1. Discuss important Macro Economic variables in Indian context.

2. What is the role of consumption, income & saving variables in economic development.

3. Explain the significance of whole sale price index in estimating the inflation

(all are included in this answer)

Macroeconomics deals with the economy as a whole; it examines the behavior of

economic aggregates.

a. Macroeconomic policies

i. Fiscal policy

ii. Monetary policy

iii. Growth policies

Three of the major concerns of macroeconomics are:

• Inflation

• Output growth

• Unemployment rate

The components of the Macro economy

Types of unemployment

 Seasonal unemployment

 Disguised unemployment

 Under unemployment

 Open unemployment

 Part time unemployment

 Frictional unemployment

 Structural unemployment

Remedial methods to Over-Come Unemployment

 Self employment
  Change in education system

 Labor intensive program

Gross National Product (GNP)

The combined value of all the final goods and services produced in a country during an
accounting year, including net factor income from foreign countries.

Calculation of GNP

GNP= GDP + Net factor income from abroad

Where,

GDP = Gross Domestic Product

Net factor income from abroad =

Income earned by Indians abroad- income earned by non-residents in India

Analysis of GNP (Pre and Post Liberalization)

Pre-liberalization 1973-1991= 203651 crores

Post-liberalization 1991-2009 =2101728 crores

GNP at factor price increased by 932%

Net National Product (NNP)

Net National Product (NNP)

Defined as the difference between GNP and CCAs

NNP =GNP – CCAs

NNP@ market price =GNP@ market price – CCAs

NNP@ factor cost =GNP@ factor cost – CCAs

Consumption of Fixed Capital

Reduction in the value of the fixed assets used in production during the accounting period
resulting from physical deterioration, normal obsolescence or normal accidental damage.
Not a method of allocating the costs of past expenditures on fixed assets. Rather, fixed assets at a
given moment in time are valued according to the remaining benefits derived from their use.

The consumption of fixed capital is one of the most important elements in the System... It may
account for 10 per cent or more of total GDP."

Analysis of CFC (Pre and Post Liberalization)

Pre Liberalization – 19553

Post Liberalization – 214834

Percentage Increase is around 998%

NDP at Factor Cost

NDP at factor cost

NDP at factor cost = GDP (factor cost) – Capital Consumption Allowances where

Capital Consumption Allowance (CCA) is a measure of capital depreciation of a country

during a given time period.

NDP at market price:

NDP at market price =GDP@ market price – CCAs

Analysis of NDP (Pre and Post Liberalization)

Pre Liberalization – 206612 (in Crores)

Post Liberalization – 1918628

Percentage Increase is around 828%

Indirect Taxes less Subsidies

They include

 Sales taxes,

 Fuel taxes,

 Duties and taxes on imports,

  Excise taxes on tobacco and alcohol products and

 Subsidies paid on agricultural commodities, transportation services and energy

Analysis of Indirect Taxes less Subsidies (Pre and Post Liberalization)

Pre Liberalization – 20982

Post Liberalization – 179093

Percentage Increase is around 753.56%

Net Factor Income from Abroad

Net Factor Income from the Rest of the World (NFIA) consists of the net income receipts from
the rest of the world such as

 Investment incomes including interest, dividends, and branch profits;

 Earnings of residents working abroad

 Other factor incomes of normal residents

Gross Fixed Capital Formation (GFCF)

It is a measure of capital stock plus changes in inventories of goods of a country or an economic

sector during an accounting period.

Personal Disposable Income

 The total income that can be used by the household sector for either consumption
expenditures or saving during a given period of time, usually one year. Disposable
income (DI) is one of three measures of income reported in the National Income and
Product Accounts maintained by the Bureau of Economic Analysis

 Officially calculated as the difference between personal income and personal tax and
nontax payments increased by around 820%.

Gross Domestic Saving (GDS)

 Savings represent the excess of current income over current expenditure and is the
balancing item of the income and outlay accounts

 GDS can be defined as the savings made by the

Household sector+ Private Corporate sector + Govt Sector.

Household sector - individuals, all non-government, sole proprietorships, partnerships owned
and/or controlled by individuals and non-profit institutions

Private Corporate Sector - all non-government financial/non-financial corporate enterprises,

co-operative institutions and quasi corporate bodies. Non-government non-financial enterprises
include public and private limited companies

Per Capita GNP

Per Capita GNP at Factor Cost is defined as the country's gross national product (GNP) divided
by its population

Per Capita GNP = GNP/Population

Shows the income each person would have if GNP were divided equally. Also called income per
capita.

It is a useful measure of economic productivity

WPI(WHOLESALE PRICE INDEX)

 Price of representative basket of wholesale goods.

 Consists of over 2,400 commodities.

 Indian WPI -> weekly, Thursday -> stock & fixed price.

 Price of goods.

WPI in India

 1902;one of the economic indicators.

 435 commodities data on price level is tracked through WPI.

 Available on a weekly basis.

The features of the wholesale price index are:

◦ Indicator of inflation.

◦ The index is published weekly.

◦ Analysis of market activity & monetary conditions.

◦ PRIMARY ARTICLES : Food, Cereals and Grains.

 ◦ NON-FOOD ARTICLE : Biofuels, building & construction, fibre etc.

CPI (CONSUMER PRICE INDEX)

 Average price of consumer goods and services.

 Measures price change for a constant market basket of goods and services.

 Price index -> of a standard group of goods -> market of an urban consumer.

 Calculated by most national statistical agencies.

 Percent change in CPI -> measure estimating inflation.

 Can be used to index wages, salaries, pensions, and regulated or contracted prices.

CPI in india

 Multiple series based on different economic groups.

 CPI UNME (Urban Non-Manual Employee), CPI AL (Agricultural Laborer), CPI RL

(Rural Laborer) and CPI IW (Industrial Worker).

 CPI UNME -> Central Statistical Organization; others -> Department of Labor.

Coonclusion

 Growth in the service sector-- improvement post liberalization while in agricultural

sector--declined.

 Household, public, private sectors– linear increase while GCF– constant during initial
stages; then linear increase. Fall in employment sector. Difference b/w M & F.

 NFI from abroad--parabolic fall. Rest– linear increase.

 CPI has shown significant improvement than WPI.

2. What are the objectives & instruments of fiscal policy?

Defination of Fiscal Policy:
Fiscal policy is an additional method to determine public revenue and public expenditure. In the
recent years importance of fiscal policy has increased due to economic fluctuations. Fiscal policy
is an important instrument in the modern time. According to Arther Simithies fiscal policy is a
policy under which government uses its expenditure and revenue programme to produce
desirable effects and avoid undesirable effects on the national income, production and
employment.

Objectives of fiscal policy:

The objectives of fiscal policy may be regarded as follows;

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. The maintenance of a
desirable price level has good effects on production, employment and national income. Fiscal
policy should be used to remove; fluctuations in price level so that ideal level is maintained.

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and economic consideration.
Consumption can be affected by expenditure and tax policies of the government. Fiscal policy
should be used to increase welfare of the economy through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the living standardof the
people. It is necessary for political stability and for maximization ofproduction. Fiscal policy
should achieve this level.

4. To achieve desirable income distribution:

The distribution of income determines the type of economic activities the amount of savings. In
this way, it is related to prices, consumption and employment. Income distribution should be
equal to the most possible degree. Fiscal policy can achieve equality in distribution of income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason for under-development.
Large amounts are required for industry and economic development. Fiscal policy can divert
resources and increase capital.

6. Degree of inflation:
In under-developed countries, a degree of inflation is required for economic development. After
a limit, inflationary be used to get rid of this situation.

Instruments of Fiscal Policy:

1. Public expenditure
2. Taxes
3. Public debts

the above mentioned instruments are used by the public authorities to achieve desirable level of
production, consumption and National Income. During inflationary trend more and more taxes
are levied on the community. In this way, purchasing power of the people can be decreased and
desirable price level is achieved. During inflation public expenditure is decreased so that all in
production may decrease high prices and increase the value of money. During deflationary
period taxes are reduced and public expenditure is increased. In this way incentives to invest are
increased and national income begins to rise. For economic development public debts are
necessary. In under developed countries, due to insufficient resources economic development is
not possible. Public loans are drawn internally and externally.

The above mentioned methods are called budgetary policy of the government. This policy can
increase national income, production level and maintain full employment level.

2. Discuss important theories of business cycles.

Business cycles refer to regular oscillations in the level of business activity over a period of
years, which when economic activity speeds up or slows down. In fact business cycles and
unemployment reflect unavoidable features of a market economy.

KEYNES DEFINITION

“A trade cycle is composed of periods of good trade characterized by rising prices and low
unemployment percentages altering with periods of bad trade characterized by falling
prices and high unemployment percentages.”

SAMUELSON

“A business cycle is a swing in total national output, income and employment, usually
lasting for a period of 2 to 10 years, marked by widespread expansion or contraction in
many sectors of the economy.”

• Business cycled denote the fluctuation in economic activity which occur in a more or less
regular time sequence in capitalist societies.
• Following Macro economic variables will reflect the fluctuations

• Volume of Employment

• Price level

• Output

• income

• The graph of the business cycled look like a wave with regular rises and falls

• Each movement of rise and fall is called a trade/business cycle

Features of Business Cycles

• Occurs only in organized economies which are money economies

• Refers to fluctuations in business conditions

• Implies regular and periodical changes in business and economic activities

• B.C consists of altering forces of expansion and contraction

• All recorded cycles are members of the same family, but among them there are no
twins

• Short term cycles & long term cycles

• The upward & downward movements of a business cycle possess a degree of

regularity in their durability and time sequence

• Highest point shows the prosperity

• Lowest point of the wave represents the depression

• The points are not symmetrical

• Downward movement is quicker and more violent than the opposite one

• The upward movement is slower and the wave has gentle slopes
 • The phases of the cycle appear in all types of business through in varying degres,ex-
production and prices

• Output and employment in durable goods and capital goods, fluctuate more than in
consumption goods

• Changes in total output and employment are generally associated with change in
currency, credit and velocity of circulation of money

• Profits fluctuate more than the other incomes

• All business cycles do not affect the macro economy to the same extent

TYPES OF BUSINESS CYCLES

Long Waves or the Kondratieff Cycles

• Period of cycle-50 to 60 years

• So far only two full waves1789-1814( industrial revolution),1814-1896(use of steam

& steel)

• 1896-1920( the discovery of electricity, the development of chemistry and use of

motors)

Short waves of 9 to 10 years

• These are common and regular

PHASES OF BUSINESS CYCLES

• Depression

• Recovery

• Prosperity

• Recession

Figure-----Refresher Course in Economics

Sampath Mukharjee-P-788

DEPRESSION
 • Every activity in low level, High Unemployment ,low incomes, low consumption
expenditure, low demand, low prices, discouragement to entrepreneurs, low
purchasing power

• After some time/some structural changes will take place

• Weak enterprises would be liquidated

• Old debts are paid off

• Bank again become strong

• The economy comes back to equilibrium on the basis of lower equilibrium and
incomes

RECOVERY-

• The process of recovery starts

• Semi durable goods wear out and have to be replaced

• Buying gradually increases

• Industries will receive the gradual push

• Industry begins to revive

• Employment increases to the factors of production

• Incomes increases

• Purchasing power increases

• MEC Increases

PROSPERITY

• Recovery gathers strength

• Profits tend to rise

• All input prices start increase faster

• Optimistic outlook of the producers

 • Increase of profits

• Larger investments

• Increase in employment & incomes

• Increase in the volume of trade

• Acceleration of economic growth

RECESSION

• Shortage of demand for inputs

• Reduced demand for labor, employment & incomes

• Decline in output & profits

• Decline in the efficiency of labor

• The cost of production increases gradually

• The money market becomes tighter

• Higher rate of interest

• Check on investments

Theories of Business Cycles

• Exogenous Vs Internal Cycles

• Exogenous theories

• Factors influencing from outside the economic system

• Wars

• Revolutions

• Elections

• Changes in Oil Prices

• Gold Discoveries
• Migrations

• discovery of new lands and resources

• Scientific break ups

• Technological innovations

• Climate change

• Change in weather

INTERNAL THEORIES

• Develop with in the economic system

• They move like the motion of the pendulam

• Multiplier and accelerator theory

• High investment stimulates more growth in output

• Reaches the optimum level

• And thereby economic growth slows

• Reduction in investment, spending and inventory accumulation, which tend the economy
into recession

• Business fluctuations are the source of Shocks in aggregate demand

Theories of Business Cycles

• Political Theory

• Innovation Theory

• Keynes Theory

• Pure Monetary Theory

• Under Consumption Over Investment Theory

 • Accelerator Theory

• Business Cycles Today

Political theories

• These are attributed to politicians who manipulate economic policies in order to be

reelected

• Parliament elections-No threat to vote bank

o Ex- presidential elections in US

• Sensitive to economic conditions in the year preceding the election

• Although the us economy went through a deep recession early in his term, by the time he
was running for election in 1984,the economy was growing rapidly which contributed to
a reelection landslide

INNOVATION THEORY

• Developed by SCHUMPETER –Dynamic Changes

• Introduction of New Product

• New method of production

• Opening up of new market

• Discovery of new source of raw materials

• The reorganization of industry

• Initially profits would be enjoyed only br entrepreneurs

• Later on innovation would be generalized and lead to trade cycles

Keynes Theory

• Business cycles are caused by-

 • changes in rate of interest & fluctuations in the MEC

• MEC-Expected Rate Of Profit

• Entrepreneurial activity depends upon the profit expectations

• BCs are periodic fluctuations of employment, income &output

• Employment depend on the above reasons and propensity to consume

Stabilization Policies

• Fiscal Policy

• Monetary Policy

• Expansionary Policy

• Contractionary Policy

• Integration of Monetary and Fiscal Policies

4. What is the significance of the International trade in Indian economic

development?
International trade is the exchange of goods and services across international borders. In most
countries, it represents a significant share of GDP. While international trade has been present
throughout much of history (see Silk Road, Amber Road), its economic, social, and political
importance have been on the rise in recent centuries, mainly because of Industrialization,
advanced transportation, Globalization, Multinational corporations, and outsourcing. In fact, it is
probably the increasing prevalence of international trade that is usually meant by the term
"globalization".

International trade is also a branch of economics, which together with International finance,
forms the larger branch of International economics.

Regulation of international trade

Traditionally trade was regulated through bilateral treaties between two nations. For centuries
under the belief in Mercantilism most nations had high tariffs and many restrictions on
international trade. In the nineteenth century, especially in Britain, a belief in free trade became
paramount and this view has dominated thinking among western nations for most of the time
since then. In the years since the Second World War multilateral treaties like the GATT and
World Trade Organization have attempted to create a globally regulated trade structure.

Communist and socialist nations often believe in autarchy, a complete lack of international trade.
Fascist and other authoritarian governments have also placed great emphasis on self-sufficiency.
No nation can meet all of its people's needs, however, and every state engages in at least some
trade.

Free trade is usually most strongly supported by the most economically powerful nation in the
world. The Netherlands and the United Kingdom were both strong advocates of free trade when
they were on top, today the United States, the European Union and Japan are its greatest
proponents. However, many other countries - including several rapidly developing nations such
as India, China and Russia - are also becoming advocates of free trade.

Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors
often support protectionism. This has changed somewhat in recent years, however. In fact,
agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible
for particular rules in the major international trade treaties which allow for more protectionist
measures in agriculture than for most other goods and services.

During recessions there is often strong domestic pressure to increase tariffs to protect domestic
industries. This occurred around the world during the Great Depression leading to a collapse in
world trade that many believe seriously deepened the depression.

The regulation of international trade is done through the World Trade Organization at the global
level, and through several other regional arrangements such as MERCOSUR in South America,
NAFTA between the United States, Canada and Mexico, and the European Union between
twenty five independant states. There is also the newly established Free Trade Area of the
Americas (FTAA), which provides common standards for almost all countries in the American
continent.
Risks in international trade

The risks that exist in international trade can be divided into two major groups:

Economic risks

• Risk of insolvency of the buyer,

• Risk of protracted default - the failure of the buyer to pay the amount due within six
months after the due date, and
• Risk of non-acceptance
• Surrendering economic sovereignty

Political risks

• Risk of cancellation or non-renewal of export or import licences

• War risks
• Risk of expropriation or confiscation of the importer's company
• Risk of the imposition of an import ban after the shipment of the goods
• Transfer risk - imposition of exchange controls by the importer's country or foreign
currency shortages
• Surrendering political sovereignty
• 5. What is inflation? Explain various means to estimate methods?

• 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. As inflation rises, every dollar
you own buys a smaller percentage of a good or service.

• The value of a dollar does not stay constant when there is inflation. The value of a dollar
is observed in terms of purchasing power, which is the real, tangible goods that money
can buy. When inflation goes up, there is a decline in the purchasing power of money.
For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will
cost $1.02 in a year. After inflation, your dollar can't buy the same goods it could
beforehand.

There are several variations on inflation:

• Deflation is when the general level of prices is falling. This is the opposite of inflation.

• Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the
breakdown of a nation's monetary system. One of the most notable examples of
hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!
• Stagflation is the combination of high unemployment and economic stagnation with
inflation. This happened in industrialized countries during the 1970s, when a bad
economy was combined with OPEC raising oil prices.

•
In recent years, most developed countries have attempted to sustain an inflation rate of 2-
3%.

Causes of Inflation
Economists wake up in the morning hoping for a chance to debate the causes of inflation.
There is no one cause that's universally agreed upon, but at least two theories are
generally accepted:

Demand-Pull Inflation - This theory can be summarized as "too much money chasing too
few goods". In other words, if demand is growing faster than supply, prices will increase.
This usually occurs in growing economies.

Cost-Push Inflation - When companies' costs go up, they need to increase prices to
maintain their profit margins. Increased costs can include things such as wages, taxes, or
increased costs of imports.

Costs of Inflation
Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects
different people in different ways. It also depends on whether inflation is anticipated or
unanticipated. If the inflation rate corresponds to what the majority of people are
expecting (anticipated inflation), then we can compensate and the cost isn't high. For
example, banks can vary their interest rates and workers can negotiate contracts that
include automatic wage hikes as the price level goes up.

Problems arise when there is unanticipated inflation:

• Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For
those who borrow, this is similar to getting an interest-free loan.

• Uncertainty about what will happen next makes corporations and consumers less likely to
spend. This hurts economic output in the long run.

• People living off a fixed-income, such as retirees, see a decline in their purchasing power
and, consequently, their standard of living.

• The entire economy must absorb repricing costs ("menu costs") as price lists, labels,
menus and more have to be updated.
 • If the inflation rate is greater than that of other countries, domestic products become less
competitive.

•
People like to complain about prices going up, but they often ignore the fact that wages
should be rising as well. The question shouldn't be whether inflation is rising, but
whether it's rising at a quicker pace than your wages.

Finally, inflation is a sign that an economy is growing. In some situations, little inflation
(or even deflation) can be just as bad as high inflation. The lack of inflation may be an
indication that the economy is weakening. As you can see, it's not so easy to label
inflation as either good or bad - it depends on the overall economy as well as your
personal situation.

8. Explain equilibrium state of economy by using aggregate supply and

aggregate demand function.

Aggregate Supply
Aggregate Supply Fundamentals

The aggregate quantity of goods and services supplied depends on three factors:
• The quantity of labor (L )
The quantity of capital (K )
• The state of technology (T )
• The aggregate production function shows how quantity
of real GDP supplied,Y, depends on labor, capital, and
technology

The aggregate production function is written as the equation:

Y= F(L, K, T).
In words, the quantity of real GDP supplied depends on (is a function of) the quantity of labor
employed, the quantity of capital, and the state of technology.
The larger isL,K, orT, the greater isY.

At any given time, the quantity of capital and the state of technology are fixed but the quantity of
labor can vary.
The higher the real wage rate, the smaller is the quantity of labor demanded and the greater is the
quantity of labor supplied.
The wage rate that makes the quantity of labor demanded equal to the quantity supplied is the
equilibrium wage rate and at that wage the level of employment is the natural
rate of unemployment

We distinguish two time frames associated with different states of the labor market:
• Long-run aggregate supply
• Short-run aggregate supply

Long-Run Aggregate Supply

The macroeconomic long run is a time frame that is sufficiently long for all adjustments to be
made so that real GDP equals potential GDP and there is full employment.
The long-run aggregate supply curve (LAS) is the relationship between the quantity of real GDP
supplied and the price level when real GDP equals potential GDP

Figure 6.1 shows anLAS curve

with potential GDP of $10
trillion.
TheLAS curve is vertical
because potential GDP is
independent of the price level.
Along theLAS curve all prices
and wage rates vary by the
same percentage so that
relative prices and the real
wage rate remain constant.

Short-Run Aggregate Supply

The macroeconomic short run is a period during which real GDP has fallen below or risen above
potential GDP. At the same time, the unemployment rate has risen above or fallen below the
natural unemployment rate.
The short-run aggregate supply curve (SAS) is the relationship between the quantity of real GDP
supplied and the price level in the short run when the money wage rate, the prices of other
resources, and potential GDP remain constant
The SAS curve is upward
sloping because a rise in
the price level with no
change in costs induces
firms to bear a higher
marginal cost and increase
production; and a fall in the
price level with no change
in costs induces firms to
decrease production to
lower marginal cost.

Along theSAS curve, real

GDP might be above
potential GDP…
… or below potential GDP

Changes in Aggregate Supply

When potential GDP increases, both the LAS and SAS curves shift rightward.
Potential GDP changes, for three reasons:
• Change in the full-employment quantity of labor.

• Change in the quantity of capital (physical or human).

 • Advance in technology

The quantity of real GDP demanded,Y, is the total amount of final goods and services produced
in the United States that people, businesses, governments, and foreigners plan to buy.
This quantity is the sum of consumption expenditures,C, investment,I, government purchases,G,
and net exports, X– M. That is:

Y= C+ I+ G+ X– M
Buying plans depend on many factors and some of the main ones are:
• The price level

• Expectations

• Fiscal and monetary policy

• The world economy

The Aggregate Demand Curve

Aggregate demand is the relationship between the
quantity of real GDP demanded and the price level.
The aggregate demand (AD) curve plots the quantity of
real GDP demanded against the price level.
Wealth effect A rise in the price level, other things
remaining the same, decreases the quantity of real wealth
(money, bonds, stocks, etc.).
To restore their real wealth, people increase saving and
decrease spending, so the quantity of real GDP demanded
decreases.
Similarly, a fall in the price level, other things remaining the
same, increases the quantity of real wealth.
With more real wealth, people decrease saving and
increase spending, so the quantity of real GDP demanded
increases.
Intertemporal substitution effect A rise in the price level, other things remaining the same,
decreases the real value of money and raises the interest rate.
Faced with a higher interest rate, people try to borrow and spend less so the quantity of real GDP
demanded decreases.
Similarly, a fall in the price level increases the real value of money and lowers the interest rate.
Faced with a lower interest rate, people borrow and spend more so the quantity of real GDP
demanded increases.
International substitution effect A rise in the price level, other things remaining the same,
increases the price of domestic goods relative to foreign goods, so imports increase and exports
decrease, which decreases the quantity of real GDP demanded.
Similarly, a fall in the price level, other things remaining the same, decreases the price of
domestic goods relative to foreign goods, so imports decrease and exports increase, which
increases the quantity of real GDP demanded.

Changes in Aggregate Demand

A change in any influence on buying plans other than the price level changes aggregate demand.
The main influences on aggregate demand are:
• Expectations

• Fiscal and monetary policy

• The world economy

Expectations about future income, future inflation, and future profits change aggregate demand.
Increases in expected future income increase people’s consumption today, and increases
aggregate demand. A rise in the expected inflation rate makes buying goods cheaper today and
increases aggregate demand.
An increase in expected future profits boosts firms’ investment, which increases aggregate
demand.
Fiscal policy is the government’s attempt to influence economic activity by changing its taxes,
spending, deficit, and debt policies.
A tax cut or an increase in transfer payments increases households’ disposable income—
aggregate income minus taxes plus transfer payments. An increase in disposable income
increases consumption expenditure and increases aggregate demand.

Because government purchases of goods and services are one component of aggregate demand,
an increase in government purchases increases aggregate demand.
Monetary policy is changes in the interest rate and quantity of money.
An increase in the quantity of money increases buying power and increases aggregate demand.
A cut in the interest rate increases expenditure and increases aggregate demand.
The world economy influences aggregate demand in two ways:
A fall in the foreign exchange rate lowers the price of domestic goods and services relative to
foreign goods and services, increases exports, decreases imports, and increases aggregate
demand.
An increase in foreign income increases the demand for U.S. exports and increases aggregate
demand
Macroeconomic Equilibrium

Short-Run Macroeconomic Equilibrium

Short-run macroeconomic equilibrium occurs when the quantity of real GDP demanded equals
the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve.

13. Illustrate derivation of investment demand curve.

An aggregate demand curve is the sum of individual demand curves for different sectors of the
economy. The aggregate demand is usually described as a linear sum of four separable demand
sources.[3]

where

• is consumption (may also be known as consumer spending) = ac + bc(Y − T),

• is Investment,
• is Government spending,
• is Net export,
o is total exports, and
o is total imports = am + bm(Y − T).

These four major parts, which can be stated in either 'nominal' or 'real' terms, are:

• personal consumption expenditures (C) or "consumption," demand by households and

unattached individuals; its determination is described by the consumption function. The
consumption function is C= a + (mpc)(Y-T)
o a is autonomous consumption, mpc is the marginal propensity to consume, (Y-T)
is the disposable income.

• gross private domestic investment (I), such as spending by business firms on factory
construction. This includes all private sector spending aimed at the production of some
future consumable.
o In Keynesian economics, not all of gross private domestic investment counts as
part of aggregate demand. Much or most of the investment in inventories can be
due to a short-fall in demand (unplanned inventory accumulation or "general
over-production"). The Keynesian model forecasts a decrease in national output
and income when there is unplanned investment. (Inventory accumulation would
correspond to an excess supply of products; in the National Income and Product
Accounts, it is treated as a purchase by its producer.) Thus, only the planned or
intended or desired part of investment (Ip) is counted as part of aggregate demand.
(So, I does not include the 'investment' in running up or depleting inventory
levels.)
o Investment is affected by the output and the interest rate (i). Consequently, we can
write it as I(Y,i). Investment has positive relationship with the output and negative
relationship with the interest rate. For example, an increase in the interest rate will
cause aggregate demand to decline. Interest costs are part of the cost of borrowing
 and as they rise, both firms and households will cut back on spending. This shifts
the aggregate demand curve to the left. This lowers equilibrium GDP below
potential GDP. As production falls for many firms, they begin to lay off workers,
and unemployment rises. The declining demand also lowers the price level. The
economy is in recession.

• gross government investment and consumption expenditures (G).

• net exports (NX and sometimes (X-M)), i.e., net demand by the rest of the world for the
country's output.

In sum, for a single country at a given time, aggregate demand (D or AD) = C + Ip + G + (X-M).

These macrovariables are constructed from varying types of microvariables from the price of
each, so these variables are denominated in (real or nominal) currency terms.

The Derivation of the Aggregate Demand Curve

We start with an aggregate demand curve, and we pick two points on that curve, points “a” and
“b”.

8. Discuss the role of central banking in both advanced and developing country.

• CB is the Supreme &Central Monetary institution of a country established for

promoting the general Monetary Policy of the Government

• It lies on the top of the pyramid of the banking structure of a country with wide
powers of supervision and control over all other banks
need for a Central Bank

• To maintain economic stability

• Control over credit

• Control &supervision over the activities of other banks

• Proper execution of monetary policy

• Special role of the CB in a developing economy

• Foreign exchange regulations & international dealings(IMF,BIS)

• CONTROL OVER MONET SUPPLY

• REGULATION OF INTEREST RATES

• ENJOYS MONOLPOLY POWER REGARDING THE ISSUE OF PAPER NOTES

AND RATE OF INTEREST

FUNCTIONS OF CB:

• Control over bank credit

• Monopoly of note issue in accordance with the existing legal procedures

• The banker to the g

• Keeps the cash balances of the government and maintains the accounts

• It gives the advances to the government

• Manages public debt &advises the government on various financial matters

• Bankers‘ bank

• Lender of last resort in emergency situations

• Custodian of the nation’s gold and foreign exchange reserves

• Maintenance of foreign exchange rates.

• Exchange control

• Maintains the stability of the value of money

 • Strengthening the banking structure

• Special role in a developing

Role of CB in Developing Economy

• Expanding currency supply for financing development plans

• Resource mobilization

• Provision of adequate credit

• Controlling inflation creation of strong infrastructural facilities

Increasing the flow of bank credit to the priority sector

• Finance to agriculture

• Finance to industries

• Finance to SMEs

• Finance to self employment

• Operating exchange control

• Development oriented monetary policy

• Developing sound banking structure

• Advising the government on plan matters

• Conducting economic surveys

• Collection of basic statistics

3. Discuss the object and tools of monetary policy in Indian context.

Monetary Policy:
• It refers to the policy of the government regarding money supply

• It is concerned with monetary management, especially with the expansion and

contraction of money supply

• It must decide about the aims and objectives relating to the monetary management

• It will be carried away by various traditional and selective instruments of credit control

Objectives of Monetary Policy

A STABLE PRICE LEVEL

• A Gently Rising Price Level-

Accoording to Keynes,in a society having an unemployment, a gently rising price level

may be a monetary policy than absolute price stability because it provides incentive to the
producers

Sameulson said that mild inflation lubricates the wheels of trade and industry

Slowly rising price level can expand output so long the country has unemployed
resources and idle capacity

• A Gently Falling Price Level

An opposite school of thought advocates a slowly falling price level as the aim of the
monetary policy

According to Dennis Robertson-in a progressive economy gently falling price level

confers greater benefits upon the fixed income-earners

Moreover it is beneficial to the consumers

• Neutral Money

Money should perform the passive functions of acting as the medium of exchange and the
unit of account without having no dynamic functions which affect the economy

But it doesn’t have wide practical application

• Exchange Stability

• Avoidance of Cyclical Fluctuations

• Full Employment and Economic Growth

 LIMITATIONS:

• Exclusive reliance alone cannot cure either inflation or deflation

• It only works as a one-sided weapon

• Since 1936,Keynes monetary policy has lost its appeal

• Empirical evidences have concluded that economic stability cannot be achieved by

monetary policy alone

• It needs appropriate use and proper coordination of monetary and other major policies of
the government which influence business activity

OBJECTIVES OF MONETARY POLICY IN DEVELOPING COUNTRIES

 High Employment

 Price Stability

 Interest Rate Stability

 Stability of Financial Markets

 Stability in Foreign Exchange Markets

 Economic Growth

MONEY SUPPLY:

• FOUR COCEPTS OF MONEY SUPPLY IN INDIA

• M1=Currency with Public(Includes with the public &The commercial banks)+ Demand
Deposits with the banking system+ other deposits with the RBI

• M2=M1+Post office savings banks deposits

• M3=M1+Time deposits with the banking SYSTEM

• M4=M3+Total post office Deposits(excluding National Saving Certificates)

 RBI

It emphasizes on two concepts-

• Narrow Money

It excludes time deposits based on the argument that they are income earning assets and
therefore illiquid

• Broad Money

It includes time deposits following the argument that, as time deposits are income earning
assets and people have acquired them by converting cash into time deposits for earning
future interest income some amount of liquidity is incorporated in time deposits

The basic flaw of the RBI in the process of accounting broad money is that it considers
only time deposits with the banking system and excludes huge volume of money held by
the public with the Non Performing Financial Companies

• These terms are extensively used by the academicians not by the monetary authorities

QUANTITATIVE CREDIT CONTROL INSTRUMENTS:

 Bank Rate/Repo Rate

 Open Market Operations

 Cash Reserve Ratios(CRR)

 Statutory Liquidity Ratio(SLR)