Fundamentals of Banking Awareness and Economics aéCL |???Contents 1. 10. 11. Financial Terms Indian Economic Development Basics of Economy Different Important Concepts of Economics Important International Institutions Important Different Laws, Theories and Graphs of Economics Contemporary Economic Terms Important Indian Financial Institutions Inflation Foreign Trade-Principles and Beliefs Indian Security Market 01 17 31 33 44 47 53 56 62 71 80Financial Terms Dear Aspirants, ln Examinations generally questions are asked about economic terms. The understanding of economic terms is a must for not only the written part of the examination butalso from interview's perspective. Here is the collection of some very important terms from examination’s perspective. Let us understand and explore them in detail (A) Basic Economic Terms 1. Capitalist Economy: A system of economies based on the private ownership of capital and production inputs, and on the production of goods and services for profit. The production of goods and services is based on supply and demand in the general market (market economy), rather than through central planning (planned economy). Socialist Economy: In a socialist economy, production involves the goal of creating useful services of goods of value. Such economic systems typically employ central planning and use accounting systems based on the labor hours expended in production. Mixed Economy: Itis the mixed form of socialistic and capitalistic economy. Certain economic activities are fully owned and controlled by the government but all the economic activities are not owned by the Government, Private and public sector both co-exist in the economy. In India, there is mixed economy system, National income at current prices and constant prices (nominal and real prices): National income is the money value of an economy's activities, So, national income can be measure at current year prices of constant year prices. National income at current or nominal year prices refers to measure the value of an economy's activities on the basis of the price which is ongoing time National income at factor cost and market prices: The value of an economies output can be measured at market prices and factor costs also. Taxes increase the prices of commodities and subsidies minimize the prices of commodities National income at factor cost = national income at market prices — net indirect taxes + subsidies Gross National Product (GNP): Gross National Product (GNP) is the market value of all final goods and services produced by a country during a one year period, The GNP includes the value of output produced in abroad. Further the value of depreciation is also included in GNP. We can derive GNP by using the following formula GNP = GDP + Net Factor Income from Abroad GNP Deflator: GNP Deflator is a important concept in macro economies to measure the general price level in an economy. GNP defiator is the ratio of nominal GNP and real GNP. ie, GNP deflator = Nominal GNP /Real GNP Fundamentals of PDP Page 1 Banking Awareness and a€CL | Economics10. 11. 12. 13, 14. 15. 16. Net National Product (NNP): NP is the total value of all the final goods and services produced bya country during a specified period excluding depreciation. So, NNP can be derived from GNP by deducting depreciation. Mathematically, NNP = GNP — Depreciation Gross Domestic Product (GDP): GOP is the total money value ofall final goods and services produced within the domestic territory of a country in a year. The contribution of foreigners to the production or output also included in GDP. Difference between GDP and GNP: GDP Refers tothe domestic output and GNP mean the output of a country produced irrespective of domestic or foreign country. The major difference between GDP and GNP is foreign factor, ie., the Net Factor Income from Abroad. Net Domestic Product (NDP): NDP is the total money value ofall the final goods and services produced within the domestic territory of a country during a specified period excluding the amount of depreciation. So, NDP = GDP —Depreciation Green GNP: Green GNP is one of the new concept in Macro Economies related to the concept of national income accounting, There is a possibility of reducing the value of GNP due to many things like environmental pollution, natural calarnities ete, Such kind of events will badly effect an economy and reduce the actual value of the final output. So, we can derive Green GNP by reducing these kind of losses from GNP. GDP Defiator: GOP deflator (implicit price deflator) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. GDP deflator is a measure of price infiation/deflation with respect to a specific base year; the GDP deflator of the base year itself is equal to 100 Poverty Line: Below Poverty Line is an economie benchmark and poverty threshold used by the government of India to indicate economic disadvantage and to identify individuals and households in need of government assistance and aid. itis determined using various parameters which vary from state to state and within states. The criteria for poverty estimation by the government is calorie intake perday for rural area itis 2400 calories per day (for rural areas) and it is 2100 calories per day (for urban area). Purchasing Power Parity: Purchasing power parity (PPP) isa theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. Types of Income: (i) Income: income is the consumption and savings opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms However, for households and individuals, “income is the sum of all the wages, salaries, profits, interests’ payments, rents, and other forms of earnings received ina given period of time.” (ii) Per Capita Income: Per Capita Income is the average income of people of a country in a particular period. It can be calculated by dividing the national income of the country by total population. Mathematically, Per Capita Income = national income / population Page 2 CL | PDP Fundamentals of Banking Awareness and Economics17. 18. 19. (iii) Private Income: Private Income refers to the income earned by individuals and other private corporates from their economic and non-economic activities irrespective of domestic territory oF foreign territory. So, transfer payments like scholarships, pensions ete. included in Private Income (iv) Personal Income: Personal Income is the income received by individuals of a country from all the sources. It can be calculated using the following formula Personal Income = Private Income — undistributed profits — profit taxes (v) Personal Disposable Income: Personal Disposable Income is the amount of income of individuals which can spend for consumption and savings. Individuals can spend their incorne only after the payment of direct taxes, So, Personal Disposable Income can be arrived by sing the following formula Personal Disposable Income = Personal Income — Direct Taxes Giffin goods: In economics and consumer theory, a Giffen good is a product that people consume more of asthe price rises violating the law of demand, A Giffen good has an upward-sloping demand curve, which is contrary to the fundamental law of demand which states that quantity demanded for a product falls as the price increases, resulting in a downward slope for the demand curve Depreciation: The monetary value of an asset decreases over time due to use, wear and tear or obsolescence, This decrease is measured as depreciation, Depreciation, ie a decrease in an asset's value, may be caused by a number of other factors as well such’as unfavorable market conditions, etc, Machinery, equipment, currency are some examples of assets that are likely to depreciate over a specific period of time. Opposite of depreciation is appreciation which is increase inthe value of an asset over a period of time Devaluation: Devaluation means official lowering of the value of acountry’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect toa foreign reference currency. Budget Terms: The basic architecture of the budget — (i) ANNUAL FINANCIAL STATEMENT: The ordinary man confuses the finance minister's budget speech for the annual budget. But as laid down in the constitution, the budget actually refers to the efinual financial statement tabled in Parliament along with the 13-15 other documents. Divided into three parts — Consolidated Fund, Contingency Fund and Public Account —it has a statement of receipts and expenciture of each. (ii) CONSOLIDATED FUND: This is the core of the government's finances. All revenues, money borrowed and receipts from loans it has given flow into this account. All government expenditure 's made from this fund, Any expenditure from this fund requires the nod of Parliament. (iil) CONTINGENCY FUND: All urgent or unforeseen expenditure is met from this %500-crore fund, which is at the disposal of the President. Any amount withdrawn from this fund is made good from the Consolidated Fund, (iv) PUBLIC ACCOUNT: All money in this fund belongs to others, such as public provident fund The government is merely working as a banker in respect of this fund (v) REVENUE RECEIPT/EXPENDITURE: All receipts like taxes and expenditure like salaries, subsidies and interest payments that do not entail sale or creation of assets fall under the revenue account Fundamentals of PDP Page 3 Banking Awareness and a€CL | Economics(vi) CAPITAL RECEIPT/EXPENDITURE: Capital account shows all receipts from liquidating (eg. selling shares in a public sector company) of assets and spending to create assets, (lending to receive interest). REVENUE VS CAPITAL: The budget has to distinguish all receipts/expenditure on revenue account from other expenditure. So all receipts in, say, the consolidated fund, are split into Revenue Budget (revenue account) and Capital Budget (capital account), which include non- revenue receipts and expenditure REVENUE/CAPITAL BUDGET: The government hasto prepare a Revenue Budget (detailing revenue receipts and revenue expenditure) and a Capital Budget (capital receipts & capital expenditure) wi Different types of Deficits (ix) Budget Deficit: When government expenditure exceeds government receipts in the budget is seid to be a deficit budget (x) Revenue Deficit: Revenue deficit refersto the excess of revenue expenditure of the government over its revenue receipts. Revenue deficit = Total revenue expenciture Total revenue receipts Fiscal Deficit: This is the gap between the government's total spending and the sum of its revenue receipts and non-debt capital receipts. It represents the total amount of borrowed funds required by the governmentto completely meet its expenditure itis also expressed as defined as excess of total expenditure over total receipts excluding borrowings. Fiscal Deficit = Total budget expenditure — Total budget receipts net of borrowings Fiscal deficitis a measure of total borrowings required by the government. Greater fiscal deficit implies, greater borrowings by the government. This creates a large burden of interst payments in the future that leads to increase in revenue expenditure, causing an increase in revenue deficit. Thus a vicious citcle sets in. In the present, a large fiscal deficit may also lead to inflationary pressures. (xii) Primary Deficit: Primary deficit is defined as fiscal deficit minus interest payment. it is equal to'fiscal deficit reduced by interest payment. Primary deficit = Fiscal deficit = interest payment (xi 24. Treasury Bills: Treasury bills (T-bills) offer short-term investment opportunities, generally up to one year. They are thus useful in managing short-term liquidity. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments, Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. Treasury bills are issued at a discount and are redeemed at per. Treasury bills are also issued under the Market Stabilization Scheme (MSS), 22, Subsidy: A subsidy isa form of financial aid or support extended to an economic sector (or institution, business, or individual) generally with the airn of promoting economic and social policy. 23. Public Debt: Government debt (also known es public debt, national debt and sovereign debtjis the debt owed by a central government. By contrast, the annual “government deficit" refers to the difference between government receipts and spending ina single year, thatis, the increase of debt over a particular year. Page PDP Fundamentals of aCL | Banking Awareness and Economics1. Balance of payment account: Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. Fiscal policy: Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. Forfeiting: In trade finance, forfaiting is a financial transaction involving the purchase of receivables from exporters by a forfaiter. The forfaiter takes on all the risks associated with the receivables but eams a margin. The forfaiter may also be immunized from certain risks if the transaction involves payment by negotiable instrument Capital account convertibility (CAC): Capital account convertibility is a feature of a nation’s financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely and at country determined exchange rates. Itis sometimes referred to as capital asset liberation or CAC. Current account convertibility: Current account convertibility allows free inflows and outfiows for all purposes other than for capital purposes such as investments and loans, In other words, it allows residents to make and receive trade-related payments — receive dollars (or any other foreign currency) for export of goods and services and pay dollars for import of goods and services, make sundry remittances, access foreign currency for travel, studies abroad, medical treatment and gifts, etc, External debt: External debt (or foreign deb!) is the total debt @ country owes to foreign creditors, The debtors can be the government, corporations or citizens of that country. The debt includes money owed to private commercial banks, other governments, or international financial institutions such as the International Monetary Fund (IMF) and World Bank. Debt service ratio: Debt service ratio is the ratio of debt service payments (principal + interest) of a country to that country’s export earnings. A country's international finances are healthier when this ratio is low. Deficit financing: When the budget deficit is financed by borrowing from the public and banks, itis called deficit financing. Deficit financing refers to the borrowing undertaken by the government to make up forthe revenue shortall Taxation: Terms (A) Direct Taxes: This tax is paid directly by a person or organization to the emposing authority therefore, is called direct tax. Different types of direct taxes are as follows: (i) Income tax: Personal income tax is levied by Central Goverment and is administered by Central Board of Direct taxes under Ministry of Finance in accordance with the provisions of the Income Tax Act Taxation of individuals is determined by their residential status. An individual is resident if he stays in India in the fiscal year (April 1 to March 31) either: * for 182 days or more, or * for 60days or more (182 days or more for NRIs) and has been in India in aggregate for 365 days or more in the previous four years. An individual who does not satisty either of these requirements is a ‘non-resident’, A resident individual is considered to be ‘ordinarily resident’ in any fiscal year if he has been Fundamentals of PDP Page 5 Banking Awareness and a€CL | Economicsresident in India for nine out of the previous ten years and, inacdition, has been in India for a total of 730 days or more in the previous seven years. Residents who do not satisfy these conditions are called individuals ‘not ordinarily residert’ (ii) Withholding Tax: A withholding tax, also called a retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. (iii) Corporate Tax: It is the tax paid by the corporates to the Govt. of India. The taxabilty of a company's income depends on its domicile, Indian companies are taxable in India ‘on their worldwide income. Foreign companies are taxable on inoome that arises out of their Indian operations (iv) Minimum Alternative Tax (MAT): MAT stands for Minimum Altemate Tax, as per Income tax Act, 1962. itis applicable to Companies and Firms/LLPs. There were large number of companies who had book profits as per their profitand loss account but were not paying any tax because income computed as per provisions of the income tax act was either nil or negative or insignificant, In such case, although the companies were showing book profits and declaring dividends to the shareholders, they were nat paying any income tax These companies are popularly known as Zero Tax companies. In order to bring such companies under the income tax act net MAT was introduced wef assessment year 1997-98. (v)_ Fringe Benefit Tax (FBT): Fringe Benefit Tax (FBT) is ah additional inoome tax payable by the employers on value of fringe benefits provided or deemed to have been provided to the employees. The FBT is payable by an employer who is a company; a firm; an association of persons excluding trusts/a body of individuals; @ local authority etc, This tax is payable even where employer does not otherwise have taxable income. Fringe Benefits are defined as any privilege, service, facility or amenity directly or indirectly provided by an employerto his employees (inolucing former employees) by reason of their employment and includes expenses or payments on certain specified heads. (vi). Dividend Distribution Tax (DDT): Under income Tax Act, any amount declared, distributed or paid by a domestic company by way of dividend shall be chargeable to dividend tax Only a domestic company (not a foreign company) is liable for the tax. Tax on distributed ptofit is in addition to income tax chargeable in respect of total income. (vii) Securities Transaction Tax (STT): Securities Transaction Tax or turnover tax, as is generally. known, is a tax that is leviable on taxable securities transaction, Itis a tax on the value of all the transactions of purchase of securities that take place in a recoghized Stock Exchange of India, It is meant to make up revenue loss from the abolition of long term capital gains tax (viii) Wealth Tax: Wealth tax is a direct tax, which is levied on the net wealth of the assessee Itisa tax on the benefits derived from ownership of property, (ix) Capital Gains Tax: Capital gain means the profit eamed from sale of capital assets (Capital assets are investments such as stocks, mutual funds, bonds, real estate, precious metals, coins, fine art, and other collectibles ). The taxes imposed by income tax department on capital gain are called as capital gain tax. (®) Indirect Taxes: These are basically those taxes that are bore by the consumer & they inorease the price of the goods. Page e PDP Fundamentals of aCL | Banking Awareness and Economics(i) Sales tax: Sales taxis levied on the sale of a commodity which is produced or imported and sold for the first time. If the product is sold subsequently without being processed further, it is exempt from sales tax. Sales tax is levied by either the Central or the State Government. Central Sales tax is generally levied on the sale of all goods by a dealer in the course of inter-state trade or commerce or, outside a state or, in the course of import into or, export from India State sales taxes, that apply on sales made within.a State. Sales tax is also charged on works contracts in most States and the value of contracts subject to tax and the tax rate vary from State to State. However, exports ahd services are exempt from sales tax (ii) Value Added Tax (VAT): VAT is a multi-stage tax on goods that is levied across various stages of production and supply with credit given for tax paid at each stage of Value adkition Sales tax charged on the sales of movable goods has been replaced with VAT in most of the Indian states since 2005. This was introduced to counter the rampant double taxation issues and resultant cascading tax burden that occurred due to the flaws inherent in the previous sales tax system, VAT, chargeable only on goods and does not include services, is levied on value addition at each stage of transaction in the supply chain. The term ‘value addition’ implies the increase in value of goods and services at each stage of production or transfer of goods and services. VAT is atax onthe final consumption of goods or services ands ultimately borne by the consumer. VAT comes under the state list: Tax payers can claim credit for the taxes paid at earlier stages and purchases known as Input Tax Credit, by producing relevant tax invoices. The oredit can be used to setoff any VAT tax liability (iii) Excise Duty: The central government levies excise duty under the Central Excise Act of 1944 and the Central Excise Tariff Act of 1985. Central Excise duty is an indirect tax levied on goods manufactured in India and meant for domestic consumption. (iv) Customs Duty: Custom or import duties are levied by the Central Governmentof India on the goods imported into India. The rate at which customs duty is leviable on the goods depends on the classification of the goods determined under the Customs Tarif. (v) Service Tax: Service Tax isa tax imposed by Government of India on services provided in India. The service provider collects the tax and pays to the government. It is charged ‘on all services except the services in the negative list of services, There has been a steady increase in the rate of service tax. At present itis 14%. (as on July 31) (vi) Expenditure tax: Any expense incurred in luxury hotels is subject to expenditure tax. The expenditure tax is 10 per cent of all payments made to luxury hotels. (vii) Gift tax: Gift tax is levied on the donor at 30 per cent of the aggregate value of taxable gifts in a tax year. Gifts up to ‘30,000 ina tax year are exempt from gifttax. However, gifts to dependent relatives at the time of marriage are exempt upto 100,000, Foreign nationals ate exempt from gift tax on non-Indian assets. Stamp Duty: Its a tax that is levied on the transaction perforrned by means of a document or instrument as per the regulations of Indian Stamp Act, 1899. It is collected by the government of the state where the transaction is carried out, Stamp duty rates vary between the states, wi Fundamentals of PDP Page 7 Banking Awareness and a€CL | Economics33. Tax Haven: A country that offers foreign individuals and businesses little or no tax liability in a politically and economically stable environment. Tax havens also provide little orno financiallinformation to foreign tax authorities. Individuals and businesses that do not reside a tax haven can take advantage of these countries’ tax regimes to avoid paying taxes in their home countries. Tax havens do not require that an individual reside in or a business operate out of that country in order to benefit from its tax policies. The Bahamas, Belize, Bermuda, the Bntish Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Istands, Hong Kong, the Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, Switzerland and St. Kitts and Nevis are all considered tax havens, 34. Other Taxes in India: Taxes can also be categorized as either regressive, proportional, or progressive, and the distinction has to do with the behavior of the tax as the taxable base (such as a household's income or a business profit) changes: (i) _ Progressive tax: Progressive tax functions of the principle of increasing rates of taxation with every increase in income. So, ifone hand) if the taxation rates rises with the increase in income, it is known as progressive taxation, Examples of progressive taxes are Wealth tax, Estate duty, Gift tax and Income tax. (ii) Proportional Tax: Irrespective of the size of the income the same rate of taxation is levied Under Proportional taxation, people from all income groups have to pay the same percentage of their revenue as tax, Examples of proportional taxes here in India are commodity taxes such as- Union excises, custom dties and sales tax Regressive Tax: A tax is understoadito be regressive when its load falls more seriously on the underprivileged than on the wealthy. Itis the just the contradiction of a progressive tax. No educated management obliges a tax in which, as revenue augments, the rate of taxation is lessened. That would be obviously unfair. But there are more than a few taxes on goods whose load rests chiefly on the underprivileged. The Indian salt tax was considered as a regressive tax, as it pushed more seriously on the underprivileged than on the prosperous (iv) Specific duties and Ad-valorem duties: Specific duties are based on specific characteristics or measures or qualities of goods. Ad-valorem duties are base on the value of goods. Specific duties are levied on the basis of physical attributes like length, weight, volume, ete,, of the commodities. Specific duties are simple, easy to estimate and administer. As a result, most of the goods wete taxed on the basis of specific duties till recently. The Latin word 'Advalorem’ means ‘according to value’. Advalorem duty is @ duty expressed as percentage of the value of the commodity. Itisleviedon the value of the goods. Advalorem duties result in higher tax revenue with increase in volume as well as price of goods, (W) Tobin Tax: Tobin taxes are levied on currency trades across borders. The “Tobin tax’ was originally proposedin the early 1970s by James Tobin, an influential American macroeconomist and recipient of the Nobel prize for economics. His idea was prompted by the collapse of the Bretton Woods system in 1971, which replaced an arrangement of fixed exchange rates ultimately based on the US dollar's peg to gold witha period of volatile floating exchange rates. (vi) Banking Cash Transaction Tax (BCTT): The Finance Act 2005 introducedtthe Banking Cash Transaction Tax (BCTT) we. June 1,2005 andapplies to the whole of India except in the state of Jammu and Kashrnir. This tax is considered to be an extremely useful tool to track unaccounted monies and trace their source and destination. It has led the Income Tax Department to many money laundering and hawala transactions. Paige 8 PDP Fundamentals of aCL | Banking Awareness and Economics37. (vil) Goods and Services Tax(GST): Goods and Services Tax — GST — is a comprehensive tax levy on manufacture, sale and consumption of goods and services at a national level. Through a tax credit mechanism, this tax is collected on value-added goods and services at each stage of sale or purchase in the supply chain. This system allows the set-off of GST paid on the procurement of goods and services against the GST which is payable on the supply of goods of services, However, the end consumer bears this tax as he is the last person in the supply chain. The GST is expected to replace all the indirect taxes in India, which is important for SMEs who pay indirect taxes as buyers of goods and services, and file returns on them as sellers. India is planning to implement a dual GST system in which Central Goods and Services Tax (CGST) anda State Goods and Services Tax(SGST) willbe levied on the taxable value of a transaction. It will not be an additional tax. CGST will include central excise duty (Cenvat), service tax, and additional duties of customs at the central level and value-added tax, central sales tax, entertainment tax, luxury tax, octroi, lottery taxes, electricity duty, state surcharges related! to supply of goods and services and purchase tax at the State level. The rate is expected around 14-16 per cent. After the total GST rate is arrived at, the States and the Centre will decide on the CGST and SGST rates. General Anti-Avoidance Rule (GAAR): General Anti-Avoidance Rule (GAAR) is an anti-tax avoidance regulation of India. It was considered controversial because it had provisions to seek taxes from past overseas deals involving local assets retrospectly. ESOP ( Employees Stock option Plan): Employee Stock Option Plan(ESOP), is a plan through which a company awards Stock Options to the employees based on their performance, Under an ESOP, the employees have right to buy the shares of the company on a predetermined date at a predetermined price. The objective of ESOP is to motivate the employees to perform better and improve shareholders’ value. Inflation and its types: Inflation: Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. In other words, Inflation is a state in which the value of money is falling and prices are rising, Two basiéltypes of inflation based on the causes are as follows (i) Demand-Pull; in the case of demand-pull, inflation is caused by aggregate demand being more than the available supply. Aggregate demand is made up of consumer spending, investments, government spending, and whatever is left after subtracting imports from exports. Factors that commonly lead to demand-pull inflation include a sudden increase in the amount of money inanieconomy and decreases intaxes on goods, which leaves consumers with more disposable income, Since people have more money to spend, manufacturers raise the general prices of goods and services. ‘Another common cause of demand-pull situationsis en increase in consumer spending because of increased optimism caused by @ boom in the economy. When people are more confident about their financial future, they tend to spend more, contributing to a rise in prices. A dip in curreney exchange rates can lead to an increase in the value of imported goods, while causing a reduction in the value of exports. When this happens, prices in the local market will go up as importers and manufacturers transfer the cost to local consumers, causing the price of goods to increase. Fundamentals of PDP Page 9 Banking Awareness and a€CL | Economicsa. 8 £ (ii) Cost-Push: Cost-push inflation occurs when manufacturers and businesses raise prices as a result of shortages, or asa measure to balance other increases in production costs, Anexample of this is rising labor costs. When workers demand wage increases, companies usually pass on these costs to their customers. An increase in the taxes imposed on goods may lead to a cost-push situation as well, since suppliers transfer the costs to consumers. This also often happens when one or several companies has a monopoly inthe market, and decides to raise their prices above demand to increase their profit. Measures of Inflation (i) Wholesale price indexes (WPIs): This index measures and tracks the changes in price of goods in the stages before the retail level. Wholesale price indexes (WPls) is reported monthly to show the average price changes of goods sold in bulk) and they are indicators to show economic growth in the economy. Latest revision of WPI has been done bby shifting base year from 1993-94 to 2004-05 on the recommendations of the Working Group set, upwith Prof Abhijit Sen,, Member, Planning Commission as Chairman for revision of WPI series, This new series with base year 2004-05 has been launched on 14th September, 2010. (ii) Consumer Price Index (GPI) : This is the most commonly used index for measuring infiation itis designed to measure changes in the prices of goods and services typioally purchased by an urban consumer, $0 it isalso known as a cost-of-living index (iii) Producer's Price Indexes (PPI) are similar to the CPI, except that they measure the prices of raw materials, intermediate goods, or final goods used by producers instead of consumers Increases in the PPI often precede increases in the CPI, as producers pass price increases along to consumers. Deflation: Deflation is defined as occurring "when prides are deciining over time. Thisisthe opposite of inflation, When the inflation rate (by some measure) is negative, the economy is in a deflationary period. Moreover, it is termed as “A general deciine in prices whichis often caused by a reduction in the supply of money or credit. Disinflation: A slowing in the rate of price inflation. Disinflation is used to describe instances when the inflation rate has reduced marginally over the short term. Disinfiation is commonly used to describe situations of slowing inflation. Reflation: Reflation is an economic term referring to stimulating measures taken to lessen or stop the effects of deflation: Reflationary measures could be comprised of consist of fiscal policy (lowering taxes) or monetary policy (changing money supply or lowering interest rates) Stagflation: In economics, stagflation isa situation in which the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. It raises a dilemma for economic policy, since actions designed to lower inflation may exacerbate unemployment, and vice versa. Core Inflation: Core inflation eliminates products that can have temporary price shocks because these shocks can diverge from the overall trend of inflation and give a false measure of inflation Recession: In economics, a recession is @ business cycle contraction. It is a general slowdown in economic activity. Macroeconomic indicators such as GDP (gross domestic product), investment spending, capacity utilization, household income, business profits, and infation fall, while bankruptcies and the unemployment rate rise. Page 10 CL | PDP Fundamentals of Banking Awareness and Economics47. 51. 52. Double Dip Recession: A second recession following a brief period of growth. A double-dip recession must come after an initial period of general economic decline. Essentially, the country’s GDP slides from negative to positive and eventually back to negative. If a country experiences a double-dip recession, the impact on the economy will be worse than the initial recession. In some cases, a double-dip recession has the ability to catapult a country into a depression. Depression: A depressions a sustained and severe recession. Where a recession is a normal part of the business cycle, lasting for a period of months, a depression is an extreme fall in economic activity lasting for a number of years. Economists disagree on the duration of depressions; some economists believe a depression encompasses only the period plagued by declining economic activity. Other economists, however, argue that the depression continues up until the point that most economic activity has retumed to normal Quantitative Easing: Quantitative easing (QE) is a type of monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the monetary base. This differs from the more usual policy of buying or selling short-term government bonds in order to keep interbank interest rates at a specified target value Sovereign Debt Crisis: A sovereign debt crisis is generally defined as economic and financial problems caused by the (perceived) inability of a country to pay its public debt This usually happens when a country reaches critical high debt levels and suffers from (perceived) low economic growth. Self Help Groups: Self Help Group is a homogeneous group of miero entrepreneurs with affinity among themselves, voluntarily formed to save whatever amountthey can conveniently save outof their earnings and mutually agree to contribute toa common fund of the group from which small loans are given to the members for meeting their productive and emergent credit needs at such rate of interest, period of loan and other terms as the group may decide. Priority Sector Lending: Priority Sector Lending is an important role given by the Reserve Bankof India (RBI) to the banks for providing a specified portion of the bank lending to few specific sectors like agriculture or small seale industries. Electronic commerce: Electronic commerce or ecommerce is a termfor any type of business, or commercial transaction that involves the transfer of information across the Intemet. Exchange rate: Infinance, an exchange rate (also known asa foreign-exchange rate or forex rate) between two currencies is the rate at which one currency will be exchanged for another. Its also fegarced as the valle of one country's currency in terms of another currency. Forward exchange rate: The forward exchange rate (also referred to as forward rate or forward price) is the exchange rate at which a bank agrees to exchange one currency for another ata future date when itenters into a forward contract with an investor. Foreign Exchange Management Act (FEMA): The Foreign Exchange Management Act, 1999 (FEMA) is an Act of the Parliament of India “to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India” Fundamentals of PDP Page 11 Banking Awareness and a€CL | Economics87. Globalization: Globalization implies the opening of local and nationalistic perspectives to a broader outlook of an interconnected and interdependent world with free transfer of capital, goods, and services across national frontiers. However, it does not include unhindered movement of labor and, as suggested by some economists, may hurt smaller or fragile econornies if applied incisoriminately Insolvent: Insolvency is 2 term that can apply to eitheran individual or a business, but is more often used in relation to a business or company. A business is said to be insolvent when it cannot pay its debts when they are due. Money laundering: The process of creating the appearance that large amounts of money obtained frorn serious crimes, such as drug trafficking or terrorist activity, originated from a legitimate source. Real interest rate: The real interest rate is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate. Real effective exchange rate (REER): The real effective exchange rate measures the value of a currency against a basket of other currencies; it takes into account changes in relative prices and shows what can actually be bought Risk asset ratio: The Risk Asset Ratio measures the amount of a bank's total regulatory capital in relation to the amount of risk itis taking. Banks must maintain a minimum RAR (total capital ratio) of 8%. In effect, this means that 8% of the risk-weighted assets must be covered by permanent or near permanent capital Venture capital: Venture capital (VC) is financial capital provided to early-stage, high-potential, growth startup companies, The venture capital fund earns money by owning equity in the companies itinvests in, which usually have a novel technology or business mode! in high technology industries, such as biotechnology and IT. (B) Capital/Stock Market Related Terms 62. Capital market: Capital markets are financial markets for the buying and selling of long-term debt or equity-backed securities. These markets channel the wealth of savers to those who can put it to long-term productive use, suchas companies or governments making long-term investments. Shares is defined 8s partial ownership in an organization in the form of units. It is also known as equity, share, security, stock. Indian Depository Reciepts: An indian Depository Receipt (IDR) is a financial instrument denominated in Indian Rupees in the form of a depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian securities Markets, Arbitrage: Arbitrage is the profit making market activity of buying and selling of same security on different exchanges or between spot prices of a security and its future contract. Here exchange refers to the stock market where shares are traded, like the NSE and BSE. Originally arbitrage occurred in the currenoy market, but now it applies equally in the commodity, futures and the stook market as well Page 12 CL | PDP Fundamentals of Banking Awareness and Economicsnm. 14, Participatory Notes: Participatory Notes commonly known as P-Notes or PNs are instruments issued by registered foreign institutional investors (Fil) to overseas investors, who wish to investin the Indian stock markets without registering themselves with the market regulator, the Securities and Exchange Board of India - SEBI Initial Public Offering: The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded, ‘Sweat Equity: Sweat equity shares are equity shares issued by a company to its employees or directors at a discount, or as a consideration for providing know-how or a similar value to the company. Exchange Traded Funds: Exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks) commodities, or bonds, and trades close to its net asset value over the course of the trading day. Asset backed securities (ABS): Asset-backed securities, called ABS, are bonds or notes backed by financial assets. Typically these assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans, manufactured-housing contracts and home-eauity loans. Blue chip: A nationally recognized, well-established and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known toweather downtumns and operate profitably in the face of adverse economic conditions, which help to contribute to their long record of stable and reliable growth Bullion: Bullion refers to precious metals in bulk form which are regulariy traded on commodity markets, The value of bullion is typically determined by the value of its precious metals content, which is defined by its purity and mass. Bear: A Bear investor is someone who is pessimistic and expects shares and asset values to fall Bull market: A bull marketis a period of generally rising prices. The start of a bull market is marked by widespread pessimism. Certificate of deposits (CDs): CDs are negotiable money market instrument issuedin demat form CDs issued by banks should not have the maturity less than seven days and not more than one year. CDs normally give a higher return than Bank term deposit. Bond: Bonds an instrumentof indebtedness of the bondissuer to the holders. Itis a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Convertible bond: Converiible bond or convertible note is a type of bond that the holder can convert into specified number of shares of common stock in the issuing company or cash of equal value. Corporate bond: A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of at least one year. Perpetual bonds: Perpetual bond, is a bond with no maturity date. Therefore, it may be treated as equity, not as debt. Issuers pay coupons on perpetual bonds forever, and they do not have to redeem the principal. Perpetual bond cash flows are, therefore, those of a perpetuity. Fundamentals of PDP Page 13 Banking Awareness and a€CL | EconomicsZero coupon bonds: A debt security that doesn't pay interest (a coupon) butis traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value. Debenture: In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, ata fixed rate of interest, Demat account: In India, shares and securities are held electronically in a dematerialized (or "Demat’) account, instead of the investor taking physical possession of certificates. A Dematerialized account is opened by the investor while registering with an investment broker (or sub-broker). The Dematerialized account number is quoted for all transactions to enable electronic settlements of trades to take place. Every shareholder will have a Dematerialized account for the purpose of transacting shares. Equity: In accounting and finance, equity is the difference between the value of the assets/interest and the cost of the liabilities of something owned. For example, if someone owns a car worth $15,000 but owes $6,000 on that car, the car represents $10,000 equity. Demonitisation: Demonetization is the act of stripping a currency unit of its status es legal tender. Demonetization is necessary whenever there is a change of national currency. Face value/nominal value: Nominal value refers to the stated value of an issued security that remains permanent as compared to its market value, which is fluctuating by nature because of factors like inflation. Besides, the nominal value is also, many a times, referred as the “book value” ofthe bond FCCB: Foreign currency convertible bonds (FCCBs) are a special category of bonds, FCCBs are issued in currencies different from the issuing company’s domestic currency. Corporates issue FCCBsto raise money in foreign currencies. These bonds retain all features of a convertible bond, making them very attractive to both the investors and the issuers. Fixed income securities: An investment that provides a return in the form of fixed periodic payments andthe eventual retum of prineipal at maturity, Uniike a variable-inoome security, where payments change based on some underlying measure such as short-term interest rates, the payments of 2 fixed-income security are known in advance. Futures contract: Infinance, a futures contract (more colloquially, futures) is a contract between {Wo parties to buy of sell an asset for a price agreed upon today (the futures price) with delivery and payment occurring ata future point, the delivery date. Giltvedged securities: High-grade bond issued by a national (federal) government or an established and stable firm with,a long record of consistent earnings, and ability to pay its obligations on time and in full. Such seourities used to have gilded edges. Hedge funds: A hedge fund is an investment vehicle and a business structure that pools capital froma number of investors and invests in securities and other instruments. It is administered by a professional management firm, and often structured as a limited partnership, limited liability company, orsimilar vehicle Indemnity: An indemnity is an obligation by a person (indemnitor) to provide compensation for a particular loss suffered by another person (indemnitee), Page 14 CL | PDP Fundamentals of Banking Awareness and Economics97. 100, 101, Index fund: Index funds are mutual funds that are intended to track the returns of a market index An index is a group of securities that represents a particular segment of the market (stock market, bond market, ete.). Among the most well-known companies that develop market indexes are Standard & Poor's and Dow Jones, Insider trading: Insider tracings the trading of a public company’s stock or other securities (such as bonds or stock options) by individuals with access to nonpublic information about the company. Invarious countries, trading based on insider information is ilegal. Market capitalization: The total dollar market value of/all of a company's outstanding shares Market capitalization is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to sales or total asset figures. ‘Mutual fund: A mutual fund is type of professionally managed investment fund that pools money from many investors to purchase securities, While there is no legal definition of the term "mutual fund’, it is most commonly applied only to those collective investment vehioles that are regulated andsoldto the general public. They are sometimes referred to as “investment companies’ or*registered investment companies Net asset value: Net asset value (NAV) is the value of a fund's asset less the value of its liabilities er unit. NAV is often associated with mutual funds, and helps an investor determine if the fund is overvalued or undervalued, When we talk of open-end funds, NAV is crucial. NAV gives the fund's value that an investor will be entitled to at the time of withdrawal of investment, In case of a close- end und, which is a mutual fund with fixed number of units, price per unit is determined by market ands either below or above the NAV. Open end mutual fund: Open-end fund (or open-ended fund) is a collective investment scheme which can issue and redeem shares at any time, An investor will generally purchase shares in the fund directly from the fund itself rather than from the existing shareholders, Option: A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put)@. security or other financial asset at an agreed-upon price (the strike price) duringa certain period of time or on a'specific date (exercise date) Oversubscribed: A situation if which the demand for an initial public offering (IPO) of securities exceeds the tolalinumber of shares issued. An oversubscribed IPO is one where there are more buyers than issued shares. Participatory notes: Participatory Notes commonly known as P-Notes or PNs are instruments issued by registered foreign institutional investors (Fil) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator, the Securities and Exchange Board of India (SEB!) Placing: The act or process of selling a new issue of a security to investors, Most of the time, a placement must be registered with the SEC before it can actually take place. Preference share: Preferred stock (also called preferred shares, preference sheres or simply preferreds) is a type of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Fundamentals of PDP Page 15 Banking Awareness and a€CL | Economics102, 103. 104, 105, 106, 107, 108, 109, Pricelearings ratio: A valuation ratio of a company’s current share price compared to its per-share eamings. For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/S1.95). Primary dealers: primary dealers a firm that buys government securities directly froma government, with the intention of reselling them to others, thus acting as a market maker of goverment securities. The government may regulate the behavior and number of its primary dealers and impose conditions of entry, Put option: Put options are most commonly used in the Stock market to protect against the decline of the price of a stock below a specified price. Ifthe price of the stock declines below the specified price of the put option, the owner/buyer of the put has the right, but not the obligation, to sell the asset at the specified price, while the seller of the put has the obligation to purchase the asset at the strike price if the owner uses the right to do so (the owner/buyer is said to exercise the putor put option) Redemption value: Redemption value is the price at which the issuing company may choose to repurchase a security before its maturity date. A bond is purchased at a discount if its redemption value exceeds its purchase price. It is purchased at a premium if its purchase price exceeds its redemption value. Right issue: A rights issue is an issue of rights to buy adaitional securities in @ company made to the company's existing security holders. When the rights are for equity securities, such as shares, ina public company, itis a way to raise capital under a seasoned equity offering Risk management: The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making. Essentially, risk management occurs anytime an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment and then takes the appropriate action (or inaction) given their investment objectives and risk tolerance. Short selling: In finance, short selling (also known as shorting or going short) is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them (‘covering’). ‘Speculation: Speculation isthe practice of engaging in risky financial transactions inan attempt to profit fromfluctuationsin the market value of a tradable good such as a financial instrument, rather thanattempting to profit from the underlying financial ettributes embodied in the instrument such as capital gains, interest, or dividends Page 16 CL | PDP Fundamentals of Banking Awareness and EconomicsIndian Economic Development Dear Aspirants, Inorder to have a broad understanding of Indian economy, we must understand how the Indian economy has evolved over a period of time since independence. Let us understand the growth of Indian economy in this chapter. The growtn of indian economy was carried out by a very pivotal institution called Planning Commission of India. This commission was instrumental in ensuring the growth of Indian Economy. Here are the details of planning commission of India its structure and the performance of different plans. (A) Indian Economic Planning Economic planning is the making of major economic decisions by a determinate authority on the basis of a comprehensive survey of the economy as a whole. Itis a conscious effort on the partof any government tofollow a definite pattern of economic development in order to promote rapid and fundamental change in the economy and society. Planning commission Planning Commission was established on March 15, 1950 by an execitive resolution of the Government of India. Itwas established on the recommendation of the Advisory Planning Board constituted in 1946, under the chairmanship of KC Neogj. It is an extra-constitutional and @ non-statutory body, It is the supreme ‘organof planning for social and economic development in India, The Prime Minister of India is the ex-officio chairman of the Pianning Commission, The Deputy Chairman is the de-facto executive head (ie., Fulltime functional head) of the Commission. The Deputy Chairman of the Commissions responsible for the formulation and submissioniof the draft of the Five-Year Plans to the Central Cabinet. He is appointed by the Central Cabinet for-a fixed tenure and enjoys the rank of a Cabinet Minister. Though he is not a member of the Cabinet, he is invited to attend all its meetings (without a right to vote). Some Central Ministers are appointed as a’parttime'members of the Commission. Finance Minister and Planning Minister are the ex-officio members of the Commission. At present, planning commission is replaced by NITI Aayog National Development Council The National Development Council (NDC) or the Rashtriya Vikas Parishad is the apex body for decision making and deliberations on development matters in India, presided over by the Prime Minister. Itwas set up on 6 August 1952 to strengthen and mobilize the effort and resources of the nation in support of the Plan, to promote common economic policies in all vital spheres, and to ensure the balanced and rapid development of all parts of the country. The Council comprises the Prime Minister, the Union Cabinet Ministers, Chief Ministers of all States or their substitutes, representatives of the Union Territories and the Fundamentals of PDP Page 17 Banking Awareness and a€CL | Economicsmembers of the Commissions. It is an extra-constitutional and non-statutory body. Its status is advisory to Planning Gommission but not binding. This body was set up by Union Cabinet with the following intended functions. To prescribe guidelines for the formulation of the national plan To consider the national plans formulated by the Planning Commission, To assess the resources for the plan and recommend a strategy for mobilizing the resources. To consider important questions of socioeconomic policy affecting development of the nation. To review the progress of the five year pian midoourse and suggest measures for achieving the original targets. e Years Plan in India irst five year plan (1951-1956) The ‘stfive year plan was presented by Jawaharlal Nehru, who was the Prime Minister during that period. Itwas formulated for the execution of various plans between 1951 to 1956 The Planning Commission was responsible for working out the plan Objectives: It was intended towards the improvement in the fields of agriculture, irigation and power and the plan projected to decrease the countries reliance on food grain imports, resolve the food crisis and ease the raw material problem especially in jute and cotton The target set for the growthin the gross domestic product was 2. percent every year. In reality, the actual achieved with regard to gross dornestic product was 3.6 percent per annum, This is a clear indication of the success of the ‘1st five year plan. 1stfive year plan proved dramatic success as agriculture production hiked, national income went up by 18%, per capita income by 11% and per capita consumption by 9%, Five IITs (Indian Institute of Technology) were also opened successfully as major technical education institutions in the country. Second five:year plan (1956-1961 It was launched in 1956. Under this planythe focus was shifted towards the industrial sector from the agrarian sector. The major emphasis under this plan was to increase the domestic production of industrial products through the development of public sector industries in India. The Mahalanobis model, formulated by Prasanta Chandra Mahalanobis, was highly used under this pian to determine the optimal allocation of resources to different sectors of production so as to attain maximum long run economic growth. Third five year plan (1961-1966) Initialy, the Third Five Year Plan was formulated with a prime focus on agriculture, majorly on improving the production of wheat butas a result of the India-China war in 1962, soon the focus was shifted towards country's defense industry. Later, India fought another war with Pakistan in 1965 which resulted in high rates of infiation in the country and consequently the focus of the Third Five Year Plan was again shifted towards price stabilization. The targeted growth rate under this Five Year Plan was to achieve a growth rate equal to 5.6% of GDP but the rate actually achieved was much lower (only 2.2% of GDP). However, some major page 18 PDP Fundamentals of aCL | Banking Awareness and Economicsdevelopments were made in the education sector, during this plan tenure, including the formation of state boards of secondary education and establishment of primary schools in rural areas. Fourth five year plan (1969-74) The Fourth Five Year Plan was initially focused towards the development of country’s industrial sector but as a result of the India-Pakistan war in 1971, a major segment of the allotted funds was diverted towards the war needs. Some major developments under this plan include the initiation of Green Revolution in India and the nationalization of fourteen Indian banks, India also successfully performed its first nuclear test in 1974, The targeted growth rate during this plan was 5.7% of GDP but the groivth rate actually achieved was just 3.3% of the GDP.In this Period, Nationalization of banks was done in the year 1969, ifth five year plan (1974-1979) The Fifth Five Year Plan formulated by the Planning Commission of India mainly focused on the alleviation of poverty and employment generation in the country, Increased domestic production of agricultural and defense products were the other prime objectives of this plan ‘Some major achievements made during the tenure of this Five Year Plan include the introduction of Indian national highway system and the enactment of the Electricity Supply Act in 1976. The targeted growth rate Under this Five Year Plan was 4.4% of GDP but a higher growth rate equal to 5.5% of GDP was actually achieved. Sixth five year plan (1980-1985) The Sixth Five Year Plan introduced the concept of family planning in India. Unlike China, the family planning in India was introduced in form of an awareness campaign and not as a forceful obligation. To achieve a growth rate equal to 5.2% of GDP was set under this Five Year Plan but a higher growth rate, 5.4% of GDP, was actually achieved. This Five Year Planis also referredito as the Janata Government Plan andit was revolutionary singe it marked a change from the Nehruvian model of Five Year Plans. The sixth five year plan has changed a lot of things in India. On one hand it had improvedthe tourism industry in india and onthe other hand it aimed at development in the Information Technology sector. During this time the Prime Minister was Rajiv Gandhi his idea about the betterment of the industrial sector was welcomed by some and opposed by lot others specially the communist groups. Even the workers who were more inclined towards the leftist ideology were not much convinced. This sowed down the pace of progress. Seventh five year plan (1985-1989) The Seventh Five Year Plan primarily focused on employment generation, increasing economic productivity and the production of food grains. The success of the Sixth Five Year Plan laid a strong foundation for this plan and made the goals set under this Five Year Plan more realistic. The target growth rate to achieve under this Five Year Plan was 5% of GDP but India successfully managed to achieve a higher growth rate equal to 5.7% of GDP. Fundamentals of PDP Page 19 Banking Awareness and a€CL | EconomicsEighth five year plan (1992-1997) The Eighth Five Year Plan was formulated and launched by the Planning Gommission in 1992 after the economic reforms of 1881 in the country. The major emphasis under this Five Year Plan was laid on the modernization of the existing public sector industries, The target growth rate set under this Five Year Plan was 5.6% of the annual GDP whereas the actually achieved growth rate was comparatively higher, standing at 6.78% of the annual GDP. Ninth five year plan (1997-2002) The Ninth Five Year Plan of the Planning Commission was formulated and launched in 1997. The primary emphasis under this plan was laid on self resilience and speedy industrialization The Ninth Five Year Plan proposed a target growth rate of 6.5% of GDR. However, India could only manage a growth rate eqiual to 5.35% of GDP. Tenth five year plan (2002-2007) The Tenth Five Year Plan was launched by the Planning Commission in 2002, The primary objectives, of this plan are listed below. * Higher Female Literacy Rate Poverty Alleviation GDP growth rate of 8% The Tenth Five Year Pian proposes schooling to be compulsory for children, by the year 2003 The mortality rate of children must be reduced to. 45 per 1000 livings births and 28 per 1000 livings births by 2007 and 2012 respectively All main rivers should be cleaned up between 2007 and 2012 Reducing the poverty ratio by at least five percentage points, by 2007 Making provision for useful and lucrative employments to the population, which are of the best qualities * According to the Plan, itis mandatory that all infants complete at least five years in schools by 2007. * By 2007, there should be a decrease in gender discriminations in the spheres of wage rate and literacy, by a minimurn of 50% * | Taking up of extensive afforestation measures, by planting more trees and enhance the forest and tree areasto25% by 2007 and 33% by 2012 * Ensuring persistent availability of pure drinking water in the rural areas of India, even inthe remote parts * The alarming rate at which the Indian population is growing must be checked and fixed to 16.2%, between atime frame of 2001 and 2011 * The rate of iteracy must be increased by at least 75%, within the tenure of the Tenth Five Year Pian 1012, The Eleventh Five Year Plan is the plan issued by the Planning Commission. The tenure of this plan will last till 2012, The emphasis under this Five Year Plan is laid on six areas which are listed below. Eleventh five year plan (200: page 20 PDP Fundamentals of aCL | Banking Awareness and EconomicsReducing Poverty less than to 10% by the year 2012. To provide drinking water in all the villages by the year 2012 To provide electricity connection for the people living below poverty line. To increase literacy rate of more than 75 % Creation of about 5 lakh additional employment opportunities, Accelerate the rate of growth in GDP to 8% per annum. This will be accomplished by a progressive acceleration in the growth rate frorn 6.5% in 2007-08 to 9% in 2011-12. The rate of growth will be targeted at 4% per annum for primary sector, 7.5% for seeondary sector and 10.5% for tertiary sector. ‘Augument power generation capacity by 05 MWin the state sector, Electrify all habitations. Connect all left over habitations with more than 500 inhabitants, by road and Provide basic amenities ( connectivity, power, water supply, primary health care and elementary education) to all villages so that there is no inter-region or intra-region disparity in access to such facilities. * Maximize Employment Generation consistent with 8% growth in the GDP. ‘Twelfth five year plan (2012-2017) The Union Cabinet on 4 October 2012 approved the 12th five-year plan withits aim to renew Indian economy and.use the funds from government in improving the facilities of education, sanitation and health. The plan would infuse a huge fund of 47.7 lakh crore rupees that will help to accomplish the economic growth to an average level of 8.2 percent, 12th five-year plan is guided by the policy guidelines and principles to revive the following Indian economy, which registereda growth rate of meager 5.5 percent in the first quarter of the financial year 2012-13. The plan aims towards the betterment of the infrastructural projects of the nation avoiding all types of bottlenecks, The UID (Unique Identification Number) will act as @ platform for cash transfer of the subsidies in the plan. The pian aims towards achieving a growth of 4 percent in agricutture andto reduce poverty by 10 percentage points, by 2017 This plan also proposes a growth target of 8 percent. As far as infrastructure sector is concerned, there is, 2 proposal of increasing the investment in this sector to 9 per cent of the GDP by the end of the Pian period, Some other major targets are: * Increasing green cover by one million hectare every year and adding 30,000 MW of renewable energy generation capacity in the Pian period. * Toreduce emission intensity of the GOP in line with the target of 20-25 reduction by 2020 over 2005 levels. * Raising agriculture output to 4 per cent for the full Plan * Manufacturing sector growth to 10 per cent for the full Pian. * Target of adding over 88,000 MW of power generation capacity in the 12th five year pian. Economic policies include all solutions and methods by which government affects, directs or controls different economic activities. These plans helped a lot in the overall economic development of India but indian economy went through a major financial orisis known as ‘Balance of Payment Crisis’ (BoP) in 1991, Here are the reasons of BoP Crisis of 1991 Fundamentals of PDP Page 21 Banking Awareness and a€CL | Economics1. Increasing Fiscal Deficit: Fiscal Deficit was continually increasing due to increase of non—pian expenditure. Fiscal Deficit means difference of gross receipts and gross expenditure of the government It does not include loans taken by the government. It equals deficit of the government. 2. Grisis of Balance of Payment: India required large foreign exchange for payment of its imports. It could eam foreign exchange by export of goods and services, When receipts of foreign exchange are less than payment of foreign exchange, it gives rise to "balance of payment crisis” 3. Decline of Foreign Exchange Reserve: In the year 1990-91, foreign exchange reserves went down to such a low level that it was not sufficient even for import expenses of 10 days. Foreign exchange reserve was at 8151 orore in 1986-87 which was down to 6252 crore in 1989-90. The situation became so alarming that government was forced to pledge its gold reserves for making payment of foreign debt and interest and other payments. 4, Rise in Prices: Before 1991, in spite of good, monsoon for continuous 3 years, there was rise in prices of food grains. This increased economic crisis which was already there due to economic slowdown and fall of Industrial production. 5. Bad performance of Public Sector: There were only 5 Public Sector Units in India in the year 41951, By 2001, there number had gone up to 232. Billions of Rupees were invested in these public sector units as these were thought to be centers of economic progress. In the beginning, these units gave good results but slowly these turned out to be liabilities, rather than assets. 6. _ International Pressure: Due to domestic economic crisis, the government was left with no alternative buttto take shelter of international economic Institution. Finally when the BoP crisis happen then India tooka loan of $7 billion from the International Monetary Fund (IMF) and ensured IMF about a package of various measures of economic reforms so asto achieve sustained economic growth of the indian economy. At that point of time, Prime Minister P. V. Narasimha Rao and Finance Minister Dr. Manmohan Singh, took several bold steps for the reforms in the Indian Financial System. As a result India implemented New Economic Policy of 1991 and initiated that Liberalization Privatization Glabalization (LPG) model for indian economic growth. The main features of Indian Economic Reforms of 1991 are as follows: (A) Libefalization; Liberalization means the government will take, Liberal view of all components of trades and business. This means that rules and regulations for establishing new industrial unitwill be made easier and restrictions will be removed, (8) Privatization: By privatization is meant that private sector is given a bigger role in economic activities. In privatizations, controls and conditions restricting private business are rernoved and private trade and economic activities are given a bigger role (C) Globalization: By globalization, we mean that Indian economy is unified with world economy, Events happening in various parts of the world affect domestic economy. Similarly, domestic economy also affects economy of other countries of the world, In other words, domestic economy is unified with world economy. This happens by opening of our economy to foreign goods and investment. page 22 PDP Fundamentals of aCL | Banking Awareness and Economics(A) (8) Liberalization New economic policy aims at reducing delays by removing license, permit, quota and red tapism Unnecessary restrictions are removed so that trade and industry can progress rapidly. Several changes in Industrial policy have been made in this regard. These are as under (i) Industrial restrictions removal: In last 4 decades, planned development had resulted in imposition of license, quota, permit, controls eto on industry and trade. In new economic policy all such restrictions are removed and economy was freed from license, permit and quota system (ii) Liberal policy for foreign capital and industry: In earlier industrial policy, inflow of foreign capital and technology was under strict controls, later onthis was gradually liberalized. (iii) Relaxation of upper limit of foreign investment: Earlier foreign capital investment was limited to 40%. This limit was enhanced in July 1991 new industrial policy (iv) Automatic approval of foreign technical agreements: In new Industrial Policy, high priority industries have automatic approval of Foreign technical agreement. Earlier Government Permission was necessary for importing foreign technology. Privatization Economic reforms aim at giving better play to private sector in the economic development. Earlier in the planned development, public sector was given major role but in new industrial policies attempt has been made to reverse this by giving limited role to public sector’and encouraging private sector. These methods are as below’ (i) _ Limiting role of public sector: In Economic policies areas reserved for central public sector have been cut down. 17 such areas where reserved for public sector in the industrial policies of 1956. In industrial policy of July 1991, public sector units are limited to only 8 areas and all other areas are open for private sector later on these where cut down to only 4 areas which are defense production, atomic energy railways and fuel for atomic energy production, (ii) Disinvestment of Public Sector Units: Witha view to improve financial resources and capacity of public sector units, Government disinvests its share holding to general public, financial and investment institutions, + Disinvestment of CPSE and privatization: Disinvestmentis process by which government money invested in Public sector unit is retrieved by government. This can be upto 100%. Privatization is a proves by which private sector gets control of capital and management of public sector: Maharatna plan: It was started in 2009 with the object of giving autonomy to Boards of big Navratna. So that it can operate in global market along with the domestic market. List of Mahartna companies in India (as on July 31, 2015) 1, Steel authority of India Oil and Natural Gas company Indian Oil Company National Thermal Power company Coal India Limited Bharat Heavy Electricals Limited Gas Authority of India Limited NOM ROS Fundamentals of PDP Page 23 Banking Awareness and a€CL | Economics(c) Navratna Plan: It is a separate group of PSUs where Government expects capacity of going global. It was started in 1997. A company must seoure 60 out of 100 marks to be classified as a Navratna, Navratna companies are given more autonomy in administrative and financial areas. They can employ capital as they wish and can collect capital from domestic and international market, They can make investment up to 1000 crore without government approval and take joint ventures internationally. Board of Directors can take decisions about mergers and demergers. List of Navratna companies (as on July 31,2015) Bharat Electronics Ltd. Bharat Petroleum Corporation Ltd. Hindustan Petroleum Corporation Lid Mahanagar Telephone Nigam Ltd) Hindustan Aeronautics Ltd Power grid Corporation of India Ltd. National Mineral Development Corporation Rural Electrification Corporation Lid National Aluminium Company 10. Rashtriya Ispat Nigam Lita, 11, Power Finance Corporation 12. Shipping Corporation of India 13.0 India Lid 14, Neyveli Lignite Corporation Miniratna Yojana 1997: This was started in 1997 where sore profit earning units are given financial, managerial and running autonomy. These are 61 at present. These are of 2 types. Category 1 consists of those units which have eared profit of 30 crores in one year and profit in threeyears consecutively. They can spend 500 crore oramount equal to their net worth without permission of government in category 2.are companies which earn profit for 3 consecutive years. They can spend up to 50% of their net worth or 150 crore: without govt approval. CENBAReNA Globalization: Globalization is unification of domestic economy with Intemational econorry. Domestic economy wil join world economy in respect of production, trade, capital and exchange rate etc. (0) (ii) Relaxation of import Licenses: Earlier in our country import was made throughlicenses and quota, Restrictions about quantity where imposed. This was done for saving Foreign exchange and protecting domestic industry. By this system Domestic products were encouraged over imported products: Meaningful duty structure: By duty structure is meant method and structure of imposing customs duty. This duty is imposed on imports. Customs duty system had become very complex ahd average duty was much higher than in other countries. Tax reform committee (Chelliah Committee) recommended for reducing duty in 1991. The duty was reduced and attempt has been made to bring it at par with other developing countries. Improvement in foreign currency trading: Eariier all exporters where depositing foreign exchange earned from exports with reserve bank of India and they were paidat fixed exchange rate in indian rupees. Similarly importers were purchasing foreign exchange From RB lat a fixed rate Page 24 aéCL | PPP Banking Awareness and EconomicsWith the help of the LPG model Indian Economy started galloping on the path of economic development however, economic developments a continuous process and to give continuity to this economic development Government of India launches various social welfare schemes and appoints committees/commissions to augument the process of economic growth. Here are some very important social welfare schemes of india and committees and commissions that contributed to the growth of Indian economy. Important Social Welfare Schemes of India [S.No. Name of the Scheme Details of the Scheme 7 Sansad Adarsh Gram Yojana [According to the scheme, each MP adopts a village every year for jall-round development and helps in development of the select Millage using the programmes of the Centre and States and their constituency development funds (MPLADS) The Yojana.drafted by Rural Development Ministry is aimed. at [substantially improving the quality of life of all sections of the population in these select villages. It aims at turning villages into model villages not just through infrastructure development but lgender equality, dignity of women, social justice, community service, cleanliness eto. Pradhan Mantri Jan Dhan Yojana The scheme provides a host of benefits including @ bank account, insurance and a debit card for all: With the'slogan "Mera Khata - Bhagya Vidhaata" the scheme is @ financial inclusion scheme covering all households in the country with banking facilities, lensuring @ bank account for each household. it is a mega jinancial inclusion plan under which bank accounts and RuPay debit cards with inbuilt insurance cover of Rs 1 lakh will be provided to crores of persons with no access to formal banking Indira Awaas Yojana Provides financial assistance to rural poor for constructing their houses themsehes, Janani Suraksha Yojana [One-time cash incentive to pregnant women for institutional/home births through skilled assistance Digital India Programme [Aims to ensure that goverment senices are available to citizens electronically and people get benefit of the latest information and communication technology Deen Dayal Upadhyaya |Gram Jyoti Yojana IE is a Government of India program aimed at providing 24x7 uninterrupted power supply to all homes in Rural India [Atal Pension Yojana [Atal Pension Yojana also know as APY Scheme was launched in continuation to the Jan Dhan Yojana Scheme to bring those lemployed in rural and unorganized sector under the ambit of Pension Schemes, The idea of the scheme is to provide a Jdefinite pension to all Indians, [One Rank One Pension scheme The Central Government allotted Rs 1,000 crore for the implementation of one rank one pension scheme. According to ithe scheme, the armed forces personnel holding the same rank Iwill get the same pension, regardless of the last drawn pay, years Jof service and the years served in a particular rank, Fundamentals of Banking Awareness and Economics CL | PDP Page 25The National Rural Employment Guarantee Act 2005 was later renamed as the "Mahatma Gandhi National Rural Employment Guarantee Act" (or, MGNREGA), is a labour law and social security measure that aims to guarantee the ‘right to work". It laims to ensure livelihood security in rural areas by providing at least 100 days of wage employment in a financial year to every household whose adult members volunteer to do unskilled manual work. The MGNREGA was initiated with the objective of “enhancing livelihood security in rural areas by providing at least 100 days of lguaranteed wage employment ina financial year, to every household whose adult members volunteer to do unskilled manual work". Ancther’aim of MGNREGA is to create durable assets (such as roads, canals, ponds, wells). Employment is to be provided within 5km of an applicant's residence, and minimum hvages are to be paid. if work is not provided within 15 days of applying, applicants are entitled to an unemployment allowance. Thus, employment under MGNREGA is a legal entitlement, IMGNREGA is to be implemented mainly by gram panchayats (GPs). For drought hit and tribal areas the number of days has been increased from 100 to 150, The Midday Meal Scheme is @ school meal programme of the lgovernment of India designed to improve the nutritional status of [school-age children nationwide! The programme supplies free lunches on working days for children in primary and upper primary classes in government, govemment aided, local body, Education Guarantee Scheme, and altemate innovative education centres, Madarsa and Magtabs supported under Sane Shiksha Abhiyan, land National Child Labour Project schools run by the ministry of labour. The programme entered the planning stages in 2001 and was implemented in 2004. The Rajiv Awas Yojana (RAY) announced in the 2009 budget 1s lone of the United Progressive Alliance govemment's initiatives laimed at improving living conditions for the urban poor through the construction of housing for the so-called economically weaker sections (EWS), a measure aimed at reining in the relentiess spread of slums across India’s urban landscape. it envisages a Slum Free India" with inclusive and equitable cities in which levery citizen has access to basic civic infrastructure and social Jamenities and decent shelter. Achieve 4% annual growth in agriculture through development of JAgriculture and its allied sectors during the XI Plan period 9 [Mahatma Gandhi National Rural Employment Guarantee |Act 10 |Midday Meal Scheme 11 [Rajiv Awas Yojana 12 [Rashtriya Krishi Vikas Yojana Page 28 aéCL | PPP Banking Awareness and Economicsry [Saksham or Rajiv Gandhi Scheme for Empowerment of Adolescent Boys [Aims at all-round development of Adolescent Boys and make them self-reliant, gender-sensitive and aware citizens, when they lgrow up. It cover all adolescent boys (both school going and out lof school) in the age-group of 11 to 18 years subdivided into two categories, viz. 11-14 & 14-48 years. In 2014-15, an allocation of Rs. 25 crore is made for the scheme ory [Sabla or Rajiv Gandhi Scheme for Empowerment of Adolescent Girls Empowering adolescent giris (Age) of 11-18 years with focus on out-of-school girls by improvement in their nutritional and health [status and upgrading various skills ike home skill, life skills and hocational skills. Merged Nutrition Programme for Adolescent IGirls (NPAG) and Kishori Shakti Yojana (KS). cry [Skill India Programme (National Skill Development Mission) The National Skill Development Mission aims to prowde a strong institutional framework at the Centre and States for implementation of skiling activities in the country. it seeks to provide the institutional capacity to train a minimum 40 crore skilled people by 2022. 16 [Swabhiman [Swabhimaan is a financial Security programme was launched by the Central Government to ensure banking facilities in habitation lwith @ population in excess of 2000 by March 2012. This nationwide programme on financial inclusion was launched in February, 2011 with its focus on bringing the deprived sections of the society in the banking network to ensure that the benefits of leconomic growth reach everyone at all levels. This campaign is a big step towards socio-economic equality by bringing the lunderprivileged segments’ of Indian population into the formal banking fold for the frst time. 7 [Swavalamban Pension scheme to the workers in unorganised sector. Any citizen who is not part of any statutory pension scheme of the Government and contributes between Rs. 1000 and Rs. 12000/- per annum, could join the scheme. The Central Government shall lcontribute Rs. 1000 per annum to such subscribers. cr HRIDAY - Heritage City Development.and Augmentation Yojana National Heritage City Development and Augmentation Yojana (HRIDAY) was launched on 21 January 2015 with the aim of bringing together urban planning, economic growth and heritage conservation in an inclusive manner to preserve the heritage character of each Heritage City.The Scheme shall support ldevelopment of core heritage infrastructure projects including revitalization of linked urban infrastructure for heritage assets lsuch as monuments, Ghats, temples etc. along with reviving certain intangible assets. 19 [Atal Mission for Rejuvenation and Urban Transformation (AMRUT) [A mission aimed at transforming 500 cities and towns into efficient urban living spaces, with special focus on a healthy and lgreen environment for children. The Cabinet approved Rs 0,000 crore for this mission which is to be spent over the next five years, Fundamentals of Banking Awareness and Economics CL | PDP Page 27Under this scheme Indian Goverment is planning to make lapproximately 22 crore Houses by 2022.In this scheme central lgovernment will contribute around Rs 1 lakh to Rs 2.30 lakh per house. The main focus to launch this scheme is to provide Decent and affordable houses to transgender, windows, low- income groups/SC_communities The National Rural Health Mission (NRHM) is an initiative lundertaken by the government of India to address the health needs of underserved rural areas, NHRM was launched in April 12005. Under the NRHM, the Empowered Action Group (AG) States as well as North Eastem States, Jammu and Kashmir and Himachal Pradesh have been given'special focus PDS is an Indian food security system, Established in 1960 by the Government of India under Ministry of Consumer Affairs, Food, land Public Distribution and managed) jointly with state lgovernments in India, it distributes subsidized, food and non-food items to India’s poor. Major commodities distributed include staple food grains, such as wheat, rice, sugar, and kerosene, through a network of public distribution shops (also known as ation shops) established in several states across the country Food Corporation of India, @ Government-owned corporation, procures and maintains the PDS. The Central goverment launched the National Food Security Mission (NFSM) in August 2007 to meet the food requirements of the country. The main objective of this. schéme is to increase production and productivity of wheat, tice and pulses on a sustainable basis. The Minimum Support Price (MSP) Scheme is a scheme of the Government of india (GO!) to safeguard the interests of the Harmers. Under this Scheme the GOI declares the minimum support Prices of various agricultural produces and assures the Harmers that theit agricultural produce will be purchased at the IMSP,:thereby preventing its distress sale. The Food Corporation lofindia (FC!) acts as the Nodal Agency of the GOI. [Sarva Shiksha Abhiyan (SSA) is Government of India’s flagship programme for achievement of Universalization of Elementary Education (UEE) in a time bound manner, as mandated by 86th Jamendment to the Constitution of India making free and lcompulsory Education to the Children of 6-14 years age group, a Fundamental Right ISSA is being implemented in partnership with State Governments to cover the entire country and address the needs of 192 million children in 1.1 million habitations. HThe programme seeks to open new schools in those habitations which do not have schooling facilities and strengthen existing [school infrastructure through provision of additional class rooms toilets, drinking water, maintenance grant and school improvement grants. 20 [Pradhan Mantri Awas Yojana (PMAY) 21_|National Rural Health Mission (NHRM) 22_ [Public distribution system (PDS) 23. [National Food Security Mission 24 [Minimum Support Prices Scheme 25° [Sarva Shiksha Abhiyan (SSA) Page 28 aéCL | PPP Banking Awareness and Economics26 [Aajeevika-National Rural |Aajeevka - National Rural Lvelinoods Mission (NRLM) was Livelihoods Mission launched by the Ministry of Rural Development (MoRD), (NRLM) Government of India in June 2017, Aided in part through investment support by the World Bank, the Mission aims at creating efficient and effective institutional platforms of the rural poor enabling them to increase household income through sustainable livelihood enhancements and improved access to financial senices. important Commissions and Committees ‘SL.NO, [Name of the Commission and |Related field Committee 1_[Serkaria Commission [Centre-State relations 2 [Malhotra Committee Insurance Reforms. 3__|Ralinder Sachar Committee [Companies and MRPT Act 4 _ [Jyoti Basu Committee Report on Octroi abolition 3 [Balwant Rai Mehta Commitee [Recommendations on decentralization system 6_|Chelliah Committees [Eradicating black money 7__ [Kothari Commission [Educational reforms &__ [Rangarajan Committee Reforms in private sector 3 __|Chakraverti Committee Banking sector reforms 70__[Rekhi Committee [Structure of incirect taxation 77_|G.V.Ramakrishna Committes [Disinvestment in PSU shares 72_|Kelkar Committee 2) Direct-indirect Taxes: 13_[Alagh Committee. [Gill Senice Examinations 14 [Abid Hussain Committee Recommendations on Small scale industries 15 |Narasimham Committes Financial sector reforms (1991)/ Banking sector reforms (1998) 76_|Chaiiah Committee Tax reforms 17_]Omker Goswami Committee __ [Industrial sickness 7@_|Raghuram C_Rajan Committes- [Financial sector reforms 79 |B_Shivaman Committee For NABARD creation 20 _|MBN Rao Committee [To prepare the blueprint of India’s first women's bank 21 | |Anind Mayaram Committee |For giving clear definitions fo Foreign Direct Investment (FD) and Foreign institutional Investment (Fl) 22 |SK Smvastava Committee FTo formulate a policy on public-private partnership model Ito raise coal output 23_|Parthasarathi Shome committee [Implementation of GAAR (General Anti Avoidance Rule) 24 |Deepak Parekh committee For Financing infrastructure sector 25 __ [MB Shah Committee For inspection of illegal mining activities 26__ |Damodran Committee [On improvement of customer services in banks 27 [Suma Verma Committes To update, and revise the Banking Ombudsman Scheme, 2006 Fundamentals of Banking Awareness and Economics a€CL | PPP Page 2928 [Parihasarathi Shome For Tax Administration Reform Commission (TARG), [suggest a system to enforce better tax compliance 29_[Kriti Parikh Committee Reform in the oil pong 30 [Suresh Tendulkar Committee [Poverty estimation 31_ |Tarapur Committee Full convertibility of rupee 32_|MS Verma Committee Public Sector Bank restructuring 33_ [Usha Thorat Committee [Lead Bank Scheme 34_ [Abhijit Sen Committee [Food policy (Long Tetin) Page 30 aéCL | PPP Banking Awareness and EconomicsBasics of Economy 1. Definition of Economy It is the study of how to allocate" scarce resources’ for inter-related economic production and consumption activities. The theory of economic problem states that there is scarcity of available resources which are insufficient to meet all human wants and needs. The problem then becomes how to determine what is to be produced and how the factor of production is to be allocated. The father of economy is "Adam Smith" who conceptualized economics as a science of wealth. The study of economies can be done under the two major classifications. They are microeconomics macroeconomics. 2. Normative Economics It is a part of economics that expresses value or normative judgments about economic fairness or what the outcome of the economy: ‘of goals of public policy ought to be. Economists commonly prefer to distinguish normative economics (‘what ought to be" in economic matters) from positive econornics ("what is") Many normative (value) judgments, however, are held conditionally, to be given up if facts or knowledge of facts changes, so that a change of values may be purely scientific 3. Welfare Economics Itis the level of prosperity and standard of living of either an individual ora group of persons. In the field of economics, it spectfically refers to utility gained through the achievement of material goods and services, Economic welfare is measured in cifferentways, depending on the preferences of those measuring it. Factors used to measure the economic welfare of a population, include: GDP, literacy, access to health care, and assessments of environmental quality. 4. Fiscal Economics The principle of maximum social advantage introduced by British economist Hugh Dalton is a€CL Fundamentals of Banking Awareness and Economics the fundamental principle of public finance which implies that all the financial operations of the state should aim at maximization of net social benefit. It takes into consideration both the aspects of public finance that is the government revenue or taxation as well as Government expenditure, Since it studies problems related to government taxation and spending, it comes under the domain of fiscal economics. Types of Economic Systems 1. PDP Closed Economy Aclosed economy is self-sufficient, meaning that no imports are brought in and no exports are sent out, The goal isto provide consumers with everything that they need from within the economy's borders, A closed economy is the opposite of an open economy, inwhich a country will conduct trade with outside regions. Open Economy Anopen economy is an economy in which there ate economic activities between the domestic community and outside (people, and even businesses, can trade in goods and services with other people and businesses in the international community, and funds can flow as investments across the border). Capitalist Economy ‘Capitalism’ a systern of economics based on the private ownership of capital and production inputs, and on the production of goods and services for profit. In general investments, distribution, income and pricing are determined by markets. In capitalism prices are determined by the demand-supply scale, For example higher demand for certain goods and ‘services lead to higher prices and lower dernand for certain goods lead to lower prices. Price mechanism is the feature of capitalist economy. "Hire and fire" is the policy of Capitalism. Example is USA Page 314, Laissez-faire Economy Itis aneconomic system in which transactions between private parties are free from government interference (Itis a free market where consumer sovereignty protected) such as regulations, privileges, tariffs, and ‘subsidies or Government does not interfere in the free functioning of demand and supply. Capitalist Economy is the best example for it. 5. Socialist Economy Asocialist economic system is based on some form of social ownership of the means of production, which may mean autonomous cooperatives or direct public ownership; wherein production is carried out directly for use. Where markets are utilized for allocating inputs and capital goods among economic units, the designation market socialism is used. When planning is utilized, the economie system is designated a planned socialist economy. Example is India 6. Mixed Economy An economic system that features characteristics of both capitalism and socialism. A mixed economic system allows a level of private economic freedom in the use of capital, but also allows for governments to interfere in economic activties in order to achieve social aims or it is the, market mechanism guided by Government participation and planning, or both the government and the private sectors operate simultaneously or co-existence of public sector as well as private sector is called mixed economy. It is reflecting characteristics of both market economics and planned economics. However, unlike a free market economy, the government has indirect influence over the economy through fiscal and monetary policies designed to counteract eeonomic downturns and capitalism's tendency towards financial crisis and unemployment, along with playing a role in interventions that promote social welfare. India is the best example for it. 7. Communist Economy Communism, also known as a command system, is an economic system where the government owns most of the factors of production and decides the allocation of resources and what products and services will be provided. According to communism capitalist class is the chief enemy of the society, Example is China Economic Growth It can be defined by many Economists like" increase in gross domestic product of country over long period of time “and some of the Economists defined as “increase in per capita income of a country over a period of time "is called economic growth, but most widely accepted definition by many economists is “increase in per capita real income in a country over a long period of ime" is called economic growth and per capita real income at constant prices is the best measure to asses a country's economic growth, because it has become the definitive measure of the standard of living Eoonomic growth is dependent on many factors, as stated in Harrod-Domarand slow growth model. The first and main factor is “level of investment’ in a country, the next factor is population growth as welll as knowledge and technology. Economic Development Itcan also be defined by many Economists in many ways, but most widely accepted definition by many economists is "improvement in technology used in production, distribution system and institutional system’. It can also be referred as quantitative and qualitative changes in the economy. It is important to understand one thing that "economic developmentis not possible without economic growth". The concept of economic development is wider than the economic growth Economic Development depends on natural resources, capital formation, and size of the economy, social inclusion, regional competitiveness, environmental sustainability, literacy, health, infrastructure improvement in various sectors of the economy. rao aCL PDP Fundamentals of Banking Awareness and EconomicsDifferent Important Concepts of Economics Classification of Economy The study of econornics can be done under the two major classifications. They are microeconomics mactoeconomnies. Microeconomics It is a branch of economics that studies the. behavior of individuals and firms in making decisions regarding the allocation of limited resources, It applies to markets where goods or services are bought and sold. Microeconomics examines how these decisions and behaviors affect the supply anddemandfor goods and services, which determines prices, and how prices, intum, determine the quantity supplied and quantity demanded of goods and services. Micro-economyisalso called price theory, Macroeconomics It is a branch of economics dealing with the performance, structure, behavior, and decision- making of an economy as a whole, rather than individual markets. This includes national, regional, and global economies. Macroeconomists study aggregated indicators such as GDP, unemployméhityrates, and price indexes to understand. how the whole economy functions Macroeconomists develop models that explain the relationship between-such factors 2s national income, output, consumption, unemployment, inflation, savings, investment, international trade and international. finance. In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable. Multiplier process in economics theory is conventionally taken to mean income of an economy grows ‘on account of an initial investment. For example, ‘suppose variable x changes by 4 unit, which causes another variable y to change by M units. Then the Ragnar Anton Kittil Frisch He was a Norwegian economist and the co-winner with Jan Tinbergen of the first Nobe! Memorial Prize in Economic Sciences in 1969. He is known for haying founded the discipline of econometrics, and in 1933 to have created the widely used term pair macroeconomies/microeconomics. Economic Activity Economic activities are those efforts which are undertaken by man to earn Income, Money, and Wealth for his life and to secure maximum satisfaction of wants with limited and scarce means or“Human activities which are performed in exchange for money or money's worth are called economic activities."E.g. A worker works in a factory and gets wages, a teacher teaching students in his class, a teacher teaching students under Sarva Shiksha Abhiyan, a teacher providing consultancy services from his residence, production of wheat by a farmers, production of medicines by a company, services given by anurse in hospital etc. Non-Economic Activities Human activities which are not performed for money or money's worth are called non-economic activities. “Here, there is no monetary consideration in exchange for such activities E.g. A person goes to temple; a boy helps his friend in studies, a teacher teaching his own daughter at home, services done by a house-wife in her own house are not included in the production eto. Production Production is a process of combining various material inputs and immaterial inputs in order to make something for consumption (the output).n economics: production means creation or an addition of utility. Production function expresses the technological relationship between physical inputs or initial Fundamentals of Banking Awareness and Economics a€CL PDP Page 33inputs and final output. The output is the function of input, According to Adam Smith the basic object of all production is to satisfy human wants. Factor of production is an economic term to describe the inputs that are used inthe production of goods and services in an attempt to make profit. Production includes many factors such as land, labour, wages etc, Economists divide the factors of production into four categories, they are (1) Land, (2) Labour, (3) Capital (4) Entrepreneurship or organisation. The cost of production includes the following elements 1) Wages of labour 2) Rent on land and building 3) interest on capital 4) The normal profit of the entrepreneurship is also included in the cost of production, because entrepreneurial ability is a special kind of labour that organizes the process of production and makes business to run into profit. The Cost of production of the producer is given by the sum of wages, interest, rent and normal or net profit (the remuneration of the entrepreneur in production is net profit). Surplus earned by a factor other than land inthe short period referred as quasi-rent and rent accrues to land which is fixed in supply even in the longer run. Itis permanent. In contrast to it is a quasi rent, introduced by Marshall, which is inelastic in the short run, but elastic in the long run, Production isneeded for creating demand, Demand and Supply In classical economic theory, the relation between these two factors determines the price of a commodity. This. relationship is thought to be the driving force ina free market/It concludes that ina competitive market, the unit price for a particular good, or other traded item such as labor or liquid financial assets, will vary Unti.it setties at a point where the quantity demanded will equal the quantity supplied , resulting in an economic equilibrium for price and quantity transacted. Demand in economics means demand backed by the purchasing power. Equilibrium price is determined by demand and supply or equlity between marginal cost and marginal revenue. One of the essential conditions of perfect competition is only one price for identical goods at any time (homogeneous a€CL Page 34 commodity) and there must be a large number of sellers or firms. Demand of commodity mainly depends on purchasing power of buyer and ‘extension or contraction of quantity demanded of a commodity is a result of change in the unit price of the commodity. For example a fall in demand or rise in supply of a commodity decrease the price of that commodity vice-versa. The supply function expresses the relationship between the price and output, The four basic laws of supply and demand are 1, if demand inereases (demand curve shiftsto the ight) and supply remains unchanged, a shortage ‘cours, leading toa higher equilibrium price. 2. if demand decreases (demand curve shifts to the left) andsupply remains unchanged, a surplus occurs, leading to a lower equilibrium price. 3. If demand remains unchanged and supply increases (supply curve shifts to the right), a surplus occurs, leading to a lower equilibrium price. 4) If demand remains unchanged and supply decreases (supply curve shifts to the left), a shortage occurs, leading to a higher equilibrium price. Equilibrium is @ condition that can change only if some internal factors changes (such as changes in demand and supply within the country) Joint Demand Goods Demand for complementary goods is known as joint demand goods. Joint demand occurs when demand for two goods is interdependent. It is a characteristic of certain products (such as tea and coffee, cars and tires, car and diesel, bread and butter, razor and razor blades, toothpaste and toothbrushes) which are used together and where a change in the demand for one causes a similar change in the demand for the other. While the quantity demanded of both will increase or decrease together, their prices may change at a different rate depending on the availability of substitutes. For example if the price of tea falls, demand for coffee will decrease, because both tea and coffee are substitutes to each PDP Fundamentals of Banking Awareness and Economicsother to a great extent Hence, the rise in price of one causes the increase in demand of the other and vice- versa Composite Demand Goods Demand for @ good that has multiple different uses. Eg. People may demand oil because it can be used to create either petrol or plastics. People may demand wheat for producing bread, biofuels or feeding livestock Land can be used for farming or building houses. Stee! could be used for building tanks oF it could be used for building bicycles. Cross Demand or Cross-price Elasticity of Demand In economics, the cross elasticity of demand or cross-price elasticity of demand measures the responsiveness of the demand for a good to a change in the price of another good. It is measured as the percentage change in demand for the first good that ocours in response to.@ percentage change in the price of second good. For example cross elasticity of demand between petrol and car is negative, because 10% increase in the price of fuel, the demand for new cars that are inefficient decreased by 20%. Joint Supply Goods It is an economic term referring to'a product or process that can yield two or more outputs. Common examples occur within the livestock industry: cows'¢an.be utilized for milk, beef andhide; sheep canbe utilized for meat, wool and sheepskin Ifthe supply of cows increases, so willthe supply of dairy and beef products. Where joint supply exists, the supply and demand for each product is linked to the others originating from the same source, For example, if demand increases for wool, and sheep farmers therefore raise more animals for wool, there will eventually be increased sheep meat production, resultingin greater meat supply and potentially lower prices. Inelasticity of Demand When the percentage change in quantity demand is less than the percentage change in price, a€CL Fundamentals of Banking Awareness and Economics then the demand for the commodity is said to be inelasticity. For certain goods called necessities (perfectly inelastic); demand is not relatedto income Demand for salt does not increase with increase in income and does not decrease with decrease in income, It means that it is irrespective of income, The demand curve slopes downward for goods like salt, but itis inelastic. Elasticity of Demand Price elasticity of demand refers to the degree of responsiveness of quantity demanded to change in price of goods (the demand for those goods which are having more than one use is said to be elastic. Elasticity is expressed by the formula 1>e>0in relative inelastic. For example electricity, because electricity can be used for number of purposes like lightening, cooking, cooling eto. If the electricity bill increases people utilize it for only purpose and if the bill falls people Use it for a number of other unimportant purposes. Perfectly elastic means an infinitesimally small change in price results in an infinitely large change in quantity demanded orsupplied. This elasticity alternative exists when the price is fixed, that is, an infinite range of quantities is associated with the same price. Economic rent does not arise when the supply of a factor unit is perfectly elastic, because the actual earnings andtransfer earings are equal Effective Demand Ineconomics, Effective Demand (ED) ina market is the demand for a product or service which occurs when purchasers are constrained in a different market. It depends on supply price. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market, In the aggregated market for goods in general, effective demand is the same thing as aggregate demand when the demand for goods is irfluencedby spillovers from quantity constraints from other markets, The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices, PDP Page 35‘Supply of Labour Itrefersto the number of hours of a given type of labour which will be offered for hire at different wage rates, usually is found that higher the wage rates larger is the supply indicating a direct relationship that exists between wage rate ie. the price of labour and labour hours supplied. The supply of labour is very much affected by the work leisure ratio which in tern is affected by the changes in wage rates. The supply of labour in economy depends on various economic and non economic factors such as, population, sex composition, age composition of the population, willingness towork, wage rates, migration and immigration; working hours, social attitude and standard, legal barriers, education and training, employer'sattitude, labour supply and leisure. In labour surplus economy labour intensive technique are chosento be used Real Wage Rate The term real wages refers to wages that have been adjusted for inflation, or, equivalently, wagesin terms of the amount of goods and services that can be bought or purchasing power of worker's earnings. This term is used in contrast to nominal wages or unadjusted wages, Because it has been adjusted to account for changesinthe prices of goods and services, real wages provide a clearer representation of an individual's wages in terms of what they can afford to buy with those wages - specifically, in terms of the amount of goods and services that canbe bought. However, real wages suffer the disadvantage of not being well defined, since the amount ofinflation (which can be calculated based on different combinations of goods and services) isitself notwell defined, Hence real wage defined as the total amount of goods and services that can be bought with a wage, is also not defined This is due to the fact that changes in the relative prices of goods and services will change the financial comparability of various bundles of goods and services, Utility and Usefulness Ineconomics, utility is a representation of preference over some set of goods and services. Preference has a utility representation so long as they are transitive, complete, and continuous. Usefulness a€CL Page 36 refers to what extent something is useful and the utility is the quality of that piece in practical use. Both are inter-related terms. Utility is a factor of usefulness term. Usefulness means having practical utility of @ piece which is beneficial, pertinent and functional. If the total utility is maximum at a point, then marginal utility is zero. Consumption Function The consumption functions mathematical formula laid out by famed economist John Maynard Keynes, The formula was designed to show the relationship between real disposable income and consumer spending, the latter variable being what Keynes considered the most important determinant of short- term demand in an economy. Classification of Goods in Economics 1. Consumer Good or Final Good Ineconomies, any commodity which is produced and subsequently consumed by the consumer, to satisfy its current wants or needs or goods which are meant either for consumption or for investment are called consumer good or final good. Consumer goods are goods that até ultimately consumed rather than usedin the production of another good. For example, a microwave oven or a bicycle which is sold to a consumer or a refrigerator operating in a chemist’s shop is a final good or consumer good. When used in measures of Nationallinoome and output, the term ‘final goods” only includes new goods. For instance, the GDP excludes items counted in an earlier year to prevent double counting of production based on resale of the same item second and third hand. inthis context the economic definition of goods includes what are commonly known asservioes. 2. Intermediate Goods or Intermediate consumption Intermediate goods or producer goods or semi- finished products are goods, such as partly finished goods, usedas inputs in the production of other goods including final goods. A firn may make andthen use intermediate goods, or make and then sell, or buy then use them. In the production process, intermediate goods either PDP Fundamentals of Banking Awareness and Economicsbecome part of the final product, or are changed beyond recognition in the process. For examples Sugar is used as a final good (when itis sold as sugar in the supermarket) or as an input (when it is used to make candy), Steel is a raw material used in the production of many other goods, such as bicycles and payment of water charges by the farmers to the government represents, ahammerinthe hands ofa house-wife, a camera in the hands of professional photographer, expenditure on advertisement and public relations by an enterprise are also a parts ofits intermediate consumption. Value of out put and value added can be distinguished if we know the value of intermediate consumption. 3, Manufactured Goods Manufactured goods are goods that have been processed in any way. As such, they are the opposite of raw materials, but include intermediate goods as well as final goods. 4, Economic Goods Alllof the goods which are scarce and limited in supply are called as economic goods. 5. Capital or Producer Goods A capital good is a durable good (ane that does, not quickly wear out) that is used in the production of goods or services. Gapital goods ate one of the three types of producer goods, the other fvo\being land and labor, which are also known collectively as primary factors of production. Capital goods are acquired by a society by Saving wealth which can be invested in the means of production. In terms of economics one can consider capital goods to be tangible. They are used to produce other goods or services during a certain period of time Machinery, plant, tools, buildings, computers, or other kind of equipment that is involved in production of other things for sale represent the term of a Capital good. The owners of the Capital good can be individuals, households, corporations or governments. Any material that is used in production of other goods also is considered to be capital good a€CL Fundamentals of Banking Awareness and Economics 6. Inferior Good In economics, an inferior good is a good that decreases in demand when consumer income rises (or rises in demand when consumer income decreases), unlike normal goods, for which the opposite is observed Normal goods are those for which consumers’ ‘demand inoreases when their income inoreases. This would be the opposite of a superior good, one that is often associated with wealth and the wealthy, whereas an inferior good is often associated with lower socio-economic groups In case of inferior good, the income elasticity of demand is negative. 7. Normal Goods In economics, normal goods are any goods for which demand inereases when income increases, and falls when income decreases but price remains constant, Le. with a positive income elasticity of demand, The term does not necessarily tefer to the quality of the good, but an abnormal good would clearly not be in demand, except for possibly lower socioeconomic groups. 8. Superior goods ‘Superior goods make up a larger proportion of ‘consumptionas income rises, and therefore are a type of normal goods in consumer theory. Such a good must possess two economic characteristics: it must be scarce, and, along with that, it must have a high price. The scarcity of the good can be natural or artificial; however, the general population (i.e. consumers) must recognize the good as distinguishably better. Possession of such a good usually signifies “superiority” in resources, and usually is accompanied by prestige. 9. Value-Added Goods It is an economic term to express differences between the value of goods and the cost of materials or supplies that are used in producing them. It is the goods and services less cost of intermediate goods and services. PDP Page 3710. Human Capital Human capital is the stock of knowledge, habits, social and personality attributes, including creativity, embodied in the ability to performlabor 80 as to produce economic value or it is about the Knowledge, technical skill, education etc. in economics are regarded as human capital Market Terms The term ‘market’ in economics means a central place where exchange of any type of information, goods and services takes place, Economists assume that there are a number of different buyers andssellers in the marketplace. This means that we have competition in the market, which allows price to change in response to changes in supply and demand. The market price is related to very short period in which supply being fixed, price is determined by demand Needs, wants and demands Needs,wants and demands are a part of basic marketing principles. Though they are 3 simple words, they hold a very complex meaning behind them along with a huge differentiation factor, Infact, a product can be differertiatedon the basis of whether it satisfies a customer's needs, wants or demands, A want becomes a demand only when it is backed by the ability to purchase. Needs Human needsae the basic requirements andinolude food clothing and shelter. Without these. humans cannot survive. An extended part of needs today has become education and healthcare. Generally, the products which fallunder the needs category of products do not require a push. Instead the customer buys it themselves. But in today's tough and competitive world, so many brands have come up with the same offering satisfying the needs of the customer that even the "needs category product” has to be pushed in the customers mind. Example of needs category products / sectors — Agriculture sector, Real Estate (land always appreciates), FMCG, ete Page 38 a€CL Wants Wants are a step ahead of needs and are largely dependent onthe needs of humans themselves. For example, you need to take a bath. But i am sure you take baths with the best soaps, Thus Wants ate not mandatory part of life. You dont need a good smelling soap. But youwill definitely use it because itis your want, Example of wants category products / sectors’— Hospitality industry, Electronics, Consumer Durables etc., FMCG, etc Demands You might want a BMW or a Mercedes for a car. You might want to go for a cruise, But can you actually buy a BMW or go on a cruise? You can provide you have the ability to buy a BMWorgo on actuise, Thus @ step ahead of wants is demands. When an individual wants something which is premium, but he also has the ability to buy it, then these wants are converted to demands. The basic difference between wants and demands is desire. A customer may desire something but he may not be able to fulfill his desire. Example of demands — Cruises, BMW's, 5 star hotels etc. Types of Market Seller's Market Asseller's market is the one where the demand is larger than the supply, People have more money to spend on real estate, so sellers will often see several buyers competing to buy their property, which drives up the price. This means that buyers will have to spend more to get what they want Buyer's Market A situation in which supply exceeds demand, giving purchasers an advantage over sellers in price negotiations. Buyer's Merket is commonly used to describe real estate markets, but it applies to any type of market where there is more product available than there are people who want to buy it. The opposite of a buyer's market is a seller's: market a situation inwhich demand exceeds supply and owners have an advantage over buyers in price negotiations, Fundamentals of Banking Awareness and Economics PDPTypes of costs 1. Selling Cost Itis total cost of marketing, advertising and selling a product It influences the commercial desire to purchase a commodity. 2. Production Cost It is the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, or land) and taxation, 3. Prime Costs Prime costs are the sum of all direct costs such as direct materials, direct labor and any other direct costs. It is equal to variable cost plus administrative cost. 4, Conversion Costs Conversion costs are all costs incurredto convert the raw materials to finished products and they equal the sum of direct labor, other direct costs (other than materials) and manufacturing overheads. 5. Variable Gost Variable costs are costs that change in proportion to the good or service that a business produces. Variable costs are also the sumof marginal costs over all Units produced, They can also be considered notmal costs. For example wages paid to Workers, because it may vary depends upon the number of hours employee worked, salaries of administrative staff, 6. Fixed Cost In economies, fixed costs, indirect costs or ‘overheads are business expenses that are not dependent on the level of goods or services produced by the business, They tendito be time- related, such as salaries or rents being paid per month, and are often referred to as ‘overhead costs. For examples rent on land, municipal taxes, insurance charges, property taxes, electricity taxes. Fundamentals of 22CL Banking Awareness and Economics 10. PDP Average Cost In economics, average cost and or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). it is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). a U shaped curve, the average cost per unit begins high and drops as production increases. Eventually, the cost begins to rise again as marginal costs increase. Itis so called because, when piotted on a chart, the cost curve looks like the letter U. Average Fixed Cost (AFC) In economics, average fixed cost (AFC) is the fixed costs of production (FC) divided by the ‘quantity (@) of output produced, Fixed costs are those costs that must be inourred in fixed quantity regardless of the level of output produced. Average fixed cost is a per-unit-of- output measure of fixed costs. As the total number of units of the good produced increases, the average fixed cost decreases because the same amount of fixed cost being spread over a larger number of units ‘of output Itaverage fixed cost curve never be’ U'shaped Total Cost In economies and cost accounting, total cost (TC) describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and inolude inputs (capital) that cannot be varied in the short term, such as buildings and machinery. Total costin economies includes the total opportunity cost of each factor of production as part of its fixed or variable costs. Full cost Full cost pricing is a practice where the price of a product is calculated by a firm on the basis of its direct costs per unit of output plus a markup to cover overhead costs and profits. Under full Page 39n. cost pricing, price is determined by adding a margin to the average cost. Marginal Cost In economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit. Thatis, it is the cost of producing one more unit of a good or the addition to total cost by producing an additional unit of output by a firm is called marginal cost. In general terms, marginal cost at each level of production includes, any additional costs required to produce the next unit, For example, if producing additionel vehicles requires building a new factory, the marginal cost of the extra vehicles includes the cost of the new factory. In practice, this analysis is segregated into short and long-run cases, so that over the longest run, all costs become marginal. At each level of production and time period being considered, marginal costs include alll costs that vary with the level of production, whereas other costs that do not vary with production are considered fixed, Its curve will be in'U’ shaped sometime 12. Opportunity Cost 13. Page 40 The opportunity cost of a choice is the value of the best alternative(cost}forgone or transfer earnings is known as opportunity cost., where a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the “cost” incurred. by not enjoying the benefit that would be had by taking the second best choice available ‘Sunk Cost An expenditure that has been made and can not be recovered or itis a cost that has already been incurred and cannot be recovered is called sunk cost. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken, Both retrospective and prospective costs may be either fixed (continuous for as long as the a€CL business is in operation and unaffected by output volume) or variable (dependent on volume) costs. 14. Implicit Cost 15. In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is, the opportunity cost equal to what a firm must give up inorder to use factor of production which italready owns and thus does not pay rent for. It is the opposite of an explicit cost, which is bone directly, Injother words, an implicit cost is ary cost that results from using an asset instead of renting it out or selling it. The term also applies to foregone income from choosing not to work. Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since ‘economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profit. The non-expenditure costs which arise when the producing firm itself ‘owns and supplies certain factors of production are implicit cost. Explicit Cost An explicit cost is a direct payment made to others in the course of running a business, ‘such as wage, rent and materials, as opposed to implicit costs, which are those where no actual payment is made. It is possible still to underestimate these costs, however: for ‘example, pension contributions and other perks” must be taken into account when considering the cost of labour. Explicit costs are taken into account along with implicit ones when considering economic profit. Accounting profit only takes explicit costs into account 16. Original Cost PDP ‘The total costs associated with the purchase of an asset. The original cost of an asset takes into consideration all of the costs that can be attributed to its purchase and to puttingthe asset to use. These costs can include such factors as the purchase price, commissions, transportation, appraisals, warranties and Fundamentals of Banking Awareness and Economicsinstallation. Original cost can be used to value an asset type, including equipment, real estate and security instruments, 17. Replacement Cost The term replacement cost or replacementvalue refers to the amount that an entity would have to pay to replace an asset at the present time, according to its current worth. In the insurance industry, "replacement cost” or “replacement cost value" is one of several method of determining the value of an insured item. Replacement cost is the actual cost to replace an item or structure at its pre-loss: condition. This may not be the ‘market value" of the item, andis typically distinguished from the “actual cash value” payment which includes a deduction for depreciation. For insurance policies for property insurance, a contractual stipulation that the lost asset must be actually repaired or replaced before the replacement cost can be paid is common. This\prevents over insurance, Which contributes to atson and insurance fraud. Replacement cost policies emerged in the mid- 20th century; prior to that concern about over insurance restricted their availability 18, Total Product Total products the overall quantity of output that a firm produces, usually specified in relation to a variable input, Total product is the starting point for the analysis of short-run production. Itindicates how much output a firm can produce adcordingto the law of diminishing marginal returns. 19. Marginal Product In economics and in particular neoclassical economics, the marginal product or marginal physical product of an input (factor of production) is the change in output resulting from employing ‘one more unit of a particular input (for instance, the change in output when a firm's labor is increased from five to six units), assuming that the quantities of other inputs are kept constant When the total product rises at an increasing rate, the total marginal product also rises. 20. Average Product Average Product is defined as the product produced by every worker. (Total Product)/ (Variable Inputs Employed = Average Product. When average cost is declining as output increases, marginal cost is less than average cost. When average cost is rising, marginal cost is greater than average cost. When average cost is neither rising nor falling (at a minimum or maximum), marginal cost equals average cost. 21. Duel Pricing The practice of setting prices at differentlevels depending on the currency used to make the purchase or price fixed by government and price in open market, Dual pricing may be used to accomplish a variely of goals, such as to gain entry into a foreign market by offering unusually low prices to buyers using the foreign currency, or as@imethod of price discrimination 22. Division of Labour The division of labour is the specialization of cooperating individuals who perform specific fasks and roles. Because of the large amount of labour saved by giving workers specialized tasksin Industrial Revolutionary-era, Asitis the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragementto dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has oceasion for, Demand for labour is called derived labour. 23. Consumer Sovereignty The concept that under a system of free enterprise, it is consumers who decide what goods and services shall be produced and in what quantities or it is a system where Fundamentals of Banking Awareness and Economics a€CL PDP Page 41buyers ultimately determine which goods and services remain in production or consumers are free to spend their income as they like is knownas consumer sovereignty. 24, Consumer protection It is @ group of laws and organizations designed to ensure the rights of consumers as well as fair trade, competition and acourate information in the marketplace. The laws are designed to prevent businesses that engage in fraud or specified unfair practices from gaining an advantage over competitors. 25. Consumer Preference/Choice Consumer preference® is @ marketing term meaning a consumer likes one thing over another or the theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. Itanalyzes how consumers maximize the desirability of their consumption as measured by their preferences ‘subject to limitations on their expenditures, by maximizing utility subject to a consumer budget constraint. 26. Producer surplus Itis defined as the difference between the amount the producer is willing to supply goods for and the actual amount received by him when he makes thejtrade or the excess of price a person is to pay rather than forgo the consumption of the commodity is called producer surplus. Producer surplus is a measure of producer welfare 27. Consumer Surplus Itis the difference between the total amount that, consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (ie. the market price) If the consumer is willing to pay more than the current asking price, then they are getting more benefit from the purchased product that they spent to buy it. Consumer Surplus is highest inthe case a€CL Market Types(Based on competition) 1. Monopoly Market Amonopoly is @ market structure in which there is only one producer/seller for a product. In other words, the single business is the industry Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity and tooth paste is a product sold under monopolistic competition. Monopoly market is also example for imperfect competition. Unlike perfect competition, the firm maintains spare capacity or excess capacity because it can easily accommodate an increase in produstion. This excess capacity is the major social cost of a monopolistic competitive market structure. The marginal revenue of a monopolistis less than or equal tothe price of good. The degree of monopoly power is to be measured in terms of firms supernormal profit, They are the six characteristics of — monopolistic competition,1) Existence of large number of firms 2) Product differentiations3) Some luence over the price 4) Absence of firm's interdependence 5) Non-price competition 6) Freedom of entry and exit. Bilateral Monopoly Market A bilateral monopoly is a market structure consisting of both a monopoly (a single seller) and a monopsony (a single buyer) Oligopoly Market inan oligopoly, there are only a few firms that make up an industry. This select group of firms has control over the price and, like a rnonopoly; an oligopoly has high barriers to entry. The products that the oligopolistc firms produce are often nearly identical and, therefore, the companies, which are competing for market share, are interdependent as a result of market forces. Assume, for example, that an economy needs only 100 widgets. Company X produces 50 widgets and its competitor, PDP Fundamentals of Banking Awareness and EconomicsCompany Y, produces the other 60. The prices of the two brands will be interdependent and, therefore, similar. So, f Company X starts selling the widgets at a lower price, it wll get a greater market share, thereby forcing Company Y to lower its prices as well 4, Perfect Market Thereare two extreme forms of market structure: monopoly and, its opposite, perfect competition Perfect competition is characterized by many buyers and sellers or large firms, many products that are similar in nature (identical and homogeneous) and, as a result, many substitutes. Perfect competition means there are few, if any, barriers to entry for new companies, and prices are determined by supply and demand. Thus, producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. Under the perfect competition average revenue (marginal cost) is equal to the marginal revenue. For example, in a perfectly competitive market, shoulda single firm decide to increase its selling price of a good, the consumers can just turn to the nearest competitor for a better price, causing any firm that increases its prices to lose market share and profits. Different firms constituting the industry, produce homogeneous and identical goods under the perfect ‘competition. In a perfect competition if a firm is operating at loss in the short-period, it should continue to operate as long as it covers even the variable cost. Equilibrium is a condition that can change only if some internal factor changes. The equilibrium of a firm under perfect competition will be determined when marginal revenue of a firm is equal to the marginal cost. Equilibrium in perfect competition is the pointwhere market demands are equal to market supply or marginal revenue with marginal cost. Under the perfect competition, the firm faces a horizontal demand curve. Itcan sell any quantity desired at the market price, but can not sell anything above the market price. Important Notes 1. Diamonds are priced higher than water because marginal utility of diamond is higher than that of water (Study Adam Smith water diamond puzzle) 2. Gold is mainly related to international market 3. Income and consumption are directly related or positively related because the income effect ineconomics can be defined as the change in consumption resulting from @ change in real income Fundamentals of Banking Awareness and Economics aéCL | PPP Page 43Important International Institutions 1. International Monetary Fund The International Monetary Fund (IMF) is an international organization headquartered in Washington, DG, of "188 countries According tothe IMF itself, tt works to foster global growth and economic stability by providing policy, advice and financing to members, by working with developing nations to help them achieve macroeconomic stability, and by reducing poverty, Formed in 1944 at the Bretton Woods: Conference, it came into formal existence in 1945 with 29 member countries andthe goal of reconstructing the international payment system. Countries contribute funds to a pool through a quota system from which countries with payment imbalances can borrow. Through this fund, and other activities such as statistics keeping and analysis, surveillance of its members’ economies and the demand for self-correcting policies, the IMF worksto improve the economies of its member countries. The organization's objectives stated in the Articles of Agreement are: to promote international economic cooperation, international trade, employment, and exchange-rate stability, including by making financial resources available to member countries to meet balance-of-payments needs. 2. World Bank The World Bank-is:an international financial institution that provides loans to developing countries for capital programs. It comprises two institutions: the International Bank for Reconstruction and Development (IBRD) and the Intemational Development Association (IDA). The World Bank is a component of the World Bank Group, and a member of the United Nations Development Group. ‘The World Bank's official goalis the reduction of poverty. According to its Articles of Agreement, al its decisions must be guided by a commitment to the promotion of foreign rae aCL investment and international trade and to the facilitation of capital investment. The World Bank is notto be confused with the United Nations World Bank Group, a member of the United Nations Economic and Social Council, and a family of five international organizations that make leveraged loans to poor countries: {i) International Bank for Reconstruction and Development (IBRD), {ii) International Development Association IDA), (ii) Intemational Finance Corporation (IFC), (iv) Multilateral Investment Guarantee Agency (MGA), (v) International Centre for Settlement of Investment Disputes (ICSID). (i) International Bank for Reconstruction and Development (IBRD) It is an international finanoial institution that offers loans to middle-income developing countries. The IBRD is the first of ive member institutions that compose the World Bank Group and is headquartered in Washington, D.C., United States. It was established in 1944 with the mission of financing the reconstruction of European nations devastated by World War II The IBRD and its concessional lending arm, the International Development Association, are collectively known as the World Bank as they share the same leadership and staff. (ii) International Development Association (IDA) itis an international financial institution which offers concessional loans and grants to the world’s poorest developing countries. The IDA isa member of the World Bank Group and is headquartered in Washington, D.C., United States. It was established in 1960 to complement the existing International Bank for Reconstruction and Development by lendingto PDP Fundamentals of Banking Awareness and Economicsdeveloping countries which suffer from the lowest gross national income, from troubled creditworthiness, or from the lowest per capita income. (iii) Intemational Finance Corporation (IFC) It is an international financial institution that offers investment, advisory, and asset management services to encourage private sector development in developing countries. The IFC is a member of the World Bank Group and is headquartered in Washington, D.G., United States. It was established in 1956 as the private sector arm of. the World Bank Group to advance economic development by investing in strictly for-profitand commercial projects that purport to reduce poverty and promote development. {iv) Multilateral Investment Guarantee Agency (MIGA) It is an international financial institution which offers political risk insurance and credit enhancement guarantees. Such guarantees help investors protect foreign direct investments against political and non- commercial risks in developing countries. MIGA is a member of the World Bank Group and is headquartered in Washington, D.C., United States. It was established in 1988 as an investment insurance facility to encourage confident investment in developing countries, MIGA's stated mission is “to promote foreign direct investment into developing countries to support economic growth, reduce poverty, and improve people's lives”, The agency focuses on member countries ofthe Intemational Development Association and countries affected by armed conflict {v) International Centre for Settlement of Investment Disputes (ICSID) Itis an international arbitration institution which facilitates legal dispute resolution and conciliation between international investors. The ICSID is a member of the World Bank Group, from which itreceives funding, and is headquartered in Washington, D.C., in the United States. It was established in 1966 as Fundamentals of Banking Awareness and Economics a€CL an autonomous, multilateral specialized institution to encourage international flow of investment and mitigate non-commeroial risks bya treaty drafted by the Intemational Bank for Reconstruction and Development's executive directors and signed by member countries. 3, Asian Development Bank (ADB) It is a. regional development bank established ‘on 22 August 1986 which is headquartered in Metro Manila, Philippines, main motto is fighting poverty in Asia and the Pacific and to facilitate economic development in Asia. The bank admits the members of the United Nations Economic and Social Commission for ‘Asia and the Pacific (UNESCAP. formerly the Economic Commission for Asia andthe Far East or ECAFE) and non-regional developed countries, From 31 members at its establishment, ADB now has 67 members, of which 48 are from within Asia and the Pacific and 19 outside. The ADB was modeled closely ‘onthe World Bank, and has a similar weighted voting system where votes are distributed in proportion with members’ capital subscriptions, ‘Since 2014, ADB releases annual report of Creative Productivity Index and comparatively inoludes Finland and United States for the list of Asia-Pacific members. Atthe endof 2013, Japan holds the largest proportion of shares at 15.67% The United States holds 15.56%, China holds 6.47%, India holds 6.36%, and Australia holds 5.81% 4, New Development Bank or BRICS Bank The New Development Bank (NDB), formerly referred to as the BRICS Development Bank, it is a multilateral development bank operated by the BRICS states (Brazil, Russia, India, China and South Africa) as an alternative to the existing American and European-dominated World Bank and international Monetary Fund The goal of the bank is to “mobilize resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries”, The bank is headquartered in Shanghai, China, Each participant country holds an equal number of shares and equal voting Tights, and none of the countries will have PDP Page 45Page 48 veto power. There will be 1 million shares with value of USD 100 000 (initially USD 600 000 shares), 20% of which will have to be directly paid in to the bankin the first 7 years after entry into force. The 7th BRICS summit (held in Ufa, Russia) in July 2015 marked the entry into force of the Agreement. On 11 May 2045, K. V. Kamath was appointed as the first President of the Bank. Organisation for Economic Co-operation and Development (OECD) Itis an intemational economic organisation of 34 countries, founded in 1961 to stimulate economic progress and world trade. The OECD's headquarters are at the Chateau de la Muette in Paris, France. It is a forum of countries describing themselves as committed to democracy and the market economy, providing a platform to compare policy experiences, seeking answers to common problems, identify good practices and coordinate domestic and international policies of its members, World Trade Organization (WTO) It is an intergovernmental organization which regulates international trade. The WTO officially commenced on 1 January 1995 under the Marrakech Agreement, signed by 123 nations on 15 April 1994, replacing the General ‘Agreement on Tariffs and Trade (GATT), which commenced in 1948,The WTO deals with regulation of trade between participating countries by providing a framework for negotiating trade agreements anda dispute resolution process aimed at enforcing participants’ adherence to WTO agreements, whieh are signed by representatives of member governments and ratified by their parliaments. Most of the issues that the WTO focuses on derive from previous trade negotiations, especially fromthe Uruguay Round (1986-1994) ‘Some important apects related with WTO (i) Intellectual property (IP) Rights Itis a term referring to creations of the intellect for which a monopoly is assigned to designated owners by law. Some common types of a€CL (ii) PDP intellectual property rights (IPR) are copyright, patents, and industrial design rights; and the rights that protect trademarks, trade dress, and in some jurisdictions trade secrets: all these cover music, literature, and other artistic works; discoveries and inventions; and words, phrases, symbols, and designs. While intellectual property law has evolved over centuries, it was not until the 19th century that the term intellectual property began to be used, ‘and not until the late 20th century thattit became ‘commonplace in the majority of the world TRIPS Agreement The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) is an international agreement administered by the World Trade Organization (WTO) that sets down minimum standards for many forms of intellectual property (IP) regulation as applied to nationals of other WTO Members. it was negotiated at the end of the Uruguay Round of the General Agreement on Tarifis and Trade (GATT) in 1994.The TRIPS agreement introduced intellectual property law into the intemational trading system for the firsttime and remains the most comprehensive international ‘agreement on intellectual property to date. In 2001, developing countries, concerned that developed countries were insisting onan overly narrow reading of TRIPS, initiated @ round of talks that resulted in the Doha Declaration. The Doha declaration is a WTO statement that Clarifies the scope of TRIPS, stating for example that TRIPS can and shouldbe interpreted in light of the goal “to promote access to medicines for all’ Spectically, TRIPS requires WTO members to provide copyright rights, covering content producers including performers, producers of sound recordings and broadcasting organizations; geographical indications, including appellations of origin; industrial designs; integrated circuit layout-designs; patents; new plant varieties; trademarks; trade dress; and undisclosed or confidential information, A TRIP also specifies enforcement procedures, remedies, and dispute resolution procedures. Fundamentals of Banking Awareness and EconomicsImportant Different Laws, Theories and Graphs of Economics 1. Law of Demand In economics, the law of demand states that, all else being equal, as the price of a product increases (+ ), quantity demanded falls ( | ); likewise, as the price of a product decreases (|), quantity demanded increases (). Insimple words, law of demand means inverse relationship between price and quantity of demand or effect of change in price of a commodity on its price or the demand curve shows that priceand quantity demanded are inversely proportional and inversely related. When there is excess demand of the commodity the prices starts rising and it continues to rise till equilibrium is reached. There is a negative relationship between the quantity demanded of a good and its price. The factors held constant in this relationship are the prices of other goods and the consumer's income, Movement along the ‘same demand curve is knownas increase and decrease of demand. When there is a change indemandjeadingto a shiftof the demand curve to the right, at the same price as before, the quantity demanded will increase; Demand is derived from consumers tastes and preferences, and it is bound by the income. 2. Exceptions to the lawoof demand ‘Ademand curve isa line ora curve showing the relationship between the quantity purchased and their respective prices. A normal demand curve will slope from the left to the right. This is said to be the demand curve for normal goods. There are exceptional like the demand curve for inferior goods or Giffen goods that does not follow this prinoiple. The demand curve for inferior goods for example will have a zero gradient since the changes in prices will Fundamentals of Banking Awareness and CL Economics not affect the quantity demanded from the market, The demand curve whether itis normal ‘or abnormal has certain unique features. For ‘example the demand curve can make some movements on the Cartesian planes when the various factors that influence the quantity demanded are vatied. The movement caneither be along the demand curve or movementaway from the original demand curve. Movement along the demand curve is referred to by economists as either expansion or contraction. The upwards movement along the demand curve is called contraction and the downwards movement along the demand curve is called expansion. Movement along the demand curve is caused only by changes in commodities prices. 3, Giffen good In economics and consumer theory, a Giffen ‘good is a product that people consume more of as the price rises—violating the law of demand. For any good, as the price of the good Tises, the substitution effect makes consumers, purchase less of i, and more of substitute goods; for most goods, the income effect (due to the effective deciine in available income due to mare being spent on existing units of this good) reinforces this decline in demand for the good Buta Giffen goodis so strongly an inferior good (being more in demand at lower income) that this contrary income effect more than offsets the substitution effect, and the net effect of the .good's price rise is to increase demand for i. The demand curve for a Giffen good is upward rising. If a good has negative income elasticity and positive price elasticity of demand is said to be Giffen good. PDP Page 474, Theory of Distribution In economies refers to the way total output, income, or wealth is distributed or equality in the distribution of the income and wealth among individuals or among the factors of production (such as labour, land, and capital). In general theory and the national income andproduct accounts, each unit of output corresponds to a unit of income. One use of national accounts is for classifying factor incomes and measuring their respective shares, as in National Income, But, where foous is on income of persons or households, adjustments to the national accounts or other data sources ate frequently used. Here, interest is often on the fraction of income going to the top (orbattom) X percent of households, the next y percent, and so forth (say in quintiles), and onthe factors that might affect them (globalization, tax policy, technology, etc.). 5. Income elasticity of demand In economics, income elasticity of demand measures the responsiveness of the demand fora goodto a change inthe income of the people demanding the good, ceteris paribus. It is calculatedas the ratio ofthe percentage change in demandto the percentage change in income. For example, if, in response to a 10% increase in income, the demand fora good increased by 20%, the income elasticity of demand would be 20%/10%'=2. A positive income elasticity ‘of demand is associated with normal goods; an increase in income will lead to a rise in demand. If income elasticity of demand of a commodity is less than 1, itis a necessity good. If the elasticity of demand is greater than 4, it is a luxury good or a superior good. A negative income elasticity of demand is associated with inferior goods; an increase in income will ead toa fall inthe demand and may lead to changes to more luxurious substitutes. For example, if the price of an inferior good falls, its demand rises vice-versa, Thus there is an inverse relationship between income and demand of inferior goods. Page 48 a€CL Marginal Utility Curve In economics, the marginal utility of a good or service is the gain from anincrease, or oss from a decrease, in the consumption of that good or service. Economists sometimes speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a good or service yields more utility than the second and ‘subsequent units, with a continuing reduction forgreater amounts. The marginal decision rule states hata good or service should be consumed ata quantity atwhich the marginal utility is equal to the marginal. cost. The marginal. utility curve slopes downward from left to right indicating an inverse relationship between marginal utility and stock of commodity. Gresham's law Gresham's law is an economic principle that states: "When a governmentoyervalues one type of money and undervalues another, the undervalued money will leave the country or cisappear from circulation into hoards, while the overvalued money will flood into circulation.” it is commonly stated as: “Bad money drives ‘out good” or Bad money replaces good money in circulation. This law applies specifically when there are two forms of ‘commodity money in circulation which are required by legal-tender laws to be accepted as, having similar face values for economic transactions. The artificially overvalued money tends to drive artificially undervalued money out of circulation and is a consequence of price control, Break-even point Break-even (or breakeven) is the point of balance between making either a profit or a loss. The term originates in finance, but the concept has been applied widely since. In economics and business, specifically cost accounting, the break-even point (BEP) is the point at which cost or expenses and revenue are equal or average revenue equals average cost there isonet loss or gain, and one has “broken even” A profit or a loss has not been made, although ‘opportunity costs have been “paid,” and capital has received the risk-adjusted, expected return PDP Fundamentals of Banking Awareness and EconomicsItis shown graphically as the point where the total revenue and total cost curves meet. In the linear case the break-even point is equal to the fixed costs divided by the contribution margin per unit. 9. The supply and demand theory of interest According to the classical view, rate of interest is determined by the interaction of supply of and demand for capital. Thus this theory is popularly called as the demand and supply of theory of rate of interest. Rate of interest is determined in the same way as the price of a commodity is determined by the forces of demand and supply. The equilibrium between demand for and supply of capital goes to determine rate of interest 10. Law of Diminishing Returns In economics, diminishing retums (also called law of diminishing returns, law of variable proportions, principle of diminishing marginal productivity or diminishing marginal retums is, the decrease inthe marginal (incremental) output ofa production process as the amount ofa single factor of production is incrementally increased, while the amounts of all other factors of production stay constant, The law of diminishing returns states that in all productive processes, adding more of one factor of production, while holding all others constant (‘ceteris patibus"), will at some point yield lower incremental per-unit returns. According to modern thinking, the:law of diminishing returns applies to all fields of production. Itis prudent to determine the size of the output when the industry is operating in the stage of diminishing returns 11. Engel’s law Itis an observation in economics stating that as income rises, the proportion of income spent on food falls, even if actual expenditure on food rises. In other words, the income elasticity of demand of food is between 0 and 1.The law was named after the statistician Ernst Engel (1821- 1896).Engel's aw doesn't imply that food spending remains unchanged as income a€CL Fundamentals of Banking Awareness and Economics increases: It suggests that consumers increase their expenditures for food products (in % terms) less than their increases in income or it states the relationship between quantity demanded and income of consumers. ‘One application of this statistic is treating it as a reflection of the living standard of a country. As this proportion or “Engel coefficient” increases, the country is by nature poorer, conversely 2 low Engel coefficient indicates a higher standard of living 412. Purchasing power parity (PPP) Theory Purchasing power parity is a componentofsome ‘economic theories and is a technique used to determine the relative value. of different currencies. The concept of purchasing power Parity allows one to estimate what the exchange rate between two currencies would have to be in order forthe exchange to be at par with the purchasing power of the two countries’ currencies. Using that PPP rate for hypothetical currency conversions, a given amount of one currency thus has the sare purchasing power Whether used directly to purchase a market basket of goods or used to convert at the PPP fate to the other currency and then purchase the market basket using that currency. 13. Economic Problem Theory The economic problem—sometimes called the basic, central, or fundamental economic problem—is one of the fundamental economic theoretical principles in the operation of any economy. Itasserts that there is scarcity; that is, that the finite resources available are insufficient to satisfy all human wants and needs. The question then becomes how to determine what is to be produced, and how the factors of production (such as capital and labor) are to be allocated, Economics revolves around methods and possibilities of solving this fundamental economic problem. The economic problem arises mainly due to two facts: human wants are unlimited, butthe means to satisfy human wants are scarce. PDP Page 4914, Malthusian Theory of Population Malthusian theory of population explored the relationship between food supply and population growth. In Essay on the Principle of Population, Matthus proposes the principle that human populations grow exponentially {ie., doubling with each cycle) while food production grows at an arithmetic rate (i.c by the repeated addition of a uniform increment ineach uniform interval of time). Thus, while food ‘output was likely to increase in a series of twenty-five year intervals in the arithmetic progression 1, 2, 3, 4, 5, 6, 7, 8, 9, and soon, population was capable of increasing in the geometric progression 1, 2, 4, 8, 16, 32, 64, 128, 256, and soforth. This scenario of arithmetic food growth with simultaneous geometriehuman population growth predicted a future when humans would have no resources to survive on To avoid such a catastrophe, Malthus urged controls on population growth 16. Liquidity Preference Theory In macroeconomic theory, liquidity preference refers to the demand for money, considered as liquigity or holding assets in the form of cash. The concept was first developed by John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936) to explain determination of the interest rate by the supply and demand for money. The demand for money as@nasset was theorized to depend on the interest foregone by notholding bonds (here, the tem “bonds” can be understood to also represent stocks and other less liquid assets in general, 2s wellas government bonds). Interest rates, he argues, cannot be a reward for saving as such because, ifa person hoards his savings in cash, Keeping it under his mattress say, he will receive no interest, although he has nevertheless refrained from consuming all his current income, Instead of a reward for saving, interest, in the Keynesian analysis, is a reward for parting with liquidity. According to Keynes, money is the most liquid asset. Liquidity is an attribute to an asset. Page 50 a€CL 16. 17. 18. Keynes’s PDP Ramsey rule The Ramsey rule for optimal excise taxation suggests that goods should be taxed in inverse proportion to their elasticity’s of demand or if the main objective of the government is to raise revenue, it should tax commodities with low elasticity of demand. This analysis shows that when the political process that determines tax rates is taken into account, the Ramsey rule may not be superior to a fiscal constitution, that specifies that all goods are taxed at the same rate, The information necessary to set taxes in conformance with the Ramsey tule is not directly observable, which will lead to rent-seeking activities as interest ‘groups try to influence the political determination of tax rates they face. Furthermore, incentives in the political process work against setting taxes according to the Ramsey rule, Building on Buchanan's work on optimal taxation and the nature of the fiscal constitution, the Ramsey tule should be reconsidered as a guide to optimal excise tax polly. Total Fixed Cost Curve ‘Acourve that graphically represents the relation between total fixed costs incurred by a firm in the short-run product of a good or service and the quantity produced, This curve is constructed to capture the relation between total fixed cost and the level of output, holding other variables, like technology and resource prices, constant Because total fixed cost is, in fact, fixed, the total fixed cost curve is, in fact, a horizontal line. The total fixed cost curve is one of three total cost curves, the other two are total cost curve and total variable cost curve. Psychological Law of Consumption Keynes promulgated a law standing on the study ‘of consumption function. This law explained the functional relationship between income and consumption expenditure. This law is called the Psychological Law of Consumption or the Fundamental Law of Consumption, This law consists of the following three related propositions:(a) When total income amplifies, Fundamentals of Banking Awareness and Economicsexpenditure on consumption will also augment but by rather less significant amount (b) The 2nd proposition is that when revenue increases, the addition of income will be alienated in some ratio between consumption and savings.(c) The 3rd proposition integratedin Keynes's Psychological Law of consumption is that as revenue increases, both saving and consumption spending will go up. 19. Supply curve In economics, graphic representation of the relationship between product price and quantity of product that a seller is willing and able to supply. Product price is measured onthe vertical axis of the graph and quantity of product supplied on the horizontal axis, Inmost cases, the supply curve is drawn as a slope rising upward from left to right, since product price and quantity supplied are directly related (ie,, 28 the price of a commodity increases in the market, the amount supplied increases). This relationship is dependent on certain ceteris, paribus (other things equal) conditions remaining constant. Such conditions include the number of sellers in the market, the state of technology, the level of production costs, the seller's price expectations, and the prices of related products. A.change in any of these conditions will cause a shift inthe supply curve. A shifting of the curve to the left corresponds to a decrease in the quantity offproduct supplied, whereas a shift to the right refieets an increase. Compare demand curve’ 20. Kinked-Demand curve theory It is an economic theory regarding oligopoly and monopolistic competition, When it was created, the idea fundamentally challenged classical economic tenets such as efficient markets and rapidly changing prices, ideas that underlie basic supply and demand models. Kinked demand was an initial attempt to explain sticky prices. “Kinked” demand curves and traditional demand curves are similar in that they are both downward-sloping. They are distinguished by a hypothesized concave bend with @ discontinuity at the bend - the "kink.” Fundamentals of Banking Awareness and CL Economics Therefore, the first derivative at that point is undefined and leads to a jump discontinuity in the marginal revenue curve. Classical economic theory assumes that a profit-maximizing producer with some market power (either due to oligopoly or monopolistic competition) will set marginal costs equal to marginal revenue. 21. Economic Theory Atheory is established explanation that accounts are statements or propositions about patterns of economic behavior under. certain circumstances, these theories help us sort out and understand the complexities of economic behavior. 22, Law of Variable Proportion The law of variable proportions states that as the quantity of one factor is increased, keeping the other factors fixed, the marginal product of that factor will eventually decline, This means that upto the use of a certain amount of variable factor, marginal product of the factor may increase and after a certain stage it starts diminishing, When the variable factor becomes Telatively abundant, the marginal product may become negative. They are three stages: 4. Increasing Returns 2, Diminishing Returns, 3, Negative Returns. 23. Lorenz Curve In economics, the Lorenz curve is a graphical Tepresentation of the cumulative distribution function of the empirical probability distribution ‘of wealth or income, and was developed by Max O. Lorenz in 1905 for representing inequality of the wealth distribution. The Gini coefficient (also known as the Gini index or Gini ratio) is a measure of statistical dispersion intended to represent the income distribution of a nation’s residents, and is the most commonly used measure of inequality. It was developed by the Italian statistician and sociologist Corrado Gini and published in his 4912 paper “Variability and Mutability” (Italian Variabilita e mutabilita). The Gini coefficient measures the inequality among values of a frequency distribution (for example, levels of PDP Page 51income). A Gini coefficient of zero expresses perfect equality, where all values are the same (for example, where everyone has the same | of income income). A Gini coefficient of one (or 100%) 100% expresses maximal inequality among values (for line of example, where only one person has alll the 80%F equality income or consumption, and all others have none). However, a value greater than one may 60%, ~N occur if some persons represent negative contribution to the total (for example, having 40% negative income or wealth). For larger groups, values close to or above 1 are very unlikely in 20% practice. 0% 20% 60% % of households A Lorenz Curve illustrates inequality Fundamentals of rage be CL | EDP Banking Awareness and EconomicsContemporary Economic Terms 1. National Income The father of moder national income accounting, Simon Kuznets defined “National income is the net output of commodities and services flowing during the year from the countries productive system in to the hands of the ultimate consumers”. If you see the economic activities like production, consumption, saving, investment etc. National income can also be defined as’ the total money value of the entire economic activity in an economy during a specified period of time” or National Income is also known as National Income at factor cost. National income at factor cost means the sum of all incomes earned by resources suppliers for their contribution of land, labor, capital and organizational ability which go into the year’s net production. Hence, the sum of the income received by factors of production in the form of rent, wages, interest and profit is called National Income. National Income is generated from any productive activity. An increase in national income because of an increase in price is calledan increase in national income at base year prices. The National Sample Survey Organisation (NSSO), now known as National Sample Survey Office, is an organization under the Ministry of Statistics of the Government of India, Itis the largest organisation in India conducting regular socio-economic surveys or National Income estimation and it also collects the data for the unorganized sector. It was established in, 1950-Sinoe 1956 the national income estimates are being prepared by CSO (Central Statistical Organization). There are three methods to calculate the national income,1) Value Added Method 2) Income Method,3) Expenditure Method. Fundamentals of Banking Awareness and Economics a€CL ‘Some of the activities not included in National Income Calculation Services provided by the housewives, income of smugglers, services of sadhus, Transfer of payments, bad debts incurred by banks, charity donations, scholarships etc, Private sector transfers inolude charitable donations and prizes to lottery winners John Hicks The national income consists of collection of goods and services reduced to common basis by being measured in terms of money. National income accounting It is @ set of principles and methods used to measure the incomeand production of a country ‘or economy. Net National Product in National Accounting refers to GNP minus depreciation. There are basically two ways of measuring national economic activity: as the money value of the total production of goods and services during a given period (usually a year) or as the total of incomes derived from economic activity after allowance has been made for capital consumption 2, Real National Income It is the value of national income adjusted for inflation calculated from a base year. 3, Gross domestic product It can be defined as sum total of incomes received forthe services of labour, landor capital ina country or “the monetary value of all final goods and services produced in a country in a financial year “or the total value of goods and services produced in a country during a given period is called GDP. It will be including the goods and services produced by the resident of the country or foreigner. PDP Page 534, Net domestic product It is the net value of GDP after deducting depreciation of plant and machinery from GDP 5. Gross National Product It can be defined as ‘the monetary value of all final goods and services produced by the residents of a country in a financial year “or money value s of the total national production for any given period . It does not include the goods and services produced by the foreigner. if county has similar inflows and outflows of income from assets, then GNP and GDP will be very similar. However, if country has many muttinationals that repatriate income from local production, then GNP will be lower than GDP.Per capita income of citizens is not required while computing GNP. 6. Net National Product It is the net value of GNP after deducting depreciation of plant and machinery Depreciation equals to Gross National Product Net National Product 7. NNP at factor cost It is the value of NNP when the value of goods and services is taken at the production cost. NNP at factor cost= NNP at market price-indirect taxes + subsidies & NNP at market price Net national product at market price is the market value of the output of final goods and services produced at current price in-one year of a country or aggregate net value of the output in ‘one year. If we subtract the depreciation charges from the gross national product, we shall get net national product at market price: NNP at market price = NNP at factor cost +indirect taxes-subsidies 9. Green GNP Many economists, environmentalists, and citizens have recently criticized the gross national product. The criticism stems from the fact that this measurement of national product does not account forervironmental degradation and resource depletion. a€CL Page 54 Anew approach to the situation of allocating these omitted environmental features in the national product has been the advent of the green national product Many people are calling for @ green national product that would indicate if activities benefit or harm the economy and well-being. This Green National Product would revolve around the social and economic issues ‘onwhich many green movements have focused: care for the earth and all that sustain it This new national product would differ from the traditional GNP by addressing both the sustainability and well-being of the planet and its inhabitants. It is. essential that this system takes into account natural capital, which is currently hidden from our traditional measurement 10. Per Capita Income When the total national income is divided by the total population, itis called per capita income itis the average income of an average person in that country. Per capita, income =national incomes population. The standard of living in a country is represented by its per capita income. A rising per capita income will indicate a better welfare if it is accompanied by changed income distribution in favour of poor. 11, Real per capita income Real per capita income as opposed to nominal per capita income, measures how much the real purchasing power of an economic agent changes, since the value of money can fluctuate. For example, it is possible that income per capita can increase but only because of inflation (increasing price levels), which would result in no Teal increase because the money would only be able to buy as many goods as before. The best index of economic developments provided by growth in per capita real income from year to year. 12. Personal income In economics, personal income refers to an individual's total earnings from wages, investment enterprises, and other ventures. It is the sum of all the incomes actually received by all the individuals or household during a given period or itis equal to the personal disposable income plus miscellaneous receipts of the government. PDP Fundamentals of Banking Awareness and EconomicsPersonal income = Private Income- undistributed profits-profit taxes, 13. Disposable income It is total personal income minus personal current taxes (direct taxes) or it is equal to personal income minus direct taxes paid by household. In national accounts definitions, personal income minus personal currenttaxes equals disposable personal income, Subtracting personal outlays (which includes the major category of personal [or private] consumption expenditure) yields personal (or, private) savings, hence the income left after paying away all the taxes is referred to as disposable income. Disposable Income = Personal income-direct taxes 14, Transfer payment In economics, a transfer payment (or government transfer or simply transfer) is a redistribution of income in the market system. These payments are considered to be non- exhaustive because they do not directly absorb resources or create output or income which is not produced by any production process is called transfer payment or transfer income. In other words, the transfer is made without any exchange of goods or services. Examples of certain transfer payments include welfare (financial aid), social security, and government ies for certain businesses (firms), public debt or tational debt(provident fund, long- term government bonds, national savings certificate but insurance policies do notoome under the national debt ), 15. Savings identity or the Savings-investment identity Itisa conceptin national income accounting stating that the amount saved in an economy will be the amount invested in new physical machinery, new inventories, etc. More specifically, in an open economy (an economy with foreign trade and capital flows), private saving plus governmental saving (the government budget surplus or the negative of the deficit) plus foreign investment domestically (capital inflows from abroad) must equal private physical investment in new machinery, inventory build-up, etc. In other words, investment must be financed by some combination of private domestic savings, government savings (surplus), and foreign savings (foreign capital inflows). Fundamentals of Banking Awareness and Economics aéCL | PPP Page 55Important Indian Financial Institutions History of Banking in India Banking in India in the modern sense originated in the last decades of the 18th century. Among the first banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829-32; and the General Bankof India, established 1786 but failed in 1791, The largest bank, and the oldest still in existence, is the State Bank of Incia. It originated as the Bank of Calcutta in June 1806. In 1809s it was renamed as the Bank of Bengal. This was one of the three banks funded by @ presidency governmert; the other two were the Bankof Bombay and the Bank of Madras. The three banks were merged in 1921 to form the Imperial Bank of India, which upon India’s independence, became the State Bank of India in 1985, For many years the presidency banks had acted as quasi- central banks, as did their successors, until the Reserve Bank of India was established in 1935, under the Reserve Bank of india Act, 1934. Classification of Indian Financial System ‘Structure of indian Financial System Indian Finenciel System To Money Market Carital Market ‘Orgarized Sefer Inigencus Schidule Bets WBhescheddle Berks pee HCARBESOIS ECHOLS, eaniing Financia) Companies (Nee} Uferganized Sector schedule Commercial Coneperative Banks Boni Nalenalzea| psusenks-| Baris 681 Group Private Banks ‘Sehedule Schedule Uiben Govaperative Banks Schedule Stee Co-aperative Banks Foreign Banks Regional Rural Banks Page 56 a€CL Important banking terms: Banking: According to Banking Regulation at 1949, banking is defined as accepting deposits of public money forthe purpose of lending or investment which is repayable on-demand or otherwise and is withdrawable by cheque, draft or otherwise Bank: A Bank is a financial organization which accepts deposits that can be withdrawn on demand and also lends money to individuals and business houses that need it OR Any financial institution thet follows the definition of bankingas defined under banking regulation act 1949 is said to be a bank Green Banking Green Bankis known forits fous on environmentally- friendly banking practices, andor its motto of ‘Doing the Right Thing’ for the environment and its people, ‘community and shareholders or financing of ‘environmental friendly projects by the banks. Important Banking Terms used in day-to-day banking 1. Creditor: A creditor is an entity that gives crecit to another entity. The entity may be an individual, a firm, a government, a company or other legal person 2. Debtor: A debtor is an entity that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person, The counterparty is called a creditor 3. Types of deposits (i) Term/Time Deposit: A time deposit is a money deposit at a banking institution that cannot be withdrawn for a certain term or period of time. (ii) Demand Deposit: Demand deposits can be “demanded” by an account holder at any time without any advance notice to the depository institution or Bank Fundamentals of Banking Awareness and Economics PDPdeposits that can be withdrawn without notice are called demand deposits. (iii) CASA Deposits: CASA is basically the Current Account & Savings Account deposits. CASA ratio is the share of current and savings account deposits to the total deposits of the bank. Interest rate paid on CASA is much lower compared to other deposits like term deposits or recurring deposits. While banks do not pay any interest on current account, interest paid on savings account deposit varies from 4% to 6% generally (as on July 31, 2018) Banks therefore make maximum effort to increase the share of CASA on their books to reduce their overall cost of deposits. HDFC Bankhas the highest share of CASA to total deposits at 52%, followed by the State Bank of India at 48% and ICICI Bank at 45%. {iv) An Overdraft: The permission given to a bank customer to draw cheques: in excess of his current account balance or it occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be “overdrawn Reserve Bank of India The Reserve Bank of India is India's central banking institution, which controls the monetary policy of the Indian rupees"The monetary policy in India is formulated by RBI. It commenced its operations on April 1935 during the British Rule in accordance with the provisions of the Reserve Bank of India Act; 1934.The original share capital was divided into shares of 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, RBlis governed by 2 central board (headed by a governor) appointed by the central government of india. RBI Preamble ‘The Preamble of the Reserve Bank of India describes. the basic functions of the Reserve Bank as. “to regulate the issue of Bank Notes and keeping a€CL Fundamentals of Banking Awareness and Economics of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.” Major Functions of RBI 1. Itis a central government Bank 2. tis Banker's Bank in india 3, It is custodian of country’s Foreign Currency Reserve 4. Itislender of last resort to the banks and central and state governments in India. 5. The Resetve Bank of India has the sole right to issue currency notes except one rupee notes which are issued by the Ministry of Finance. 6. »Itactsas regulator and supervisor of the financial ‘system in order to maintain public confidence in the system, protect depositors’ interest and provide cost-effective banking services to the public 7. It Formulates, implements and monitors the monetary policy of the country in order to maintain price stability and ensuring adequate flow of credit to productive sectors, The main interest rate is set by the Reserve Bank of India: This is Known as the base rate. If the RBI is worried that inflation is likely to increase, then they may decide to increase interest rates to reduce demand and reduce the rate of economic growth Usually, if the RBI increases base rates it will lead to higher commercial rates too. Higher interest rates have various economic effects: 1. Increases the cost of borrowing: Interest payments on credit cards and loans are more expensive. Therefore this discourages people from borrowing and saving, People who already have loans will have less disposable income because they spend more on interest payments, Therefore other areas of consumption will fall. 2. Increase in mortgage interest payments: Related to the first point is the fact that interest payments on variable mortgages will increase This will have a big impact on consumer spending, This is because a 0, 5% increase in interest rates can increase the cost of a £100,000 mortgage by £60 per month, This is a significant impact on personal discretionary income. PDP Page 573. Increased incentive to save rather than spend: Higher interest rates make it more attractive to save ina deposit account because of the interest gained, 4. Rising interest rates affect both consumers and firms: Therefore the economy is likely to experience falls in consumption and investment. 5. Government debt interest payments increase: Higher interest rates increase the cost of government interest payments. This could lead to higher taxes in the future. 6. Reduced confidence: Interest rates have an effect on consumer and business confidence. A rise in interest rates discourages investment; it makes firms and consumers less willing to take ‘out risky investments and purchases. 7. Decrease in loan: At Higher interest rates people will not take loans from the banks and there is no money to invest in the business. It will automatically lead to increase inthe cost of production. Money or Credit Creation Inthe contemporary economic system, most money in ciroulation exists not as cash or coins but as bank deposits or commercial banks create credit on the basis of their deposits. The main way in which those bank deposits are created, is through loans made by commercial banks. When a bank makes a loan, a deposit is createdat the same time in the borrower's bank account: In that way, new money is created)as a bookkeeping entry, with the loan representingan asset andthe deposit liability on the bank's balance sheet Credit Control by RBI Credit Controlis an important tool used by Reserve Bankof India, a major weapon of the monetary policy used to control the demand and supply of money (liquidity) in the economy. Central Bank administers control over the credit that the commercial banks grant. Such a method is used by RBI to bring "Economic Development with Stabilty’ it means that banks will not oniy control inflationary trends in the economy but also boost economic growth which would ultimately lead to increase in real national income with stability. In view of its functions such as issuing a€CL Page 58 notes and custodian of cash reserves, credit not being controlled by RBI would lead to Social and Economic instability in the country.RBI controls the credit operations in the country by two measures. They are given below 1. Quantitative Measures It means total quantity of credit controlled by RBI through its various reserve rates and polioy rates. A. Reserve Rates or Reserve Ratios Itis the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out).There are two reserve rates or ratio fixed by the RBI for all the banks in Ingia {i) Cash Reserve Ratio The ratio of a bank's cash holdings to its total deposts liabilities or itisa specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank CRR is a crucial monetary policy tool and is used for controlling money supply inan economy. CRR is set according tothe guidelines of the central bank of a country {il) Statutory Liquidity Ratio It is the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) .Itregulates the credit growth in India. Note 1: Smaller the GRR and SLR, the scope for lending by the banks is greater vice-versa Note 2: If the central bank wants to encourage an increase in the supply of money and decrease in the cost of borrowing money, it should lower GRR and SLR. B. Policy Rates Policy rates in India will set up by RBI After every monetary policy review RBI changes its policy rates depending upon the inflation and economic stability of the country PDP Fundamentals of Banking Awareness and Economics(i) Bank Rate It is the rate at which central bank (RBI) lends money to other banks (commercial banks) or financial institutions for a long term or the central bank re-discounts the commercial bills brought to it by the commercial banks, If the bank rate goes up, long-term interest rates also tendto move upand credit will decrease, ifthe bank rate reduced, long-term interest rates also tend to move downand credit will increase. When bank rate is increased, banks increase their own lending rates and it will lead to decrease in credit in the system. Current bank rate is 8.25%. (ii) Liquidity adjustment facility (LAF) itis a monetary policy tool which allows banks to borrow money through repurchase agreements. LAF is used to aid banks in adjusting the day to day mismatches in liquidity. LAF consists of repo and reverse repo operations. {iii) Repo (Repurchase) rate Itis the rate at which the RBI lends money to the banks for a short term. When the repo rate increases, borrowing from RBI becomes more expensive. If RBI wants to make it more expensive for the banks to bortow money, itinoreases the repo rate similarly, ifit wants to make it cheaper for banks to borrow money it reduces the repo rate. (iv) Reverse Repo rate Itis the rate atiwhich RBL borrows money from banks for a short term. The Reserve bank uses this tool whemit feels there is too much money floating in the banking system, An increase in the reverse repo rate means that the banks will get a higher rate of interest from RBI. As a result, banks prefer to lend thei money to:RBI which is always safe instead of lending it others (people, companies etc) which is always risky. Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse Repo rate signifies the rate at which the central bank absorbs liquidity from the banks Reverse Repo Rate is linked to Repo Rate with a difference of 1% between them. Fundamentals of Banking Awareness and Economics a€CL (v) MSF - Marginal Standing facility Itis @ special window for banks to borrow from RBI against approved government securities in an emergency situation like an acute cash shortage. MSF rate is higher then Repo rate. Current MSF Rate: 8.25%. (vi) Open Market Operations An open market operation (OMO) is an activity by a central bank to buy or sell government bonds ‘on the open market. A central bank uses them as the primary means of implementing monetary policy The usual aim of open market operations is to manipulate the shortterminterest rate and the supply of bse money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rales, are used to guide this implementation. 2. Qualitative Measures The qualitative measures are aclopted by the Certral Bank in its pursuit of economic stabilization and as part of credit control as well as credit management inthe country (A) Margin Requirements (8) Credit Rationing (©) Reguiation of Consumer Credit (D) Moral Suasion Monetary policy of India Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth. In india, the central monetary authority is the Reserve Bank of India (RBI). The interest rate policy is a component of RBI Its so designed as to maintain the price stability in the economy. Dear Money or Tight Money Policy of RBI Itis @ policy through which RBI tightens the money supply by increasing interest rates in the country. It is very difficult to obtain money or loans from the banks by the customers and business people in the PDP Page 59country. If you do have the opportunity to seoure a loan, then interest rates are usually extremely high. it is also known as ‘tight money or Dear money”. Cheap Money or Easy Money Policy of RBI It is a policy through which RBI ease the money supply by decreasing interest rates in the country. It is very ease to obtain money or loans from the banks bythe customers and business people inthe country. Ifyou do have the opportunity to secure loan, then interest rates are usually extremely low or interest rates are low. Itis also known as “Cheap money ar Easy money" Prime rate or Prime Lending Rate It is a term applied in many countries to reference an interest rate used by banks, The term originally indicated the interest rate at which banks lent to favored customers—ie., those with good credit— but this is no longer always the case. Some variable interest rates may be expressed as a percentage above or below prime rate. Ways and means advances (WMA) Itis a mechanism used by the Reserve Bank of India (RBI) under its credit policy by which provides to the States banking with it to help them to tide over temporary mismatches in the cash flow of their receipts and payments. This is guidedunder Section 17(5) of RBI Act, 1934, and are.tepayable in each case not later:than three months from the date of making that advance’. States and Central governments in India will take advances from the RBI through ways and means advances. Excess Reserves The reserves held by the commercial banks over and above the statutory minimum with the RBI are called excess reserves, Money Supply In economics, the money supply or money stock is the total amount of monetary assets available inan economy ata specific time. There are several ways to define “money,” but standard measures usually include currency in circulation and demand deposits (depositors’ easily accessed assets on the books of financial institutions). Money supply in India is a€CL Page 60 governed and regulated by RBI. The RBI regulates money supply in India through its several policy rates and reserve ratios. The money is an example for floating capital. Classification of Money Modern money has several components. Apart from justcash andooins, money also consists of deposits with the banking system, both interest-free demand deposits and interest-bearing time deposits, such as fixed deposits Thevarious components of money can be aggregated together in order ofliquicity. Since money is primarily used to settle day-to-day transactions, itnneeds to be readily usable as a means of doing so. Clearly, cash and coins are the most liquid forms of money, since they can be used instantaneously and universally used to settle unlimited transactions Demand deposits, or accounts with banks, are also quite liquid, as they can be used to write cheques against, in settling daily transactions. The Reserve Bank of India defines the monetary aggregates as 4, Reserve Money (MO): Currency in circulation + Bankers’ deposits with the RBI + ‘Other deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI's claims on banks + RBI's net foreign assets + Government's currency liabilities to the public- RBI's net non-monetary liabilities, 2, MM: Currency with the public + Deposit money of the public (Demand deposits with the banking system + ‘Other’ deposits with the RBI) 3. M2: M1 + Savings deposits with Post office savings banks 4, MB: (board concept of money supply) M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government's currency liabilities to the public — Net non- monetary liabilities of the banking sector (Other than Time Deposits) 5, M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates). Fundamentals of Banking Awareness and Economics PDP6. Narrow Money: The sums of currency in ciroulation and demand deposits with banks are called M1, or ‘narrow money’ 7. Broad Money: In economics, broad money is a measure of the money supply that includes more than (just physical money such as currency and coins (also termed narrow money). It generally includes demand deposits at ‘commercial banks, and any monies held in easily accessible accounts. Components of broad money are stil very liquid, and non-cash components can usually be converted into cash very easily ‘One measure of broad money is M3, which includes currency and coins, and deposits in. checking accounts, savings accounts and small time deposits, overnight repos at commercial banks, and non-institutional money market accounts. This is the main measure of the money supply, and is the economic indicator usually used to assess the amount of liquidity in the economy, as itis relatively easy to track Money Market in India The Money market in India is the money market for short-termand long-term funds with maturity ranging from ovemight to one year in India including financial instruments that are deemed to be close substitutes. of money, Similar to developed economies the Indian money marketis diversified and has evolved through many stages, from the conventional platform of treasury bills and call money to commercial paper, certificates, repos, forward rate agreements and most recently\interest rate swaps. Call money market The call money market deals in short term finance repayable on demand, with a maturty period varying from one day to 14 days. The interest rate paid on call money loans, known as the call rate, is highly Volatile. Itis the most sensitive section of the money market and the changes in the demand for and supply of call loans are promptly refiected in call rates, There are now two call rates in India: the Inter bank call rate’and the lending rate of DFHI. S.K Muranjan commented that call loans in India are providedito the bill market, rendered between banks, and given for the purpose of dealing in the bullion market and stock exchanges. a€CL Fundamentals of Banking Awareness and Economics Treasury bill market Treasury bills are instrument of short-term borrowing by the Government of India, issued as promissory notes under discount or a short term government. security paper is called treasury bills. The interest received on them is the discount which is the difference between the price at which they are issued and theirredemption value. They have assured yield and negligible risk of default. Under one classification, treasury bills are categorised as ad hoc, tap and/auction bills and under another classification it is'classified on the maturity period like 91-days TBs, 182-days TBs, 364-days TBs and twotypes of 10-days TBs, In the recent times (2002- 03, 2003-04), the Reserve Bank of India has been issuing only 91-day and 364-day treasury bills. The auction format of 91-day treasury billlhas changed from uniform price to multiple price to encourage more responsible bidding from the market players. Money market mutual funds Money market mutual funds invest money in specifically, high-quality and very short maturity. based money market instruments. The RBI has approved the establishment of very few such funds inIndia. In 1997, only one MMMF wasin operation, and that too with very small amount of capital. Hot money Infinancial markets, ‘hot money’ is the flow of funds (or capital) from one country to another in order to eama short-term profit on interest rate, differences and/or anticipated exchange rate shifts. These speculative capital flows are called ‘hot money’ because they can move very quickly in and out of markets, potentially leading to market instability or foreign currency which has a tendency of quick migration. Legal tender Money It is a medium of payment recognized by a legal systemto be valid for meeting financial obligation. Paper currency and coins are common forms of legal tender in many countries or Coins and banknotes are usually defined as legal tender. Legal tender is variously defined in different jurisdictions, Formally, it is anything which when offered in payment extinguishes the debt. PDP Page 61Inflation Inflation: inflation is definedas a sustained increase in the general level of prices for goods and services. Its measured as an annual percentage increase. Inother words, Inflation isa state in which the value of money is falling and prices are rising According to economist Kemmerer, Inflation means too much currency in comparison to the physical volume of business done. Keynes stated that the. rise in the price level after the point of full employment is true Inflation. Deflation: Deflation is defined as occurring “when prices are declining over time or itis asituation in which the value of money is increasing. This is the opposite of inflation. When the inflation rate (by sore measure) is negative, the economy isina defiationary period. Moreover, it is termed as “A general decline in prices which is often caused by a reduction in the supply of money or credit or Deflation can be caused also by @ decrease in government, personal or investment spending The opposite of inflation, deflation has the side effect of increased unemployment since there isa lower level of demand in the economy, which’can lead to an economic depression. The decline in prices of assets is often known as Asset Deflation. inflation: A slowing in the rete of price inflation or the process of curing inflation by reducing money supply is called disinflation. Disinflation is used to describe instances when the inflation rate has reduced marginally over the short term. Disinflation is commonly used to describe situations of slowing inflation. Usually, the rate of inflation is slowed by controlling the amount of credit (bank loans, hire-purchase) available to consumers without causing more unemployment. Disinflation is a milder version of defiation, and may also occur automatically during a recession when. sales slowdown. Reflation: Refiation is an economic term referring to stimulating measures taken to lessen or stop the effects of deflation. Reflationary measures could be comprised of consist of fiscal policy (lowering taxes) or monetary policy (changing money supply or lowering interest rates). Forexample, the Reserve Bank of India may opt for lowering interest rates'to stimulate a weak economy which is common in deflationary periods. Inotherwords, reflationisa type of cortrolledinflation ‘When deflation is carried to an extreme limit and the prices of goods and services fall to extremely low levels, then the governmentmay resort to reflation to protect the economy, Types of Inflation: 1. Demand Pull inflation This type of inflation occurs due to the increase in aggregate demand in the economy or whien the too much money chasing too few goods, that situation is called demand pull inflation. The movement of aggregate demand from AD1 to AD2 results inan increased average rice level in the economy ie. P1 to P2. Demand pull inflation is caused due to the changes in the determinants of AD. Whenever, any of the components of AD (i.e. consumption, investment, government spending and net exports) will increase, this will result in an increase in aggregate demand. SRAS LS vernon — 4 ‘An increase in Agaregate t demand results in SX a rise in price level 2o “AD1 Page 62 a€CL Fundamentals of Banking Awareness and Economics PDP2. Gost Push Inflation Increase in cost of production will result in cost push inflation. As the cost of production increases, the firms will reduce supply. The aggregate supply will shift to the left, from ‘SRAS1 to SRAS2. This will result in anincrease in the average price level in the economy. Real output will fall SRAS2 SRAS1 Cost Push Inflation Caused due to increase in cost of production x moves to the LEFT Cost Push inflation is mainly caused due to the following factors: + Increase in wages (wage push inflation) + Increase in cost of raw materials 3. Open Inflation If the government takes no steps to check the price rise andthe market mechanisms allowed to function without any interference, itis called open inflation, Thus, infiation is opened when the prices grow without any time-out In open inflation, it is authorised to mechanism of the free marketto execute function of rationing of scarce goods and to distribute them on ability of consumers to pay. Thus,the basic characteristic of open inflation is work of the price mechanism as the unique agent of distribution. The post-war hyperinflation in the twenties in Germany is 20th century a living example of open inflation 4. Suppressed Inflation ithe government actively makes efforts to check the price rise through price control and rationing, itis called suppressedinflation These measures can check inflation as long as their effect continues. The essential characteristic of the Suppressed inflation, unlike opened, that it is directed on prevention of aistribution ofa rise in prices in the conditions of a free market Fundamentals of Banking Awareness and CL Economics mechanism is and replaces all it is the system of distribution based on control facilities, Thus, control introduetion is the important feature of the suppressed inflation. Infiation repressing is condemned, as it bears in itself much more harm, such as a black market, hierarchy of the prices and dependence on rationing officers, uneconomical costs of industrial resources of the basic industries 5. Creeping Inflation The most mild form of inflation is called creeping inflation. This is considered as an importantinstrument of econornic development and usedto keep the national economy free from the effects of stagnation, Creeping inflation may also grow to hyper inflation. 6. Walking Inflation Walking inflation is little more faster inflation than the creeping inflation. It is treated as a signal for hyperinflation, 7. Running inflation When the price rise happens in a faster rate, than walking inflation we can calll it running inflation. The highest rate of infiation is called jumping or galloping or hyperinflation. 8, Galloping Inflation if annual rate of inflation exceeds 20% it results in Galloping Inflation. The inflation rates may rise to double or triple digits (in percent) per year in Galloping Inflation. 9. Hyper inflation Hyperinflation is a situation where the price increases are too sharp. Hyperinflation often occurs when there is a large increase in the money supply, which is not supported by growth in Gross Domestic Product (GDP) In hyper inflation, prices rise every moment and there is no limitto the highest to which the prices might rise. Hyper inflation is an indication of the highest degree of abnormality in the monetary system of a country. All assets (like salary, savings, bonds etc.) having fixed income lose their value under the hyper inflation PDP Page 63In hyperfiation, the prices rise more than 100 percent per year. The prices rise every minute and may rise to above its limits. This cause Gifficulty to measure the inflation rate and severe problems to economy like prices of goods become in stable, Wages decrease, inequalities rise, purchasing power of goods becomes weak an increase in gas prices, it is considered a ratchet. Measuring Inflation: Inflationis measured as the percentage change ina price index. A price index measures the average price level for a set of goods and services, relative to a and worse, Circulation of money becomes faster. | base year The classical examples of hyper-inflation are (@) the Great Inflation of Germany after the | 4, Wholesale price indexes (WPls) World War |, and (&) the Great Inflation of China after the World War I. This index measures and tracks the changes in price of goods in the stages before the retail level. Wholesale price indexes (WPls) is reported monthly to show the average price 10 Stagflation changes of goods sold in bulk, and they are Stagflation refersto a condition of slow economic | indicators to show economic growth in the growth and relatively high unemployment ‘economy. accompanied by a rise in prices, or inflation Stagflation occurs when the economy isn’t | ___ Although some countries are still using the WPis growing but prices are on rise and which |_—_as a measure of inflation, many countries, not a good for economy. This happened to a including the United States have opted for the great extent during the 1970s, when world oil producer price index (PPI) for measuring inflation, prices rose dramatically, fueling sharp inflation | The weighing diagram for the WPI series has in developed countries, been derived on the basis of Gross Value of Output, The output values at current prices 11. Core Inflation Itis a measure of inflation that excludes certain items that face volatile price movements. because these price rise against these items can digress the overall trendof inflation and give a false measure of infiation. Core inflation is most often calculated by taking the Consumer Price Index (CPI) and excluding certain items from the index, usually energy and food products, Other methods of calculation include the outers method, which removes the products that have hadthe largest price changes, Core inflation is contsrued to be an indicator of underlying long-term inflation, 12. Ratchet Inflation Page 64 In this type of inflation, increases or decreases a price occurs by a certain amount triggered by any sudden event For example, many events that happen around the world, such as natural disasters or conflicts in the Middle East, can affect the gas prices. Whena natural disaster or a new conflict causes a€CL PDP wherever available at appropriate disaggregation, have been obiained from the National Accounts Statistics published by Central Statistical Organization, Ministry of Statistics & Programme Implementation. The price data are collected on a self-disclosure basis from individual private sector firms and official sources. National Sample Survey Office also facilitates, collection of price data from organized manufacturing units. Latest revision of WPI has been done by shitting base year from 1993-94 to 2004-05 on the recommendations of the Working Group set up with Prof Abhijit Sen,, Member, Planning ‘Commission as Chairman for revision of WPI series. This new series with base year 2004.05 has been launched on 14th September, 2010 Thus the latest WPI has a basket of 676 items with 5482 quotations. The major criticism for this index is that ‘the general public does not buy at the wholesale level’, thus WPI does not give the actual feeling of the amount of pressure borne by the general public. Fundamentals of Banking Awareness and Economics