for investment, because the
burden of loan repayment is reduced. For
ex., a company that borrows Rs.100 crore
today will repay only Rs.78 crore in real
terms at the end of five years, if the rate of
inflation is 5%.
SOURCES OF INFLATION
 There are two sources of inflation:
1. Demand pull inflation.
2. Cost push inflation.
DEMAND PULL INFLATION
 Demand pull inflation is caused due to
excessive demand for goods and services.
When aggregate demand increases, the price
level also simultaneously moves up.
COST PUSH INFLATION
 Cost push inflation results from an increase
in the cost of factors of production or a
decrease in the supply of goods with demand
remaining the same.
TYPES OF INFLATION
 Depending on the rate at which prices which,
inflation is classified into three categories:
1. Creeping inflation.
2. Running inflation.
3. Galloping inflation.
CREEPING INFLATION
 When the increase is small or gradual, it is
called creeping inflation. Creeping inflation
leads to a small increase in prices, which
induces investment in the economy.
RUNNING INFLATION
 If creeping inflation continues for a long
period of time without any monetary or fiscal
control, it may lead to running inflation.
Price will then increase at 8% to 10% per
annum.
HYPER OR GALLOPING
INFLATION
 If running inflation is not controlled, it may reduce
savings in the economy and become a hindrance in
the future for the economic growth. When monetary
authorities completely lose control over running
inflation, it will lead to galloping inflation. When
inflation reaches double or triple digit figures, it is
called galloping inflation. In galloping inflation,
people expect the price to rise and so spend all
their money quickly so that they can consume to the
maximum extent possible. They believe that the
purchasing power of the money they are having will
fall further soon. This increases the velocity of
circulation of money in the economy.
MEASURES TO CONTROL
INFLATION
 Inflation usually adversely affects helpless
people and disturbs the social, political and
economical equilibrium. Hence it need to be
controlled.
 Inflation can be controlled through an
integrated set of measures which may be
classified as:
1. Monetary measures.
2. Fiscal measures.
3. Other measures.
MONETARY MEASURES
1. Quantitative credit control measures can
be in the form of bank rate policy, open
market operations and variable reserve
ratio to influence the cost and availability
of credit in an economy.
2. Qualitative control measures includes all
those methods which can be used to
regulate the consumer credit. Credit
facilities can be curbed by raising down
payment requirements or reducing the
payment periods.
CONTD……..
 The various other methods that can be
adopted to contain inflation are as under:
1. To check money supply.
2. To raise the interest rates.
3. Credit control.
4. Demonetization of old currency.
FISCAL MEASURES
1. Public expenditure.
2. Taxation.
3. Public borrowing and debt.
OTHER MEASURES
1. Price control.
2. Credit rationing.
3. Wage policy.
EXCHANGE RATE POLICY
 When countries of the world trade with each
other, the transactions are made through
foreign exchange. Foreign exchange is any
currency issued by a foreign government. It
is used to pay for imported goods and to
meet foreign debt repayment obligations. In
a foreign exchange market, individuals,
banks and other institution trade in
currencies.
OBJECTIVE
 The principal purpose of the foreign
exchange market is to transfer funds of a
particular currency and nation to another.
This is done mainly through commercial
banks which act as clearing houses by buying
and selling foreign currencies.
TYPES OF EXCHANGE RATE
SYSTEM
 Exchange rate means the price of one
currency in terms of another. Exchange rates
are either fixed by the government or
determined by the market forces. The two
basic exchange rate regimes are the fixed
exchange rate and the floating exchange rate
systems.
CONTD………
 Further based on the level of intervention by
the central bank of the country in
maintaining currency value, exchange rate
regimes can be classified into:
1. Fixed rate: The government fixes the
exchange rate, called the parity rate and
defends it.
2. Hard peg: It is a permanently fixed rate
and the government has no plan to change
it.
3. Adjustable peg: Rates are periodically
adjusted.
CONTD……..
 4. Soft peg: High frequency pegging such as
day to day dollar pegging or week to week
pegging.
 5. Low frequency pegging: Here the
frequency of pegging is month to month or
quarter to quarter pegging.
TRADE CYCLES
 History shows that the economics do not
grow in an uniform pattern. There may be
several years of economic growth followed
by a recession and in some cases even a
prolonged depression. In course of time, the
economy recovers and if the recovery is very
strong it may lead to a boom. This would be
followed by another slump in the economy.
And thus the cycle continues………
CONCEPT
 A business cycle is a swing in total national output,
income and employment. It usually has two phases:
1. Recession.
2. Expansion.
It is difficult to predict the duration and timing
of business cycles. During expansion, production
increases in all sectors of the economy and so do
the employment opportunities. some of the
factors that come into play during expansion
leads to recession. The general rise in costs
relative to prices is an important factor leading to
recession.
CONTD…….
 Recession ultimately leads to depression and
there is substantial fall in the production of
goods and services and the level of
employment.
 During recovery, there will be more
employment opportunities and income will
go up which in turn will lead to more demand
for goods and service. There will be an
upward movement in the price, thus
encouraging investment and growth in the
economy.
PHASES OF BUSINESS CYCLES
 According to Joseph schumpeter, there are
four stages in a business cycle:
1. Prosperity.
2. Recession.
3. Depression.
4. Recovery.
PROSPERITY
 Prosperity is also known as expansion. During
this stage, production increases in all sectors
of the economy. As a result of increased
production, employment opportunities
increases. This in turn, increases the
purchasing power of the people.
RECESSION
 Recession in the economy will lead to
liquidation of bank loans, fall in prices,
decline in the demand for cancellation of
new projects. Initially, the demand for
consumer goods will remain the same, but
slowly it will diminish. The most visible sign
of the advent of recession is the weakening
of the stock market.
DEPRESSION
 Recovery ultimately leads to depression.
When the economy moves towards
depression, there will be a substantial fall in
the production of goods and services and
level of employment. The effect of
depression are felt most in manufacturing,
mining and construction sectors. Moreover,
the price level will fall despite the fall in the
output of goods and services.
RECOVERY
 In recovery, there is a tendency in the
economy to move towards normal price.
During recovery the first step is to stop the
fall in the price level. During a period of
depression, all inventories are exhausted,
due to lack of demand; but inventories have
to be replenished.
THEORIES OF BUSINESS CYCLES
1. Multiplier Accelerator Theory.
2. Demand induced cycles.
3. Fiscal and monetary policies.
ECONOMIC GROWTH
 According to Samuelson, ‘Economic growth
represents the expansion of a country’s
potential GDP or national output
 Economic growth can be measured as an
increase in the economy’s output. Economic
growth could be measured in terms of
change in GDP/GNP.
DETERMINANTS OF ECONOMIC
GROWTH
 Economic growth is in general attributed to
the following four factors:
1. Natural resources.
2. Human resources.
3. Capital formation.
4. Technology.
ECONOMIC DEVELOPMENT
 Economic development is a broad term which
consider various aspects relating to the
structure of the economy, social attitudes,
cultural set up, techniques of production and
institutional frame work along with the real
output or per capita income of the economy.