Dr.

Ranga Sai

F.Y.B.M.M Lecture Notes

Dr. Ranga Sai Vaze College, Mumbai

Introduction to Economics
First Year BMM Semester I, Economics (w.e.f. June 2009)

Revised June 2010

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Dr.Ranga Sai

As per First Year Bachelor of Mass Media (wef 2009-2010) Semester-I: Paper VI Section I Basic Concepts of Micro Economics 1. Nature and scope of Micro Economics- Concept of equilibrium – assumptions of Ceteris paribus 2. Market forces of demand and supply: their determinants- Elasticity’s of demand and supply 3. Production function: short and long run – various in input proportions and variations in scale 4. Cost of production: Meaning • Total revenue, total cost and profit – breakeven analysis • Concept of opportunity cost • Various measures of cost: fixed variable cost, average and marginal costs, production and selling costs • Economies and diseconomies of scale 3. Introduction to competitive markets• Objectives of firms • Features of perfect competition, monopoly, monopolistic competition and oligopoly markets I. Fundamentals of Macro economics 1. Basic concepts of income aggregates: • National income, Gross domestic product, per capita income, • State domestic product ( w r t economy of Maharashtra) 2. Introduction to money, banking and public finance a. Concepts of money supply, velocity of circulation of money supply, liquidity preference Monetary policy and fiscal policy, Inflation Features and phases of trade cycles b. Banking and non banking financial institutions: features of commercial banks and central bank, introduction to mutual funds and insurance sector c. Components and functions of Indian financial system: • Features and functions of financial markets • Money and capital markets- characteristics of primary and secondary markets • Role of stock exchanges – role of SEBI d. Introduction to public finance: direct and indirect taxes, Union budget 3. Introduction to external sector: Balance of trade and balance of payments, exchange rate, foreign direct investment and foreign portfolio investment II India in a globalized world Introduction to the concepts of privatization, liberalization and globalization- Globalization and its impact on Indian economy – WTO agreements and India’s commitment to WTO
Available for free and private circulation At www. rangasai.com and www. vazecollege.net

First Year BMM Semester I, Economics (w.e.f. June 2009)

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Dr.Ranga Sai

CONTENT
Section I: Basic Concepts of Micro Economics 1. Nature and scope of Micro EconomicsConcept of equilibrium Ceteris paribus Demand Elasticity’s of demand Supply elasticity of supply Market equilibrium Production function: short and long run Law of variable proportions Isoquants and producers equilibrium Laws of returns to scale Cost concepts Breakeven analysis Economies and diseconomies of scale Objectives of firms Features of perfect competition, monopoly, monopolistic competition and oligopoly, duopoly Fundamentals of Macro economics National income, Gross domestic product, per capita income, State domestic product of Maharashtra Money supply, demand for money, Liquidity preference Monetary policy Fiscal policy, Inflation Trade cycles Commercial banks Central bank, Mutual funds Insurance sector Indian financial system: Features and functions of financial markets Money marketsCapital markets: primary and secondary markets Role of stock exchanges SEBI Introduction to public finance Direct and indirect taxes Union budget Balance of trade and balance of payments, Exchange rate, Foreign direct investment and foreign portfolio investment India in a globalized world Privatization, liberalization and globalization Globalization and its impact on Indian economy WTO agreements and India’s commitment to WTO

Section II

First Year BMM Semester I, Economics (w.e.f. June 2009)

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who will be writing their Economics First Semester examinations on or after October 2009. are made available to all. These notes will be useful to all F. authentic as well as free. Dr. Ranga Sai rangasai@rangasai. without any restrictions. We no way intend to replace text books or any reference material. This is purely for academic purposes and do not have any commercial value.Ranga Sai Dear Student friends… During these days of commercialization it becomes very difficult to find information on web which is relevant. which are originally intended for the students of Vaze College. This is neither a text book nor an original work of research. complied to help the students readily understand the subject and write the examinations.f.e. Mumbai. June 2009) 4 . We believe that knowledge should be free and accessible to all those who need. Economics (w.com June 2010 First Year BMM Semester I.M.Dr.M students of University of Mumbai.B.Y. It is simple reading material. We solicit your opinions and suggestions on this endeavor. Feel free to use and share. Prof. With this intention the notes.

Distribution: Distribution deals with determinations of factor prices.f. consumer behavior models. Micro economic theories help in the designing the models of demand forecasting. The equilibrium is attained by a set of two or more economic forces.Ranga Sai 1. In detail the microeconomics deals with decisions at 1. 3. or a household. he has to optimize his performance within the limitations of income and prices 2. The individual can be a consumer. The producer has to optimize.e. Most micro economic theories are partial equilibriums which provide in depth details of a specific economic activity. First Year BMM Semester I. June 2009) 5 . Consumption: The consumer aims at maximizing consumer satisfaction. "Microeconomics deals with the decision making and market results of consumers and firms". Production: The producer has to coordinate inputs to produce goods so that the out put is maximized and the cost is minimized. They have conflicting interests. Economic equilibrium Equilibrium is a state of rest where there is no urge to change. Microeconomics deals with economics decisions made at individual level. the objectives of economic activity are achieved. It is important in the determinations of factor incomes/ household incomes.Dr. costs and factors. Depending on the market the prices are determined which fulfill the consumer objectives as well as the firm objectives. pricing and determination of factor prices. Nature and scope of Micro Economics Micro economics is that branch of economics which analyzes the market behavior of individual consumers and firms to understand the decisionmaking process of firms and households. At equilibrium. Economics (w. 4. the producer/firm. Exchange: The buyers and sellers meet at the market.

Subject to the given set of variables. .e. Any change in any one of the factor. Such economic models have large application in policy making e. a cause and effect relationship can be studies in greater detail. Ceteris paribus Ceteris paribus is a Latin phrase. The equilibrium is valid as long as the factors determining it remain unchanged.Dr. First Year BMM Semester I.g. By holding all the other relevant factors constant.it explains the relationship between various economic activities Dynamic equilibrium: It is an advanced economic model which gives relationships between several economic variables and can also accommodate change.Ranga Sai • Consumer equilibrium – consumer satisfaction is maximized. Such equilibrium may not have large policy applications. This is an advanced model of explaining circular flow of incomes. e.g. circular flow of incomes. The output of one sector becomes the input for the other sector. These functional relationships relate one dependent variable and several independent variables. which means “all other things being equal or held constant” A ceteris paribus assumption is used to formulate scientific laws. • Producers’ equilibrium – the cost are minimized • Market equilibrium – the price and quantity are so determined that are acceptable to both buyers and sellers. In economics the laws are made based on the cause and effect relationship. for separating factors which interfere while studying a cause and effect relationship. Economics (w.f. Static equilibrium: In economics static equilibrium refers to rigid models which do not accept more or changing variables. Economic equilibrium is not permanent. the equilibrium will undergo a change. the equilibrium is attained. June 2009) 6 . input-output matrix of national income accounting provide relationships as well as determinants at each level of economic activity.

e. demand and supply in a regulated market. advertising-A. holding all other things constant. The demand function relates the quantity demanded-Q. In any free market the price transacted depends on the free will of buyers and sellers. The prices in a free economy are determined by demand and supply. (or ceteris paribus).A. First Year BMM Semester I.Ranga Sai Ceteris paribus represent relationships (such as demand and supply) between two variables (such as price and quantity). 2. in order to isolate the influence of one independent variable (such as price) on the dependent variable (such as quantity). The quantity demanded depends on several factors • Price: Price is major factor determining the quantity demanded. Quantity demanded. income-Y. as an effect of several factors like price-P. June 2009) 7 . Economics (w. Q = f (P. The Government may impose restrictions on price. and tax-T. These regulations will be designed as per the social and economic objectives of an economy. Y. Demand Demand refers to the desire backed by willing ness of the buyer and willing to pay a price.Dr. The clause of keeping other factors constant by retaining one major determinant for the purpose of forming a law is called as ceteris paribus.T/F) Yet while studying the relationship as a law. it assumes all factors to be constant and isolates one major determinant.f. fashions that are the external influences on tastes and the preferences that are selected out of given alternatives. There is an inverse relationship between piece and quantity demanded. • Taste. Market forces of demand and supply Market forces refer to demand and supply. The free will of buyers is represented by demand and free will of seller is determined by supply. fashions and preferences: The quantity demanded depends on tastes that are personal.

Law of demand The quantity demanded depends on variety of factors. At the same price or the consumer may demand more goods. Quantity demanded increases with increasing income and vise versa. Important among them is price. • Taxation: taxation increases the price.Ranga Sai • Income: Income and quantity demanded are positively related.f. First Year BMM Semester I. This is because use and application increase with utility. Substitute goods are those which give similar utility. The quantity demanded decreases with increasing price and increases with decreasing price. The law of demand relates price and the quantity demanded.Dr. The effect is that of increasing price. • Utility: Goods with multiple utility have larger demand. • Price of related goods: There are two types of related goods. The price of substitute goods directly influences the demand for good. Economics (w.substitute goods and complementary goods. So the demand changes with changing season. According to the law of demand The quantity demanded and price is inversely related. • Availability of related goods: The availability of substitute and complementary goods effect the quantity demanded. These are joint good that have complementary demand The price of complementary goods indirectly influences the demand for a good. June 2009) 8 . • Advertising: Advertising increases the demand. • Seasons: There are certain goods where the consumption is seasonal. Complementary goods are those which give utility in combination.e.

When the real income increase the consumer demand more goods. So with increasing quantity the willingness to pay a price decreases. the consumer tends to consume more of it by sacrificing a costlier substitute. With increasing consumption of a good its marginal utility decreases.f.Ranga Sai The inverse relationship between quantity demanded and price is because of three reasons 1. income or the price of a related First Year BMM Semester I. 3.e. Real income is the amount of goods an consumer can buy with his income. When a good becomes cheaper. June 2009) 9 . 2.It means that all other factors remain constant • The income of the consumer remain unchanged • The tastes. the real income of the consumer increases. other factors remain unchanged • Ceteris paribus. The price is paid as per the marginal utility. Elasticity of Demand Elasticity of demand measures intensity of changes in the quantity of a commodity for changes in the price. The law of demand depends on the following assumptions • The price alone changes. Economics (w. choice and preferences remain constant • The utility of the good is given and constant • The supply is uniform without uncertainties.Dr. When the price of a good decrease.

income elasticity or cross price elasticity of demand. Unitary elastic. Economics (w. Relatively elastic.Dr. Price elasticity relates quantity demanded and the price. Perfectly inelastic.Ranga Sai commodity. June 2009) 10 . hypothetical ep = 0. necessary goods ep = ∞. luxury goods ep < 1. Perfectly elastic. because the price decreases for an increase in the quantity demanded. Accordingly. hypothetical First Year BMM Semester I.f. Price elasticity is measured as The price elasticity has a negative value. Price Elasticity of demand Price elasticity of demand measures proportionate changes in the quality of a commodity for proportionate changes in the price. it is called price elastic. ep = 1. Relatively inelastic.e. reference elasticity ep > 1.

Elasticity of Supply measures proportionate changes in the quality of a commodity for proportionate changes in the price.Ranga Sai Supply Supply refers to the It is the willingness of the produces to make available goods for sale at a given price. the quantity of goods supplied increases with increasing price and decreases with decreasing price. There is appositive relationship between quantity supplied and the price.f. Stock of goods refers to the amount of goods available or produced. Supply is that part of stock which is available for sale at a given price. June 2009) 11 . It is the quantity of goods available for sale at a given price. Law of supply According to the law of supply.e. Elasticity of supply is measured as First Year BMM Semester I. Elasticity of Supply Elasticity of demand measures intensity of changes in the quantity of a commodity for changes in the price. Economics (w.Dr.

hypothetical es = 0. hypothetical First Year BMM Semester I. because the quantity decreases for a decrease in the supply. Perfectly elastic. necessary goods es = ∞. Unitary elastic. Relatively elastic.f. The value of elasticity of supply changes with changing responsiveness of quantity changes for changes in the price. June 2009) 12 .Dr. reference elasticity es > 1. No change in the quantity the elasticity will be zero. es = 1.Ranga Sai The elasticity of supply has a positive value. Economics (w. luxury goods es < 1.e. For highly sensitive quantity. Relatively inelastic. the elasticity will be infinity. Perfectly inelastic. Larger the responsiveness greater will be the elasticity.

to sell goods at different price The cost conditions Nature of factor markets First Year BMM Semester I. The demand curve indicates The choice and tastes of the consumers The utility of the good The utility behavior of the consumer The capacity and willing of the consumer to pay the price Similarly. In the market period the elasticity of supply is zero. Long run is that time period where the industry has enough time to change the fixed factors as well and bring large changes in the out put. The period of time is so short that the industry does not have any time to change the supply for any change in the price. the supply curve indicates The willing ness of the firm.e. The industry gets time to make changes in the variable factors of production and change production in a limited range. 3. June 2009) 13 .Dr. Equilibrium with free market In a free market the price is determined by the market forces of demand and supply. Under such perfect competition the price is determined by the firms and buyers. In the short run the supply becomes relatively elastic. It is market where the buyers and sellers are equally important in the determination of price. Free market is a case of perfect competition.f. Economics (w. The buyers are represented by demand curve and the firms are represented by supply curve. The market period is in turn defined as the shortest time period where the supply is perfectly in elastic. no single firm or buyer can influence the price. 2.Ranga Sai Elasticity of supply and time period Elasticity of supply changes with changing time 1. It is an ideal situation whether both the buyers and the sellers are equally represented. The supply will be highly elastic in the long run.

Nature of market economy: Demand and supply are both responsible in the determination of equilibrium. Price 10 9 8 7 6 Quantity demanded 600 700 800 900 1000 Quantity Supplied 1000 900 800 700 600 D<S D<S D=S D>S D<S Market Surplus Surplus Equilibrium Scarcity Scarcity At P1 D<S. the demand and supply get equated automatically.f. the firms do not accept low price At P3 D=S. the price is acceptable to both sellers and buyers This is the equilibrium price. there is scarcity. June 2009) 14 . Goods are not being sold. First Year BMM Semester I. price is high At P2 D<S. the equilibrium is a natural process.Dr. This is determined by the large number of buyers and spellers. The price remains unchanged as long as the demand and supply remain constant.Ranga Sai Supply and demand curve together determine the equilibrium price. According to classical economics. Economics (w. The equilibrium price is the one which is acceptable to both buyers and sellers.e.

It leads to efficient allocation of resources. On the other hand variable factors change with changes in the out put. In the long run all factors change. The production function can be classified as per time period.Dr. A production function is a functional relation between the inputs and out put. So the expression of production function will have fixed and variable factors.f. Between time periods the nature of factors can change. Q = f ( Labor.e. raw material. power. In the short run certain factors are fixed certain other variable. 3. T) Where F represents the fixed factors which remain unchanged in the short run and T is the level of technology given and constant. when all factors change there can be large changes in the out put can be brought. First Year BMM Semester I. = f ( labor. land. machinery / T) Where T. buildings. Economics (w. raw material. Fixed factors remain fixed even with changing out put. June 2009) 15 . It is the qualitative description of capital. Quantity of out put. an embedded (associated) factor of production.Ranga Sai Market encourages efficiency of firms. There can be short run production function and the long run production function. So. Production function Production function A production function provides the relationship between out put and various factors of production. is technology. the technology can change. the expression of long run production function will be Quantity of out put. the cost structure may be totally renewed. power/ F . Q.

The fixed factors become more productive. The variable factors become more and more productive. = f ( labour / F . According to the law of variable proportions. b. if the usage of one variable factor increases. It deals with a short run production function with one variable factors with all other factors are given and kept constant. c. MP reaches a maximum called as the point of inflexion. Economics (w. MP and TP are increasing. separately. June 2009) 16 .f.Dr. Law of variable proportions The law of variable proportions studies the relationship between one variable factor and the out put.e. T) Where F represents the fixed factors which remain unchanged in the short run and T is the level of technology given and constant. ‘all other factors remaining constant. It studies the behavior of out put for changing variable factor.Ranga Sai The short run production function will always carry the expression fixed and variable. The elasticity of production is more than 1 ( Ep>1) During the first stage AP. initially. then slowly and finally decreases’. From this point onwards there will be a change in the level of factor productivity. Q. Total Labour Product Units TP Average Product AP Marginal Product MP Production Elasticity Stages of production 1 2 3 4 5 6 7 5 8 15 24 30 30 28 5 4 5 6 6 5 4 0 3 7 9 6 0 -2 Ep>1 Increasing returns I Stage Ep<1 Ep<0 Diminishing returns II Stage Negative returns III Stage I Stage: Stage of increasing returns During the first stage the out put increase rapidly because a. First Year BMM Semester I. the out put will increase rapidly.

MP<AP. 3. MP decreases and TP is increasing. AP=MP and TP continues to increase. First Year BMM Semester I.Ranga Sai At the end of the stage. but slowly. The elasticity of production is more less 1 ( Ep<1) During the second stage AP decreases but it is slower than MP. The elasticity of production is less than o ( Ep<0) During the third stage. All factors re given and remain constant and only labour changes 2. The level of technology remains same. AP. June 2009) 17 . The factor substitution becomes limited b. c. Fixed factors also become less productive. At the end of the stage MP=0 II Stage: Stage of negative returns During the third stage the out put decreases because a. MP and TP are all decreasing. There will overcrowding of one variable factor b. Other factors become less and less productive c.e. Assumptions: 1. There is perfect competition in product and factor markets. II Stage: Stage of diminishing returns During the second stage the out put increase slowly because a. Further.Dr. Economics (w.f.

F – fixed factors. Factors of production are not perfect substitutes. This is the area where there is factor substitutability. L – labor.Capital.e.T) where K . The analysis is confined to this area alone. Isoquants An isoquant is made up of various combinations of two factors which give rise to a fixed amount of out put. June 2009) 18 . First Year BMM Semester I. The Isoquant depends on the level of factor substitutability. The ridge lines give the limits of factor substitutability. Isoquant deals with a production function with two variable factors. The area out side the ridgelines can not be used for any study. kept constant in the short run and T – the technology given. because the factor substitutability ends.Dr. The area between the ridge lines is called the economic zone. Economics (w. Isoquants away from the origin represent higher out put and isoquants towards the axis represent lower out put. Output = f (K.L / F . Each Isoquant deal with a specific level of out put.Ranga Sai 4.f. Variable factors are of similar productivity.

L – labor.Capital.T) Where K . By choosing isoquant we consider a production function with two variable factors all other factors and technology remaining constant.Dr. F – fixed factors. Producers' equilibrium (Least cost combination) Producers’ equilibrium deals with a least cost combination of producing a specific level of out put the producer would like to produce. This can be done by using isoquants. Economics (w. June 2009) 19 .e.Ranga Sai The slope of the Isoquant represents the Marginal rate of technical substitution (MRTS). Output = f (K. kept constant in the short run and T – the technology given.L / F . Such slope of isoquant depends on the nature of factors and intensity of production. It is the ratio of change in K for changes in L.f. The Marginal rate of technical substitution is the manner one factor is substituted by the other factor so as to give a fixed output through out the isoquant. First Year BMM Semester I. A producer will be a t a state of equilibrium when he produces a desired level of out put at a cost which is least.

Economics (w. There are different least cost combinations for different levels of out put.Ranga Sai Firstly the producer will determine the level of out put to be produced. 2. All other factors are given and constant 4.f. There is perfect competition in factor and product markets.e. Assumptions 1. The level of technology remains same 3. June 2009) 20 .Dr. Mathematically. the isoquant is selected. The producers' equilibrium is found at a place where the slope of the isoquant is same as the factor price ratio line. The producers' equilibrium finds the least cost combination. When all the points of equilibriums First Year BMM Semester I. Or the slope of the price ratio line is same as the Marginal rate of Technical Substitution. Least cost combinations are found at different levels of out put by following the condition of producers’ equilibrium. The prices of two factors are given and remain unchanged. the slope of the isoquant is equal to the slope of the price ratio line. Producers’ equilibrium considers a production function with two variable factors. Least cost combination is the combination of two factors which will produce a given level of out put at least cost.

Laws of Returns to Scale The laws of returns to scale deals with the long run production function.Dr. land. First Year BMM Semester I. So.f. In the long run all factors change. the production path or the scale line can be derived. Economics (w. raw material. June 2009) 21 . machinery / T) Where T.e. if it is toward the labor axis the technology is labor intensive. It is the qualitative description of capital. is technology.Ranga Sai or the least cost combinations at different levels of out put are joined. The shape and position of the scale line will indicate the type of technology or the intensity of factor usage. when all factors change there can be large changes in the out put can be brought. power. the expression of long run production function will be Quantity of out put. the technology can change. Q = f ( Labour. buildings. the cost structure may be totally renewed. If the production path is towards the capital axis it is capital intensive. an embedded (associated) factor of production. According to the laws of returns to scale In the long run when the scale of production increase.

Economies of scale .f. E2. Economics (w. June 2009) 22 .Capital. 1.T) Where K . The out put may increase in the same proportions as the inputs used called Constant returns to scale OR c. L – labour. The laws of returns to scale can be explained with the help of isoquants. kept constant in the short run and T – the technology given. By choosing isoquant we consider a production function with two variable factors all other factors and technology remaining constant.e.Ranga Sai a. the out put may increase in larger proportions than the inputs used called increasing returns to scale Increasing returns to Scale . The out put may increase in lesser proportions than the in puts used called Diminishing returns to scale. Increasing returns to Scale According to Increasing returns to scale In the long run when the scale of production increase.L / F . F – fixed factors.Decreasing costs First Year BMM Semester I. and E4 decreases . The out put may increase in larger proportions than the inputs used called Increasing returns to scale OR b.Dr. E3. Output = f (K.The gap between E1.

f.Ranga Sai The out put responds positively because.Constant costs In case of constant returns to scale the out put increases in the same proportions as the inputs. 2. the out put may increase in the same proportions as the inputs used called Constant returns to scale Constant returns to Scale . it operates on economies of scale. In the long run the firm derives certain advantages called economies of scale.Neutral Economies of scale . E2.e. The firm is a said to be operating on neutral First Year BMM Semester I. This is called decreasing costs. Constant returns to scale In the long run when the scale of production increase. Due to economies of scale the costs keep on decreasing.Dr. In the diagram it can be seen that the gap between the isoquants keep on decreasing thus showing that lesser and lesser factors are needed for producing additional output.The gap between E1. These economies of scale can come from within called internal economies or come from out side the firm called external economies. June 2009) 23 . Economics (w. and E4 remains constant . E3.

Economics (w. These diseconomies of scale can come from within called internal diseconomies or come from out side the firm called external diseconomies. Diminishing returns to scale. This is called increasing costs. E3. and E4 increases .The gap between E1. E2. the out put may increase in lesser proportions than the in puts used called Diminishing returns to scale. because. The firms neither get nor loose any advantages due to large scale production. This is case of constant costs 3. In the long run the firm may face certain disadvantages called diseconomies of scale. In the diagram it can be seen that the gap between the isoquants remain constant thus showing that same ratio of factors are needed for producing additional output.Increasing costs The out put responds discouragingly. Diminishing returns to Scale . Due to diseconomies of scale the costs keep on increasing. First Year BMM Semester I. it operates on diseconomies of scale. In the long run when the scale of production increase.Dr.Diseconomies of scale .Ranga Sai economies. The per unit costs remain constant. June 2009) 24 .f.e.

short run and long run costs and the opportunity cost. each suitable for a different purpose.f. First Year BMM Semester I. Assumptions: 1. Financial cost and social costs: Financial costs are private costs. Financial costs and physical costs: Financial costs are economic costs mentioned in uniform value terms. 5. 1. 4. Cost of production: Costs There are several concepts of cost developed. Technology remains same 4. Accounting cost and economic costs: Accounting costs consider documentation of expenditure for purpose of future analysis. the costs paid by a firm to procure factors for creating out put. It is case of long run production function 2. and resource conservation.e. Economics (w. The analysis deals with spent money. their behavior and methods of optimizing cists for minimizing cost of production and maximizing profits. Most of the social costs can not be quantified. June 2009) 25 . There are financial cost and social costs.Ranga Sai In the diagram it can be seen that the gap between the isoquants keep on increasing thus showing that more and more factors are needed for producing additional output. It is the analysis in retrospection. But these cots are very important in terms of social objectives and justice. it is easy to apply any quantitative or statistical method for regulating their usage and optimizing for profits. 2. On the other hand the social cost deal with the burden of production on the society. The major consideration is optimizing usage of factors for cost reduction and maximizing profits. The scale of production increases 3. There is a perfect completion in factor and product markets. Since all the factors are mentioned in uniform terms. As against this. the economic cost study the nature of costs. environment. accounting cost and economic costs. 3. Each isoquant represents a fixed increment of output.Dr.

Total cost Total cost = Total fixed cost + Total variable cost The total cost is the sum of total fixed cost and total variable cost. Economics (w. In the ling run. Any payment less than this will make the factor leave the production function and join an alternative use. Economic costs in the short run 1.f. Average Variable Cost First Year BMM Semester I.e. Total Fixed cost It is the fixed cost which remains same in the short run irrespective of out put. 2. This is the minimum which needs to be paid to bring a factor in use. Larger the opportunity cost higher will be the factor price.Ranga Sai Physical costs on the other hand are factors mentioned in dissimilar units. Opportunity Cost: Opportunity cost is the cost of a factor in its alternative use. the fixed cost also changes. The fixed cost remains constant in the short run at level of out put. June 2009) 26 . Average Fixed cost Average Fixed cost is the fixed cost per unit of out put Average Fixed Cost = Total fixed cost Out put 5. At zero level of out put the total cost is equal to total fixed cost. The concept of opportunity cost is useful in determining the factor price. At zero level of out put the total cost is equal to total fixed cost 4. Yet physical costs are important for production planning and procurement of factors. The total variable cost increases with increasing cost. 3. At zero level of out put the variable cost is zero. Total variable cost: It is the cost incurred on the variable factors. The factor price needs to be equal to or greater than the opportunity cost. Since they are dissimilar in expression and quantitative.Dr. it is not easy to apply techniques of quantitative analysis. The use of variable factor increases with increasing output even in the short run. 4.

Dr.Ranga Sai

Average Variable Cost is the per unit average variable cost Average Variable Cost = Total Variable Cost output 6. Average Cost Average cost is the cost of unit out put on the aggregate Average Cost = Total cost Out put Or Average Cost = Average Fixed cost + Average Variable Cost 1. Marginal cost Marginal cost is the cost of an additional unit of out put. It is measured as Marginal cost = TC (n-1) - TC n

Break even Analysis
Break even out refers to the level of output where TR = TC. This is the minimum out put the firm need to produce its costs. Any output there after will grant profit to the firm. Usage of break even point for corporate decision making is called Break even analysis. At break even point total cost is equal to total revenue. After break even point the profitability begins. The out put less than break even out put shows losses. Every firm aims at break even level of output in the beginning. The break even level is a no profit no loss condition. In other words it is case of normal profits. The costs cover only the manager’s remuneration and there is no surplus over that. It is similar to the condition AR = AC.

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Dr.Ranga Sai

At break even point there are no profits, so TR = TC Where, TR is total revenue TC is total cost P is price AVC is average variable cost TFC is total fixed cost Q is out put

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Dr.Ranga Sai

Break even analysis is based on the following assumptions 1. The cost and revenue functions are linear functions. This is for the sake of simplicity. 2. The firm can estimate the cost and revenues in advance. 3. Price remains uniform at all levels of out put. 4. The costs are made up of fixed and variable costs.

Angle of Incidence
The angle of incidence is the angle made by the TR and TC functions at the break even point. In break even analysis the angle of incidence is very important in selecting a project among various competing projects. The angle of incidence decides the nature of break even point. If the angle of incidence is larger the break even out put will be smaller. In other words, if the angel of incidence is smaller the break even out put will be larger. While comparing competing projects on the basis of break even points, a project with larger angle of incidence will be selected. Because a firm will always wishes to keep the Break even out put small so that, it can operate on profits hat sooner.

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the revenue in excess of all these provisions yield profits that can be distributed among owners or retained as reserves and surplus. The firm now provides for taxes after deducting depreciation. Economics (w.e. June 2009) 30 .f. Finally. Limitations First Year BMM Semester I. When a firm makes profits it has to pay taxes. It is that part of fixed assets that is consumed during the year and that part of fixed cost that can be charged to the out put. However.Dr. These marketing overheads are for more than one year. Depreciation is the first priority after attaining break even out put. the firm needs to allot revenues for different purposes depending on the earnings of profit or revenue.Ranga Sai Application of Break even analysis A firm will firstly. Thereafter. So if the revenue permits the firm may provide for durable marketing overheads. Depreciation is a nominal expenditure. the firm will slot revenue for depreciation on assets. Firstly. attain the break even out put so that it can be out of losses and start making profits. marketing overheads can be deducted.

f. Technical economies: The firms will have improved technology in the long run and the firm will progressively reduce costs. 6. This will add to the revenues of the firm. Internal economies of scale These are the advantages the firm gets from the factors within the firm. It assumes that the quantity of goods produced is equal to the quantity of goods sold 7. 3. 1.Ranga Sai 2. First Year BMM Semester I. The revenue will increase Similarly.e. It assumes average variable costs are constant per unit of output. Economics (w. 6. This again reduces the cost and adds to the profit margins. 3. as it tells you nothing about what sales are actually likely to be for the product at these various prices. A. 5. When the firm increases the scale of production it gets certain advantages. Managerial economies: In the long run the firm will have better managerial talent in organizing factors for better productivity. June 2009) 31 . Economies of cost: With improved supply chain and labour productivity the costs will reduce in the long run. Economies of by product: The firm will be able to develop waste into marketable by product in the long run.Dr. In multi-product companies. It assumes that the price remains uniform at levels of out put 4. it assumes that the relative proportions of each product sold and produced are constant Economics of Scale In the long run all factors becomes viable and the firm can increases its scale of production. These factors are endogenous to the production function. 4. Break-even analysis is only a supply side analysis. Economies of supervision: Better supervision will improve the factor productivity in the long run. 2. These advantages are called economies of scale. It assumes that fixed costs are constant 5. Economies of integration: In case of forward integration the firm will undertake an additional process of production and add value o the out put. backward integration will enable a firm produce such factors which were earlier bought form the factor markets.

All objectives are important. June 2009) 32 . economic. Economic objectives Economic objectives are material objectives which may be short as well as long run. Economies of marketing: The firms will be able to market with ease due to establishment of brand and dealership network 2. Risk bearing economies: Firms will greatly increase capacity to take risk with new products and technologies in the long run. The firm will also have better institutional axis for raising more finance easily. B. These economic objectives can be classified as follows: 1. These factors are exogenous to the production function.f. Economies of environment: In the long run the firm becomes more environmentally friendly with larger investment on pollution control and resource conservation 5. 8. This is due to established market and strong finances. Economics (w. a. Following are some of the important objectives of a firm.Dr. Some objectives are uniformly significant for all firms. 1. short run. 3. Economies of finance: The firms will have better financial position in the long run due to accumulated profits. This may create niche and better price.e. Certain firms may have material objectives significant certain other firms may have normative objectives significant.Ranga Sai 7. long run material and non material in nature. However the firm may decide its own priorities in objectives. Profit maximization: First Year BMM Semester I. Introduction to competitive markets Objectives of Firm The firm may have several objectives ranging from. Economies of specialization: The firm may develop certain specialization in the long run depending on the production function and acceptance in the market. External economies of scale These are the advantages the firm gets from the factors out side the firm. Economic objectives are normally considered by all firms.

MC is equated with MR.Ranga Sai Each firm tries to maximize profits. MC=MR emerges as equilibrium condition for optimizing out put for a firm. Workers welfare First Year BMM Semester I. By equating slopes.e. Firms may aim at maximizing rate of profit or profit. This is a universal objective for firms. The gap between TR and TC can be maximized by drawing two tangents.f. So. The rate of profit is maximized by pricing so that there is larger gross profit margin. On the other hand maximizing profit may be attained by maximizing out put. The slope of TC is MC and slope of TR is MR. The firm will produce such out put which will give maximum profit. The firms aim at maximizing the difference between total revenue and total cost. 2. one on each with same slope. Economics (w. June 2009) 33 .Dr.

Creating brand equity Every firm aims at creating a brand and as large consumer following as possible. It is give back from the society from where the firm makes a living. Growth: forward and backward integration The firm may go for forward integration thus adopting an additional process of production or take up backward integration whereby. Market leadership The firm wills always aim at being the market leader. 4. Accordingly. market share and growth. Consumer satisfaction Consumer satisfaction helps in maintaining brand image. 3. market share. Investors benefit In case of joint stock companies. In the long run the competition may increase. In most cases profit depends on this objective. First Year BMM Semester I. 5. This is the objective before aspiring for market leadership. 2.Ranga Sai Workers welfare helps in maintaining harmonious relationships and also maintaining high levels of productivity and loyalty. Long run objectives 1. June 2009) 34 . This is a material objective as well as normative objective. it will have a investor friendly policy in dividends and bonus.f.e. the firm will aim at increasing the net asset value of the company. This is in the long run interest of the firm. b. produce locally such component which was earlier brought form the factor market. Non material objective 1. c. Increasing market share The firms will initially aim at increasing market share. 6. in such a market the basic principle is to survive. prevents defection of consumers to another brand. Survival The basic objective of firm is to survive in the long run. Economics (w. 3. Specialization Specializing in certain product or service will be useful in establishing brand image.Dr. 4. Social responsibility The forms may assume social responsibility as an important factor.

In the long run the perfect competition has only firm which operate on normal profits. Resource conservation The resource conservation may help in reducing costs but it also helps in reducing social costs. 4. June 2009) 35 . so that no form has a reason to charge a different price. Features of perfect competition 1.Dr. efficient firms which can operate at normal profits only exist. get distributed among more and more firms. Economics (w. The society benefits form resource conservation 4. Environmental protection The firm may work in the direction of protecting the environment. This is dome by being eco-friendly and having less pollution.f. hospitals. At the same time when the profits decrease the less efficient firms leave the industry. With new firms joining the super normal profits. the firms keep joining the production as long as there are profits. Large number of buyers and sellers The number of buyers and sellers should be so larger that no firm can determine the supply or no single buyer can determine demand and no singe person can determine the price. 2. 5.Ranga Sai 2. Perfect Competition Perfect competition refers to a competition between large umber of buyers and sellers dealing in homogenous product at uniform price. 3. So in the long run.e. Perfect knowledge The buyers and sellers have perfect knowledge of \demand. Free mobility of factors of production First Year BMM Semester I. Homogenous product The product is homogenous. Free entry and exit of firms: When there is free entry and exit of firms. Creating social infrastructure The firm may create social infrastructure by constructing educational institutions. and aforestation. 3. townships. supply and price.

Advertising will add to cost and reduce profits 8. Equal factor prices give all the firms same opportunity to make profits and survive. Since a single firm supplies to the large number of buyers.f.e.Dr.Ranga Sai Free mobility of factors ensures that the cost of factors is same across all the regions. No advertising The firms need not advertise. No Government restrictions There are no government interventions by way of taxes or mobility of goods. Single seller: The monopoly market has a single firm. because each firm will have infinite market at the given price. So. First Year BMM Semester I. No transport cost The transport cost should be insignificant as compared wt the cost of production. However there may be differences in the elasticity of demand in each segmented market. efficiency of firms will determine the profitability of firms. 7. Monopoly Monopoly refers to an imperfect market situation where a single seller sells the product in different markets at uniform or discriminating prices. Monopoly is identified with single firm large number of buyers and the monopolist as the price maker. Features of Monopoly 1. Product: The product may be homogenous or even differentiated depending on the nature of market and division of submarkets. 3. There is no distinction between firm and industry. 6. This is possible only when the firms cater to local markets. Economics (w. June 2009) 36 . 9. Uniform price Uniform price ensures that the consumers have choice between firms and the firms have no reason to charge different price due to homogenous product. the firm tends to be large and specializing in its production 2. Following are the features of monopoly market. Large number of buyers: There is a large market even under monopoly.

Ranga Sai 4. the relation ship between AR and MR also changes Relationship between Average revenue and Marginal revenue under monopoly A monopolist faces a downward sloping demand curve. a.f. Further. Economics (w. The personal monopolies continue 5. the monopoly power remains intact d. The objective of price discrimination is profit maximization. 6. c. so he can sell more only by reducing the price.Dr. It remains as monopoly. Government monopolies on entry b.g. Registered trade marks and brands: I case of registered trade marks. They can not be duplicated. Personal monopolies: Personal monopolies have individual branding. The demand is direct on to the firm. e. the industry faces down ward sloping demand curve and the firm gets the perfectly elastic demand curve. First Year BMM Semester I. Price discrimination: With price discrimination a monopolist sells the same product at different prices in different markets at the same time. Incase of perfect competition. AR and MR are related through elasticity of demand. This is due to the monopoly power the firm has. Exclusive ownership of technology of production: If the technology of production is known only to a single firm the monopoly power remains un effected. Legal restriction: The law may prevent other firms from entering. It means that the firm can sell more only by reducing price. firms can not duplicate and compete in a market. E. AR is not equal to MR. The monopoly power is got by the firm due to following factors. June 2009) 37 . there is no distinction between firm and industry. Monopoly power: The entry into monopoly market for other firms is restricted. In case of monopoly the firm directly faced the downward facing demand curve.e. With this difference. A monopolist faces a downward sloping demand curve: Under monopoly. Exclusive ownership of raw material: Access to raw material is held by a single firm. Since it is an imperfect market. It can be seen that AR is greater than MR. This will change the AR and MR relationship.

So any perpendicular drawn on Y axis will show the property. AR curve cuts the plain below AR into two halves. Following are the features of monopolistic competition: 1.f.Dr. First Year BMM Semester I. Economics (w.e. It is a large market where firms compete. June 2009) 38 . compete with differentiated product at dissimilar prices.Ranga Sai Q 1 2 3 4 5 Price 10 9 8 7 6 TR 10 18 24 28 30 AR 10 9 8 7 6 MR 8 6 4 2 Geometrically. Large number of buyers: The number of buyers is large. ab = bc Monopolistic Competition Monopolistic competition is a case of imperfect competition where limited number of firms.

It is seen that dual utilities have improved the quality of the product like the two-in-one products. This is done by creating unique selling proposition. With differences in cost the price also changes.e. contests. The objective of price differentiation is to claim monopoly power in an imperfect market. The prices need not be uniform. The consumer is made to pay higher pries which are falsely justified through advertising. utility differ. Non-price competition benefits the firms. The firms justify the price by either different image/ brand equity or by different qualities/utility of the product. 4. First Year BMM Semester I. prices. The quality should be such that the utility of the product gets enhanced. Limited number of firms: The number of firms remains limited due to intense competition. Product differentiation Product differentiation means the same product being projected different.Ranga Sai 2. Products with different utilities have elastic and larger demand. Etc. b. By an additional quality: the firm may show a different quality of the product which may not exist in the market. c.Dr. quality or term of sale. 3. but competition discourages new firms. By different term of sale: the fir may offer a different terms of sale. by modifying with additional utility. quizzes. The competition between firms with different prices is called non-price competition. Firms sell at different prices.f. Economics (w. Product differentiation means differences in cost. In such a case the prices also differ. It may be by way of guarantees. Each firm produces goods as per their own market. This is one method of improving the appeal of the product. June 2009) 39 . after sale service. so the product quality. The entry is not restricted by law. The product differentiation is done in flowing ways: a. By an additional quality: The product can be designed with an additional utility.

Selling cost Selling cost is the cost of generating demand. publicity. the demand curve has shifted upwards and also became elastic. Whereas. proportion. Under monopolistic competition. Oligopoly Oligopoly is an imperfect market condition identified with limited number of firms with high interdependence competing with differentiated or uniform product at uniform prices. field campaign and similar promotional activities. the firms engage in non price competition. brand image and justifying the price. Selling cost is a burden on the consumer. advertising becomes more and more expensive.e. The firms charging different prices justify their prices by advertising. Selling cost makes demand elastic and shifts demand curve u wards. This is the advantage the firm receives by spending selling cost. selling cot has increased the average cost. This is due to economies of scale.Dr. The production cost decreases with increasing out put in. In the diagram it can be seen that. Selling cost does not give utility. This is because. with increasing out put. Production cost on the other hand generates utility. June 2009) 40 . Selling cot helps in generating demand.f.Ranga Sai 5. Yet. Economics (w. the selling cost increases in larger proportions to increasing out put. Following are the features of oligopoly market First Year BMM Semester I.

Advertising allows the product to have the required exposure to the consumer so that the consumer can include the product in his options. 6. Advertising Advertising is an essential part of oligopoly market. When the price is accepted by the firms and the buyers. This is called as price illusion.f. Advertising is essential for registering the product with the consumer. Large number of buyers The number of buyers will be very large. Limited number of firms: The number of firms is limited due to intense competition. On the other hand reduction in the price may be treated as a loss of quality.Dr. 3. No firm can deviate and change the product description. Rigid and uniform prices The price will remain uniform and rigid.Ranga Sai 1. June 2009) 41 . The firms almost share the same demand curve. Any change made by the firm will lead to the consumer shifting to other competing firms. A firm will not reduce the price because the consumer is willing to pay the given price. 5. advertising make the demand elastic. The demand remains very flimsy for a firm. A consumer will not pay a higher price because he can continue to get the same price from other firms. the firm will be able to sell more goods at the given price. 2. Further. 4.e. There will be huge market for which the firms compete. By making the demand elastic. similar product details and advertising. The industry remains as a small group of firms. The demand is maintained carefully by maintaining the same price. Types of oligopoly There are different types of oligopoly each based in a different marketing practices followed to manage competition. High degree of interdependence between firms The firms will have high degree of interdependence in terms of price and product design. However. First Year BMM Semester I. the demand is made elastic or remains inelastic depending on the nature of advertising. Economics (w. it continues for a long time.

With product differentiation.e. The leadership firm will have the privilege of designing the product. however with interdependence. price and market share. Economics (w. The market offers flexibility the firms to change the nature of the product keeping the base utility same. enter into agreements to lessen competition and share the market to exploit the consumers. the price tends to change because of cost variations. In ace of pure oligopoly it is easy to maintain price uniformity. For this reasons the firma can only adopt apparent product differentiation without changing the cost structure. Collusive and Non collusive oligopoly Non collusive oligopoly refers to a market where the forms operate independently. there can be one large firm emerging as the leader. Whereas in case of partial oligopoly. Cartels Cartels are a case of collusive oligopoly. price and the nature of competition.Dr. Pure oligopoly may at times change to partial oligopoly by frequent mergers. Firms in market with intense competition form arrangements to avoid competition by making agreements so that all firms tend to benefit at the cot of the consumer. 7. b. The leader will have the advantage of giving a lead price to the product which other firma will follow. Even in theses conditions the firms need to maintain the uniform prices. c. the firms may collide. June 2009) 42 . Firms merge among themselves to form a large firm so that a leadership role can be achieved. Pure and differentiated oligopoly Pure oligopoly deals with goods are homogenous whereas differentiated oligopoly may have apparent product differentiation. Cartels are harmful First Year BMM Semester I.Ranga Sai a. In case of collusive oligopoly. Complete and partial oligopoly Complete oligopoly refers to market where all the firms are equally placed in terms of competition.f.

All these agreements where the firms or the counties get captive markets belong to cartels. Hence it is a model of oligopoly. Duopoly Duopoly is a model of oligopoly market with two firms designed to study the interdependence of firms for pricing. There will be huge market for which the firms compete. The counter may form commodity agreements. June 2009) 43 . 2. Economics (w. The firms may have system of marketing royalties as consideration for sharing territory for attaining monopoly power. The cartels can be operating at international levels. Two firms: The number of firms is limited to two. This is for the purpose of studying the details of interdependence. These are price cartels. bilateral agreements. There can be different types of cartels depending on agreements. b. where the regions are shared on the basis of trading currencies or countries. a.f. In this case the market has one monopoly firm selling the product. the firms with high price may insist that its price prevail. c. In a cartel. 3.Dr. Following are the feature of a model duopoly market: 1. and multilateral agreements for a specific time. d. The firms may divide the market geographically and restrict mutual entry in respective territory.Ranga Sai business organization formed to enhance exploitation and increase profits. Large number of buyers The number of buyers will be very large.e. so that all firms can maximize profits. High degree of interdependence between firms First Year BMM Semester I. In both these cases competition is avoided and market becomes lucid. At the same time the firm with lesser price may insist on its price to be followed so that larger out put can be sold. A firm operating in market as an exclusive monopolist may have to pay market royalty to other firms restricting entry.

6. June 2009) 44 . Any change made by the firm will lead to the consumer shifting to other competing firm. A firm will not reduce the price because the consumer is willing to pay the given price. This is called as price illusion. These are the demand curves made by the firms by the independent advertising campaigns and publicity. When the price is accepted by both the firms and the buyers. Economics (w. On the other hand reduction in the price may be treated as a loss of quality. the firm will be able to sell more goods at the given price. A consumer will not pay a higher price because he can continue to get the same price from other firm. However. similar product details and advertising. Single firm can deviate and change the product description. Further. Advertising allows the product to have the required exposure to the consumer so that the consumer can include the product in his options. Advertising Advertising is an essential part of oligopoly market. 5. Kinky demand curve The demand curve for the duopoly market is med up of the individual demand curves of two forms. Advertising is essential for registering the product with the consumer. advertising make the demand elastic. Two firms almost share the same demand curve. Rigid and uniform prices The price will remain uniform and rigid.e.Ranga Sai The two firms will have high degree of interdependence in terms of price and product design. By making the demand elastic. The demand remains very flimsy for a firm. the demand is made elastic or remains inelastic depending on the nature of advertising.Dr. The demand is maintained carefully by maintaining the same price. it continues for a long time. 4. First Year BMM Semester I.f.

f.Dr. June 2009) 45 . Economics (w.Ranga Sai First Year BMM Semester I.e.

National income estimates are represented as Gross and net.e depreciation Gross National Income – depreciation = Net National Income 2. National Income at factor costs – subsidies + taxes =National Income at market prices Measurement of National Income There are three approaches through which national income can be calculated but all these approaches give the same value of the national income. Economics (w. Domestic and national product and market prices and factor costs 1. Expenditure approach 1.f.Dr. Income approach and 3. Gross Domestic product Gross National Product The difference between GDP and GNP is the net earning from the external sector GDP = C + I + G and GNP = GDP + (X-M) 3. Output approach. National Income at market prices and National Income at factor costs The difference between factor costs and market prices is the net of subsidies given to industry and the taxes levied. 2. 1.Ranga Sai Section II 1. Net National Income and Gross National Income The difference between Net National Income and Gross National Income is the capital consumption i.e. Basic concepts of income aggregates National Income National income is the total of the value of the goods and the services which are produced in an economy. First Year BMM Semester I. Gross Domestic Product: Gross Domestic Product (GDP) measures the value of output produced within the domestic boundaries of a country over a given time period. Output approach. June 2009) 46 .

Net Indirect Taxes 2.Dr. income support paid to families on low incomes • Private transfers of money from one individual to another. This is known as the parallel economy where goods and services are exchanged but the value of these transactions is hidden from the authorities. the state pension paid to retired people. Expenditure approach The measurement of National Income by Expenditure Method considers consumption.g. • Income that is not registered.M) Where: C = Personal consumption expenditures I = Gross investment G = Government consumption First Year BMM Semester I. to this the net earnings from external sector is added. GDP = C + I + G + (X . 3. Economics (w.f.Depreciation + NFIA (Net Factor Income from Abroad) .Intermediate consumption NNP at factor cost = GDP at market price . Income approach The Income Method of calculating GDP (the Sum of Factor Incomes) GDP is the sum of the incomes earned through the production of goods and services. June 2009) 47 .e. Income from people employment and in self-employment + Profits of private sector companies + Rent income from land = Gross Domestic product (by factor income) This method excludes the following items: • Transfer payments e.Ranga Sai The method for calculating National Income by Output method considers the value of output. GDP at market price = Value of Output in a year . investment expenditure and government expenditure.

e. June 2009) 48 . 1 State for FDI Special Economic Zones The SEZs are earmarked as duty free enclaves and have a flexible and business-friendly policy regime 93 Special Economic Zones being set up in various parts of the state both Multi Product and Product First Year BMM Semester I.Dr.f.Ranga Sai X = Gross exports M = Gross imports Maharashtra State Economy Most industrialized and urbanized State in India Ranks 1st in terms of State Domestic Product accounting for over 13 percent of the National GDP Maharashtra’s economy is growing at over 9 percent (9. FIs and the Reserve Bank • Time Zone – is an added advantage • BSE & NSE account for over 70 percent of the volume across all Stock Exchanges in the country • Over 90 percent of commodities turnover transactions executed from NCDEX and MCX • 90 percent of all merchant banking activities take place in Mumbai • Center of Entertainment – Bollywood • The only Indian State to feature in the IMD Switzerland’s World • Attracted the highest FDI (21 percent of the country’s total) between 1991-2007 with 3957 proposals having committed investments of USD 17 Billion • FICCI FDI Survey 2006 says Maharashtra continues to be No.below 34 years Literacy is at 77 percent. banks. State Overview • Sixth Largest Metropolitan Area in the World and Most Cosmopolitan City in India • Generates 5 percent of India’s GDP • Headquarters of most corporates.4 percent in 200607) Contributes over 40 percent of the National fiscal receipts Per Capita Income is 44 percent higher than the national average 67 percent of the population is young . Economics (w.

Gross Domestic Product at constant prices is expected to grow by 9.2 percent in the previous year.3 percent during 2006-07. June 2009) 49 . • In 2006-07 revenue growth is estimated at 24. IT and Food Processing SEZ’s for Power Generation.33 percent in the year 2007-08. • Containment in non-plan expenditure has been achieved despite higher allocations for the maintenance of assets.Ranga Sai Specific sectors like Auto.42 percent against the revenue growth of 18. First Year BMM Semester I. • The States own tax revenue income in 2006-07 is estimated to outpace the nominal rate of growth in the Gross State Domestic Product. Textiles.e. Port-Based SEZs also being developed Service Sector Services contribute 61 percent to the State’s economy 25 percent of the Top 500 Software Companies present 20 percent of country’s software exports 32 percent of country’s IT professionals 90 percent of all merchant banking activities take place In Mumbai Infrastructure 11 percent of National Road Network 9 percent of National Railway Network 34 percent of international passengers and cargo handled by Airports 56 percent of container traffic handled by Jawaharlal Nehru Port in the State 4 international airports and domestic airports at all major cities India’s only expressway upgrading Mumbai-Pune connectivity to 10 lane Mumbai Trends in State Gross Domestic Product • At the All India level.10 percent in 2005-06.2 percent in 2006-07 as against 9 percent in the previous year. Revenue receipts are estimated to grow at 13. • In comparison to this the Gross State Domestic Product of Maharashtra at constant prices is expected to increase by 9. Bio Technology. while the revenue expenditure growth is expected at 6. Free Trade Warehousing Zone. as against increase of 9. It has been mainly achieved by containment of the expenditure on establishment. • The State is moving from fiscal consolidation to fiscal stabilization stage.Dr. Economics (w.82 percent.f.

It is further estimated to decline to 25.Ranga Sai • Growing debt stock and high debt servicing to the revenue receipts ration has been a matter of concern for the State. If velocity is low.Dr. money is changing hands quickly. and it takes a much larger money supply to fund the same number of purchases. Velocity of Money = Gross Domestic Product Money Supply Factors determining velocity of money • Change in Price for goods and services. State has been able to reduce the debt as a percentage of Gross State Domestic Product to 27.05 percent in 2006-07 as against 28. 2. • Availability of Substitutes First Year BMM Semester I. • Debt servicing to revenue receipts which was as high as 36. June 2009) 50 .14 percent in 2005.41 percent in 2006-07 and 29. then money is changing hands slowly. banking and public finance Velocity of money Velocity of money is defined simply as the rate at which money changes hands. Velocity refers to how many times a given quantity of money is spent during the period under consideration. If velocity is high.f. Economics (w. It is known that GDP = M x V.53 percent in the year 2007-08.e.11 percent in 2007-08. GDP equals the quantity of money times its velocity.76 percent in 2005-06. By dividing the Gross Domestic Product (GDP) by the Money Supply (M1) Velocity of Money can be derived. • As a result of better fiscal management. that is. and a relatively small money supply can fund a relatively large amount of purchases.06 is estimated to decline 30. Introduction to money. usually one year.

Traditionally the supply of constitutes coins and currency. They are liquid but with a time prescription. Economics (w. This is similar to the measure M3 followed by Reserve Bank of India. Coins and currency + Demand deposits + Time deposits The spending of the house hold is influenced by the cash held by them. Milton Friedman’s approach is accepted and followed all over the world as the standard of measuring money supply. The Central bank possesses the monopoly of issue of currency. The deposits which are chequable are as liquid as cash. Since David Hume. 1. the composition of money started including coins and currency together with demand deposits. First Year BMM Semester I. With ever expanding properties and functions of money the constituents of money has been rapidly changing.f. There are several approaches to the constituents of money supply. So primarily. Time deposits are those which have a time obligation between the bank and the depositors. June 2009) 51 . money supply should be made up of: Coins and currency + Demand deposits 2.e.Ranga Sai • • • • • • • Credit Supply Rate of Interest Banking habits Development of banking system Inflation Future expectations Liquidity preference Constituents of Money supply The supply of money is the State function. According to him money supply should comprise coins and currency. But the time deposits also enhance the spending decisions.Dr. demand deposits and also time deposits. Milton Friedman described money with wider coverage and functions. Time deposits can function as liquidity preference thus allowing households exercise greater spending.

It is this primary level liquidity which influences the hose hold price index of necessary goods.Ranga Sai 3. E. It brings out the strength of the Post Office Savings Organization in India. securities.f. loans. The method has wider coverage. India with its kind of spread. However.Dr. M1 = Coins and currency + Demand deposits of all Commercial and cooperative Banks M2 = M1 + Demand deposits of Post office saving organization M3 = M1 + Time deposit of Commercial and Cooperative Banks M4 = M3 + All deposits of Post office savings organizations M1 is the measure of basic liquidity. the assets shall be included in money supply based on their liquidity. According to them. For control of inflation based on general price index. Reserve bank of India The II Working Group appointed by The Reserve Bank of India suggested four measures to the money supply. it includes assets depending on liquidity and convertibility.e. These assets shall be included as per the weightages assigned to their liquidity. money supply shall include all that can be converted into cash. Reserve Bank of India followed method similar to this upto 1977. 4. Bank of England follows the method suggested by Radcliffe Committee. where as time deposit has lesser liquidity. gold all have liquidity which gradually declines. M2 is specially designed for the Indian context. M1 is used for policy purposes. when the II Working Group suggested an alternative and indigenous method of measuring money supply. 5. These measures provide better definition to money supply and provide different estimates for use of monetary policy. First Year BMM Semester I.g. depending on convertibility of asset. Gurley and Shaw offer the widest definition of money supply. June 2009) 52 . Cash is cent percent liquid. Economics (w.

The first two motives are classical the third motive of speculation is introduced by Keynes. Precautionary motive: Money demanded to satisfy the precautionary motive is for meant for unforeseen circumstances. These are transactions. for comparing different economies of the world. This is an important measure for monetary targeting by RBI. It depends mainly on the size and responsibilities of the family and size of the income. Demand for money to satisfy transactions motive is about 50 percent of the size of an individual or household income. M3 is the international standard of money supply. 1. In the short run these factors remain constant and hence demand for money also remains nearly constant. M3 is similar to Milton Friedman’s measure of money supply. Liquidity preference theory There are three chief motives for which money is demanded.e.Ranga Sai PO organization is selected as agency of banking facilities in the remote areas. IMF.Dr. It includes the demand. M3 is the measure of aggregate liquidity in the economy. Both households and firms have to carry out a variety of transactions for which they need money. households and firms. precaution and speculation. June 2009) 53 . Economics (w. M4 is the widest measure of monetary resources in India. It is related to the size of the income and type of activities performed by individuals. Transactions Motive: Money is demanded for regular economic transactions. cooperative bank and PO savings organization. 3. M2 brings out the role of PO savings organization. This amount of money kept aside can be used during times of uncertainty or emergency. World Bank and WTO use this measure. time and other deposits of commercial banks. 2. uniformly. Speculative motive: First Year BMM Semester I.f.

Keynes has called this as demand for Passive Cash balances or money. Economics (w. Active cash balances depend on the income of the households. securities etc. bonds.Ranga Sai Keynes was the first to identify the role of speculative activities. when their prices are low. Any increase in money supply at this level will not have any effect on the liquidity preference. Such demand is made to invest in capital market for buying shares. Keynes calls this the demand for Active Cash balances or money. Speculative demand depends upon the prices of securities. It all depends upon fluctuating prices and market conditions for securities. There after. The total demand for money or liquidity can be classified into two parts: Total demand for money = L = L1 + L2 L1 is that part of money or liquidity demanded to satisfy transactions and precautionary motives. The negative relationship between rate of interest and liquidity preference is found only up to a minimum interest rate. The zone where the demand for money is infinity is called as the liquidity trap.f. At liquidity trap the demand for money tends to be infinity.Dr. the demand for money becomes infinity. First Year BMM Semester I.e. The second part L2 is money demanded made to satisfy the speculative motive. June 2009) 54 . Keeping money in this idle form is known as hoarding of money.

Monetary policy may also be used to influence the exchange rate of the country’s currency. reduces the incentive to save and encourages nonproductive investment. Objectives of monetary policy Control of Inflation: In a developing country like India. It raises the cost of living.e. Economics (w. The monetary policy has to balance the objectives of economic growth and price stability. A high degree of inflation has adverse effects on the economy. June 2009) 55 . increase in investment activity puts a pressure on prices. The Central Bank may adopt an expansionary or contractionary policy depending on the general economic policy of the Government and conditions in the economy. RBI increases the SLR which reduces availability of loanable funds with commercial banks. Economic growth requires expansion in the supply of money so that no legitimate productive activity suffers due to finance shortage. First Year BMM Semester I.Ranga Sai Monetary Policy Monetary Policy deals with changing money supply and rate of interest for the purpose of stabilizing the economy at full employment or potential output level by influencing aggregate demand The RBI makes use of instruments to regulate money supply and bank credit so as to influence the level of aggregate demand for goods and services.Dr. makes exports costlier. Price stability requires control the expansion of credit so that money supply does not cause inflation. Changes in the monetary policy can be made anytime during the year.f.

Ranga Sai By increasing bank rate. The RBI attempts to ensure exchange rate stability. They reduce the shocks and foreign business cycles. taxation and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand. the cost of bank loan is increased which in turn reduces money supply and credit which tend to reduce price rise. To promote economic growth availability of bank credit is increased and the cost of credit is reduced. A currency that uses a floating exchange rate is known as a floating currency Many economists think that. the Reserve Bank releases more dollars from its foreign exchange reserves. Exchange Rate stability: Until 1991 India followed fixed exchange rate system. First Year BMM Semester I. in most circumstances. Alternatively to prevent depreciation of rupee.f. Promotion of economic growth needs a liberal monetary policy. The policy of floating exchange rate and globalization of the Indian economy have made the exchange rate volatile. Price stability means a reasonable rate of inflation. June 2009) 56 . output and employment. A tight policy will prevent fall in the value of rupee. A floating exchange rate or a flexible exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. Economics (w.Dr. Economic Growth: Accelerating economic growth so as to raise national income is another objective of the monetary policy. floating exchange rates are preferable to fixed exchange rates.e. Fiscal Policy Fiscal policy refers to the use of government spending.

• The Keynesian feel that fiscal policy can have powerful effects on aggregate demand. • Monetarist economists feel that government spending and tax changes can only have a temporary effect on aggregate demand. output and employment when the economy is operating well below full capacity national output. Economics (w. June 2009) 57 .Ranga Sai Fiscal policy has been seen as an instrument of demand management. output and jobs. It involves changes in government spending.f.Dr.e. The working of fiscal policy First Year BMM Semester I. direct and indirect taxation and the budget.

It adds to the economy’s capital stock and clearly can have important demand and supply side effects in the medium to long term. capital gains tax. Direct taxes include income tax. and corporation tax. They provide a means by which the government can change the overall distribution of income in a country. Housing Benefit. Income Support and the Working Families Tax Credit. Capital spending. the basic State Pension. Government capital spending on the national infrastructure (e.e.Ranga Sai The fiscal policy is mage up of two components Government spending Government (or public) spending each year takes up over 40 percent of gross domestic product.g. wealth and profit. cigarettes and alcohol and Value Added Tax on many different goods and services Effects of Fiscal Policy Changes in fiscal policy can affect the economy and contribute to long term economic growth. Labour market incentives: Cuts in income tax might be used to improve incentives for people to actively seek work and also as a strategy to boost labour productivity. improvements to our motorway network or an increase in the building programe for new schools and hospitals) contributes to an increase in investment across the whole economy. Spending by the public sector can be broken down into three main areas: • Transfer Payments: Transfer payments are government welfare payments made available through the social security system including the Jobseekers’ Allowance. • Capital Spending: Capital spending would include infrastructural spending such as spending on new motorways and roads. First Year BMM Semester I. Taxation • Direct taxation is levied on income. Economics (w. • Indirect taxes are taxes on spending – such as excise duties on fuel.f. schools and prisons. hospitals. Child Benefit. national insurance contributions. June 2009) 58 .Dr. • Current Government Spending: It is spending on stateprovided goods and services.

f. Conversely during a slowdown or a recession. Human capital of the workforce: Higher government spending on education and training and increased investment in health and transport can also have important supply-side economic effects in the long run. Presently. Inflation First Year BMM Semester I. tax credits and other tax allowances could be used to encourage an increase in private business sector research and development. Economics (w. Automatic stabilizers and discretionary changes in fiscal policy Discretionary fiscal changes are deliberate changes in direct and indirect taxation and government spending Automatic stabilizers include those changes in tax revenues and government spending that comes about automatically as the economy moves through different stages of the business cycle Tax revenues: When the economy is expanding rapidly the amount of tax revenue increases which takes money out of the circular flow of income and spending Welfare spending: A growing economy means that the government does not have to spend as much on means-tested welfare benefits such as income support and unemployment benefits Budget balance and the circular flow: A fast-growing economy tends to lead to a net outflow of money from the circular flow. Economics of Inflation According to neoclassical economics inflation refers to increase in the level of economic activity after full employment. the government normally ends up running a larger budget deficit.Dr. June 2009) 59 .Ranga Sai Entrepreneurship and new business creation: Government spending can expand the rate of new small business start-ups Research and development and innovation: Government spending. inflation is found even with unemployment.e. This is called stagflation.

• Inflation is caused by excess demand pressures on the goods and factors of production due to increase in monetary resources. the Government generates resources by currency expansion. Wartime inflation: During the emergencies of war. In addition. If Government expands money for non productive purposes it leads to inflation. Demand Pull Inflation Demand pull inflation is caused by increasing demand arising out of excess money supply and increase in demand for factors by the industry.Ranga Sai • Inflation is post Keynesian concept. Economics (w. June 2009) 60 . Primarily inflation is caused by indiscriminate expansion of money supply. there can be four types of inflation Budgetary inflation: This is the inflation caused by expansion of money supply resulting out of Government’s budgetary activities. • Inflation is a monetary phenomenon. the prices may incase due to scarcity followed by hoarding and black marketing. War time inflation is a common occurrence these days. Demand pull factors 1.Dr. During Post Keynesian period. Accordingly. • Increase in monetary resources against stagnant real output leads to inflation. The Government may increase money circulation to meet the deficits in the budget for financing any contingency. • Inflation means too much money chasing too few goods. Increase in money supply due to budgetary activity 2.f. this has been a major cause for rapid increase in inflation all over the world. Increase in demand for goods First Year BMM Semester I.e. Such inflation is generally controlled after war. Types of Inflation Inflation can be classified based on major causes.

Economics (w. D2. The deficits create additional resources of around Rs. The unorganized money markets pump in those additional resources which cause inflation.10. and P3. after full employment E if the aggregate demand increases to D1.000 crores annually. Cost Push Inflation Cost push factors First Year BMM Semester I. Rapid monetary expansion leads to excess inflationary pressures. d. 65. June 2009) 61 . Public expenditure. Due to in appropriate taxation large disposable income is left causing high rates of inflation. This is the inflation driven by demand pull factors Demand-pull factors in India a. the real output can not increase and the equilibrium will be shifting only on the ASF to E1. c.e. Increasing public expenditure creates large amount of incomes.Dr. and D3. Increase in demand for factors by the industry According to Keynes. 2. and E3. Deficit financing create those resources which create inflation. E2. P2. b.f.000 crore generates a large income and the following demand. A monetary base of Rs.Ranga Sai 3. As a result the prices will increase to P1. e. The parallel economy creates demand pressures from unexpected sectors of the economy. which constitutes 43 percent of GNP is a major source of income. f.

increases and reaches a peak. Increase in demand for factors 5. The First Year BMM Semester I. Increase in demand for more wages 6. Increasing prices 2. Such cyclical changes in the level of economic activities constitute the trade cycle. Trade Cycles Periodic changes in the level of economic acclivities in the long run are commonly termed as trade cycles. Economics (w. shows a change in trend. The real out put remains same and the value of out put increases to P1. D2. The cost structure undergoes a change and the equilibrium will be found on the same inelastic supply curve. changes trend towards increase.f. Wages increase due to strong trade union 7. and D3 will shift the supply curve. and P3. Increase in the cost of production 8.Ranga Sai 1. This is cost push inflation. Hence the prices will increase. P2. June 2009) 62 . 4.Dr. The level of economic activity periodically. The concept of trade cycle was initially developed by Joseph Schumpeter.e. Decreasing in the standard of living. The prices increase. decreases and bottoms out and finally. Under cost push inflation even with increasing demand the supply can not shift. Decrease in the real income (purchasing power) 3. Against an inelastic supply curve an increase in demand D1. Trade cycle is a neoclassical concept of macro economics which tries to explain the changes in the economic activities with respect to time.

Depression. 4. Increasing demand leads to increasing product prices. 5. During inflation.f. it is called inflation. the prices will decrease and the economic activity shrinks. The price level will be very high. Economics (w. Accordingly. The markets collapse. Boom: Boom refers to the peak in the level of economic activity after full employment. Deflation: It is the downward trend in the economic activities after boom. At boom level the Government will take corrective measures due to which the economic activity will show a change in trend. The demand pressures will be at the peak. and 6. Deflation 4. Large scale unemployment will lead to poverty and First Year BMM Semester I.Ranga Sai different phases in the trade cycle are named in relation to the full employment level. Depression: This is the lowest level of economic activity. increasing demand for factors. higher wages and then increasing demand again. Inflation 2. Inflation: When the economic activity increases after full employment level. 2. Recovery 1. The level employment will decreases. Recession: When the economic activity reduces below full employment It is called recession. Boom 3. the demand pressures will be high. there are six phases of trade cycle: 1.e. Recession 5. 3.Dr. June 2009) 63 .

If inflation is reduced. According to Phillip. incomes. By selecting such a combination. The world experienced Great depression during 1929 and 1933. there is a trade off between inflation and unemployment. In such case the ideal alternative is to find such a point on the curve which is closest to the origin. The economic activity will increase towards full employment. one can be reduced only at the cost of the other. 6.Ranga Sai suffering. unemployment increases and if unemployment is reduced inflation may increase. both inflation and unemployment can be maintained at tolerable levels. June 2009) 64 . Phillips curve is the modern concept which relates unemployment and inflation. In absence of any other theory. Economics (w. The Sun spot theory relates the level of economic activity with the number of sun spots.e. First Year BMM Semester I. Three will be increase in the level of employment.f. the Sun Spot theory still holds valid.Dr. Recovery: From the lowest levels of economic activity the markets recover due to positive Government policy. The reasons for the occurrence for the trade cycle has been not yet explained satisfactorily. investment and demand.

b. Scheduled. Private sector banks.Dr. commercial banks and co-operative banks. Non-scheduled. which is the central bank. First Year BMM Semester I. Banking and non banking institutions Indian Banking system: The Indian banking sector consists of the Reserve Bank of India (RBI).Ranga Sai b. its seven associates. Public sector banks comprising of the State bank of India. Commercial banks are of two types: 1. Economics (w.e. Other nationalized banks b. which are not. which can be either domestic or foreign. June 2009) 65 . Scheduled banks can be further classified into a.f. which are subject to statutory requirements and 2. Regional Rural Banks and c.

defines banking as "Acceptance of deposits of money from the public for the purpose of lending or investment". a bank performs the following functions: • • • • • • Issuing Demand Drafts & Travelers Cheques Collection of Cheques.f. draft. In addition. and withdrawable by a cheque. b. These deposits are repayable on demand or otherwise. d. e. Bills of exchange Discounting and purchase of Bills Safe Deposit Lockers Issuing Letters of Credit & Letters of Guarantee Sales and Purchase of Foreign Exchange 66 First Year BMM Semester I. order or otherwise. Economics (w. June 2009) . Banks are the only financial institutes which can accept demand deposits (Saving / Current) which can be withdrawn by a cheque. b. c.Dr. c. 1949. Old generation private banks New generation private banks Foreign banks in India Scheduled Co-operative Banks Non-scheduled Banks Scheduled and Un-scheduled Banks The commercial banking structure in India consists of: • • Scheduled Commercial Banks in India Unscheduled Banks in India Commercial banking Section 5b of the Banking Regulations Act. State Bank of India and its associate banks called the State Bank group 20 nationalized banks Regional Rural Banks mainly sponsored by Public Sector Banks Private Sector Banks a.e.Ranga Sai Public Sector Banks a.

Formally. By savings mobilization. The amendments to RBI Act in 1962 provided the First Year BMM Semester I. the issue department and the Banking department. Reserve Bank of India The Hilton Young Commission in 1926 originated the idea of Reserve Bank of India as the central Bank. d. This was taken over by RBI in 1934 under the Reserve Bank of India Act. The Banking Regulation Act of 1949 gave RBI the control and supervision of commercial Banks. Extensive banking sector can improve the banking habits of people. Commercial banking aids industrialization by providing liberal trade credit or working capital. Prior to 1926. This commission came to be known as the Royal Commission on Indian Currency and Finance.f. b.e. It had a division of two separate activities viz.Dr. the Presidency Banks had the right of note issue. Economics (w. e. in 1935 RBI was established as an apex institution and the nation's monetary authority. Entrepreneurship can be promoted by commercial banking finance. commercial banks help in capital formation. June 2009) 67 . Commercial banking is looked upon as an agent of economic growth.Ranga Sai • Custodial Services • Investment services • doing all such other things as are incidental or conducive to the promotion or advancement of the business of the company. f. The role can be explained as follows: a. Commercial banks through their operations of mobilizing deposits and extending advances help in redistribution of resources across regions. Role of commercial banking The finance sector is an important factor of rapid development. c.

of fiduciary balance constitutes the minimum Reserve for the issue of currency. 2. Annually. RBI as an apex institution has the overall control over the monetary policy.f.200 cr. RBI has emerged as a potential apex monetary authority with control over the capital markets. Economics (w. the monetary growth is conditioned by monetary resources. June 2009) 68 . It also promotes financial institutions to augment Government of India. Issue Functions: Reserve Bank of India issues currency for denominations of Rs. This is due to the deficit financing activities undertaken by the Government. Banking for the Government : Reserve Bank of India is the principle banker to the Government of India. worth of gold and Rs. Currently. liquidity. but the growth of monetary resources reaches the 18 percent mark. lending operations of financial institutions etc.Dr. The government finances its activities by issue of treasury bills.e. The one rupee currency is issued by the Ministry of finance. RBI issues currency under the Minimum Reserve system.115 Cr.85 cr. It maintains the state treasury. worth of foreign exchange reserves. Government of India.2 and upwards. money markets.Ranga Sai RBI right of information from commercial banks regarding their credit functions. Nearly. Rs. It maintains a fiduciary reserve made up Rs. These are First Year BMM Semester I. 1. It regulates the monetary economy by sets of guidelines pertaining to interest rates. It maintains a fudiciary reserve system. foreign exchange markets and the monetary policy. The basic functions include: • Regulation of issue of banknotes • Maintenance of reserves with a view to securing monetary stability and • Operating credit and currency system of the country to its advantage Reserve Bank of India and its monetary functions: RBI as an apex institution has a variety of functions in the areas of monetary issue and banking.

RBI also maintains the public debt. 5. Bankers' Bank : RBI provides the basic banking functions in addition to control and regulations. repayment and now instruments of Government securities.6000 cr. June 2009) 69 . RBI maintains the reserves of the commercial banks. It provides the rediscounting facility. For the purpose of bill market operations. In excess of which. 50. It advises the Government on issues of rescheduling. First Year BMM Semester I. The Treasury bill market is an important part of the Indian money market. The cash Reserve and statutory liquidity Reserve are the important stipulation of the functioning of the commercial banks. it retains them: thus RBI is the passive holder of Treasury bill. The Narasimham committee provided the much needed reforms to the Bill market by stipulating realistic guidelines.e. 3. per anum. RBI provides liquidity. The commercial banks rediscount bills in bunches of Rs. This way RBI organizes the commercial Bill market. This rediscount rate is called as the Bank rate. At a bank rate of 10 percent. The recent memorandum of understanding between RBI and Government pegs the treasury bills to Rs.000. When the bills reach RBI. The Treasury bill market operated at the RBI discount these bills. the discounting and finance House of India is being promoted. the CRR be reduced to 10 percent from the existing 15 percent. On behalf of the Government. In the reinforcing Indian Bill market.Dr. needed by banks. Similarly.000 and denominations of Rs. The commercial banks. RBI maintains the provident fund and small savings accounts. RBI issues instruments of public debt and redemption. RBI has a prominent place. In case of emergencies these constitute an important source for financing public expenditure. In this regard the Narasimham committee suggested that the SLR be reduced to 25 percent progressively from the existing 38 percent. depending on their liquidity needs can rediscount the commercial bills already discounted by them.f. Economics (w. On behalf of the Government. the Government has to indulge in commercial borrowings.Ranga Sai the bills drawn for period ranging from 91 days to 364 days.

Forex Reserves : All international transactions are routed through RBI. Economics (w. RBI is the facilitator of exports in co-ordination with the ministry of commerce. 5. These measures give rise to rediscounting operations reserve regulations and government securities trading. At the instance of RBI. in 1991.Dr. RBI controls credit. It uses a variety of measures like Bank rate policy. RBI issues credit regulatory directives to commercial banks to suit monetary policy. Export promotion measures are also taken up by RBI. to the tune of 18 percent. Qualitatively. RBI controls convertibility on current account and capital account in a restricted way.Ranga Sai 4. forex position enough for 45 to 90 days import bill. It also actively participates in the foreign exchange market. First Year BMM Semester I. The position in the capital. The FERA is effectively implemented by RBI. Earlier the value of the currency was administered by exchange controls. RBI may also suggest devaluation to suit the BOP position. The operations of commercial banks are regulated to contain credit. June 2009) 70 . However. variable reserve policy and open market operations to control credit. devaluation was effected in two rounds. RBI together with its subsidiaries plays an important role in the monetary sector. money and financial markets is monitored by the credit policy.f. Due to this RBI can maintain the needed forex resources. RBI is guided by the general objectives like controlling inflation. For this purpose RBI can advise the Government to seek foreign assistance from IMF. World Bank or similar sources. generation of employment and financing of government projects and schemes. stabilizing investment. At any point of time it is expected to maintain. Credit Control: As the apex authority of monetary policy. The value of rupee is maintained by RBI. The convertibility of Rupee has given free hand to the exchange market to determine the value.e. sectoral balance.

RBI is actively engaged in economic research. June 2009) 71 . Thus RBI evolves as a custodian of Indian monetary system. important ones are IDBI. Development Functions: RBI is the executive head of the monetary policy.Dr. First Year BMM Semester I. IFCI. employee’s provident fund. Economics (w. State Financial Institutions Like SFCs. All-India Financial Institutions like IDBI. supporting the policy objectives. RBI may even develop financial infrastructure or promote institutions. co-operative banks and term lending institutions. The securities normally issued with different maturity dates. SIDCs.e.Ranga Sai 6. insurance companies. Its publication department comes out with research reports and data periodically. and other governmental bodies. The securities are issued in form of bonds and credit notes. The buyers of such securities are banks. RBI and even individuals. Agricultural finance and refinance co-operations etc. NABARD. Among the prominent institutions promoted by RBI. Components and functions of Indian financial system Capital markets Composition of Capital markets Gilt-Edged Securities Market: This market deals with the securities issued by Central Government. State Government. ICICI. These types of securities have the full backing of the Government and as such they are more secured as compared to other securities in the industrial securities market. c.f. It has an advisory role is framing monetary policy and economic legislation for smoother functioning of monetary economy. It has consultancy function for various commercial.

term funds from various financial institutions in the country. shares and debentures to the members of the public. Lending of funds: The capital markets make it possible to lend funds to various industrial concerns can borrow long . Interested individuals or corporate bodies do subscribe for the issue of shares and debentures.e. There are three ways in which a company may raise capital in the primary market: Public Issue: This involves sale of securities.Ranga Sai New Issue Market (Primary Market) It is also called as primary market. 3.e.f. i. 5.Dr. Functions of capital markets 1. 2. Rights Issue: This is a method of raising further funds from existing shareholders. 4.e. Link between investors and users of funds: First Year BMM Semester I. Secondary Market: The market for outstanding securities is referred to as secondary market or stock market. Private Placement: It involves selling securities to a small group of private investors. shares and debentures of well-established companies. The stock markets are organized markets to trade securities i. Every day crores of rupees are changing hands on the stock exchange. Economics (w. Such savings are mobilized and then utilized for the economic development of the country. June 2009) 72 . Mobilize savings: The capital markets make it possible to lend funds to various industrial concerns. Easy liquidity: The secondary market makes it possible for the investors to sell off their holdings in form of shares and debentures and convert them in liquid cash. Direct collection of funds: The primary markets make it possible to collect direct funds from the market.

e. Accelerates Industrial Growth The resources mobilized by the capital market are utilized by the industrial sector for productive purposes.f. 6. users and the society.Ranga Sai The capital market acts a link between the owners of funds and the users of funds. Ready made market and healthy competition The primary market provides facilities for new issues of listed companies while the follow up activities continue in the secondary market. Economics (w. the capital market attracts masses that bring investment in the capital market. Long term capital to the industrial sector Capital market provides a permanent long-term capital for the companies. A link between investors and industrial users. By providing liquidity and security. Profitable use of funds: Capital market makes it possible to make productive and profitable use of funds. 2. Thus it satisfies the investment requirements demanded by the private and the public sector.Dr. Better allocation of resources through efficient market system the capital market ensures the effective allocation of resources and high productivity. i. Such activities help in promoting industrial growth. This is because the funds that are lying idle with the owners are utilized by industrial enterprises in a profitable manner. First Year BMM Semester I. the capital the security. June 2009) 73 . Role and Importance of Capital Markets 1. The secondary market provides a readymade market for the securities already purchased. thus bringing rewards to the investors. Accelerates Capital formation though mobilization of resources Capital market plays a crucial role in mobilizing savings from people especially the small investors.e.

the foreign investors have turned towards the Indian market. Unit Trust of India (UTI). Economics (w. A lot of formalities are required to be fulfilled before a security can be sold. it is not so in the Secondary Market.Ranga Sai Foreign capital The capital market also acts as a source of foreign capital. • New security certificates are issued to the investors once the company receives money from them. since 1993 onwards. Usually. Encouraging role of financial institutions The various agencies of capital market such as Industrial Financial Corporation of India (IFCI). It is also known as New Issue Market. That is. Industrial Credit and Investment Corporation of India (ICICI). First Year BMM Semester I. Primary Capital markets The part of the capital market dealing with new securities is known as Primary Market. Industrial Development Bank of India (IDBI). However. Especially. small or medium scale companies enter into the market of new securities in order to widen the scope of their business. the securities are sold for the first time in the Primary Market. the securities are sold by the company directly to the investors. Both private and or public sector organizations can get funds by selling new shares or bonds. State Finance Corporation (SFC’s). Life Insurance Corporation (LIC) etc. They have been financing promoting and underwriting the functions of the capital market. Some of the important features of Primary Markets are as follows: • It is the market that deals with new long-term securities. The security dealers earn a commission that is added in the cost of the securities. have been rendering useful services to the growth of industries.e. not the existing ones.Dr. • In the primary market. The selling process of new securities to investors is called underwriting.f. June 2009) 74 . • The funds from selling the securities are used by companies for starting new business or expanding the existing ones. They extend assistance to sick units and small units.

However. • Preferential issue: Issue of shares kept aside for the designated buyers. Stock Exchange Market Stock exchange market is a market where stock. • Rights issue (for existing companies): It refers to a special form of shelf offering or shelf registration. the securities are released for public. shares. gilt-edge. Under these rights. After the initial sale of a security. Thus. Secondary Market deals with the further trading. It is the opposite of Initial public offering where shares are issued to the general public through stock exchange. • The investment banks play key role in Primary Market. the existing shareholders enjoy the freedom to buy a specified number of new shares from the firm at a particular price and time. bond and other securities are bought and sold. That is. like loans from financial institutions. the employees of the issuing company.Dr.f.e. For example. They decide the starting price range for a particular security and then direct its sale to investors. • Primary Market doesn't include other new long-term external finance sources. Generally small and young companies are a part of Primary Market. large-scale private companies that desire to be publicly traded also become a part of this market. the securities can be issued through any of the following methods: • Initial public offering: It refers to the initial sale of securities by a private company to the public sector. • Private capital is converted into public capital.Ranga Sai • It facilitates capital building in the economy. affecting the economic sector to a great extent. June 2009) 75 . It is known as public issue or going public. In Primary Market. First Year BMM Semester I. Economics (w.

A Group large turnover and high floating stock. Price Transparency: Because all trades for a stock flow through one exchange. There are several other indices like FMCG index. 3.Dr. B2 group are like B1 with fortnightly settlement. a means of selling and buying. 5. June 2009) 76 .Ranga Sai Some Features of Stock Exchange Market 1. There are 150 scrips 2. Health care index. There re around 1100 scrips in this group 3. Corporate Performance: Stock exchange serve as a yard stick for measuring the performance of company etc. 2. 6. There are 3200 scrips New F group was started in 1996 pertaining to debt segment Launched enterprise market for small and medium enterprises in 2005 to provide small and medium enterprises an easy access to capital market BSE introduced trading in derivatives First Year BMM Semester I. Low trading volumes. it forecasts the future economic trends 8. Stock exchange acts as a barometer. Economics (w.e. Evaluation of policy: the trends in the stock exchange evaluates the strength of economic policy Bombay Stock Exchange BSE is the oldest stick exchange in India It was established in the year 1857 BSE sensitive index was launched in 1986 with base year 1978-79. Its activities are controlled by the company ordinance in our country. At the Bombay Stock Exchange the securities are listed in three groups 1. Tech Index. Liquidity: Stock exchange offers liquidity. Economic barometer. Standard guidelines: There are large number of buyers and sellers who conduct their activities according to rigid rules. 7. this means that everyone sees and has the opportunity to execute on the same exact price as everyone else. Specialized market: Stock exchange is a specialized market for the purchase and sale of industrial and financial securities. Corporate formation. B1 groups with equity of more than Rs. 3 crore high potential and trading frequency. It has 30 scrips.f. 4.

NSE has greater market capitalization than BSE. conducts investigation and enforcement action. Wholesale debt market for Banks.Dr.Ranga Sai National Stock Exchange NSE was incorporated in 1992 by IDBI and co sponsored by LIC. It drafts regulations. CPs and CDs b. June 2009) 77 . Economics (w. Following were the objectives: • To Establish a nation wide debt market • To Ensure investors all over the country equal access and communication • To provide fair and transparent securities market • Enable shorter settlement cycles through electronic trading system • To establish international standards.f.e. Treasury bills. to regulate the securities market. convertible debentures RBI empowered NSE for inter-bank security deals. NSE provided two segments: a. and passes rulings and orders in its judicial capacity. GIC. Capital Market segment dealing with equities. to promote the development of Securities Market. It replaced the earlier Controller of Capital Issues. judicial and executive functions combined into one. The basic objectives of the Securities and Exchange Board were: • • • to protect the interests of investors in securities. However. the Capital Market Segment performs better than the Wholesale debt market Securities Exchange Board of India In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of India as a fully autonomous and statutory Board. financial institutions for trading in PSU bonds. SEBI has legislative. in the year in 1992. SEBI has promoted trading in stock indices (like S&P CNX Nifty and Sensex) in 2000. SBI caps and others. Such an index is useful because: First Year BMM Semester I.

• It can be used for passive fund management as in case of Index Funds. individuals and self regulatory organizations associated with the security market. First Year BMM Semester I. To monitor and control the performance of stock exchange and derivative markets. share transfer agents. merchant bankers. underwriters. As well as the FII need to be regulated and encouraged to pump in large funds 3. Undertake periodic audits of stock exchanges. The market intermediaries: The market intermediaries like banks.f. portfolio managers.Dr.Ranga Sai • • • It acts as a barometer for market behavior. Forbid unjust and dishonest trade practices in the security markets and forbid insider trading in the security market. trustees of trust deeds. registrars to an issue. SEBI has to be responsive to the needs of three groups. The investors: The retail investor needs to be protected.e. It is used in derivative instruments like index futures and index options. Functions • • • • • • The Board is responsible for the securing the interests of investors in securities and to facilitate the growth of and to monitor the securities market in an appropriate manner. The issuers of securities: In the primary capital markets. Listing and monitoring the functioning of stock brokers. sub brokers. 2. bankers to an issue. Economics (w. mutual funds. and other financial institutions should have a ideal atmosphere to trade. Monitoring and Controlling the functioning of venture capital funds and mutual funds. SEBI ensures fair play for the promoting companies as well as investors. investment advisers and others associated with securities markets by any means. which constitute the market: 1. June 2009) 78 . It is used to benchmark portfolio performance.

sub brokers. including Mutual funds. Law and Reserve Bank of India. Registering and regulating the working of collective investment schemes. 8. Economics (w.Dr. share transfer agents. Mutual Fund Securities Exchange Board of India formulated the Mutual Fund (Regulation) 1993.f. Levying fees or other charges for carrying out the purposes 9. Registering and regulating the working of stock brokers.Ranga Sai SEBI has jurisdiction in the following matters 1. Prohibiting Fraudulent and unfair trade practices 6.. registrars to an issue. Conducting research Limitations of SEBI • The regulations of SEBI monitoring capital markets need to be approved by the Government. Out of 5 directors only 2 can be from outside and these are to represent the Ministries of Finance. which for the first time established a comprehensive regulatory framework for the mutual fund industry. 3. June 2009) 79 . 4.e. Since then several mutual funds have been set up by the private and joint sectors. Regulating the business in stock exchanges and any other securities markets 2. Its Board of Directors is dominated by government nominees. Regulating substantial acquisition of shares and take over of companies. This causes delays in implementations • SEBI will have to seek prior approval for filling criminal complaints for violations for the regulations. First Year BMM Semester I. This will again cause delay at government level. merchant bankers and other intermediaries who may be associated with securities market in any manner. Promoting investors education and teaching of intermediaries 7. • SEBI has not been given autonomy. Promoting and regulating self regulatory organizations 5.

The invested money in a particular scheme of a Mutual Fund is then invested by fund manager in different types of suitable stock and securities. The biggest Indian Asset Management Company is UTI while Alliance. Franklin Templeton etc are international Asset Management Companies.Dr. • the board of Trustees or Trustee company.Ranga Sai In India. money-market instruments or combination of all. as a single State Monopoly. bonds. Thus. bonds and money market instruments. First Year BMM Semester I.e. • the asset management company and • the custodian.f. The private sector and foreign Institutions began setting up Mutual Funds thereafter. banks. As per Clause 14 of SEBI guidelinesA mutual fund shall be constituted in the form of a trust and the instrument of trust shall be in the form of a deed. A Mutual fund in India is registered / incorporated as a public trust. The fast growing industry is regulated by the Securities and Exchange Board of India (SEBI). There are four constituents of a mutual fund in India: • the sponsor. If the Trust Deed so provides the trustees can appoint an Asset Management Company for the day to day administration of the MF and investment of its funds. duly registered under the provisions of the Indian Registration Act. private companies or international firms. June 2009) 80 . Each Mutual Fund is managed by respective Asset Management Company. A Mutual Fund is a system where a number of investors come together to pool their money with common investment goal. Mutual Funds are managed by Asset Management Companies formed by financial institutions. the Mutual Fund industry started with the setting up of Unit Trust of India in 1964. 1908 (16 of 1908) executed by the sponsor in favor of the trustees named in such an instrument. gilt. Each Mutual Fund creates a portfolio which includes stock and shares. The Industry was brought under the control of SEBI and opened for private sector participation in 1993. Twenty-three years later Public Sector banks and financial institutions were permitted to establish Mutual Funds in 1987. Economics (w.

Diversification: Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors.f. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. Low Costs: Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage. Mutual Funds save your time and make investing easy and convenient. June 2009) 81 . Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Convenient Administration: Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries. income growth. delayed payments and unnecessary follow up with brokers and companies. good post tax return and reasonable safety. transparency. The operations of Mutual Funds are regularly monitored by SEBI.e. 5. Professional Management: The investor avails of the services of experienced and skilled professionals who are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. The advantages of investing in a Mutual Fund are: 1. First Year BMM Semester I. liquidity. custodial and other fees translate into lower costs for investors. 4. Economics (w. Mutual Funds offer several benefits to an investor such as potential return. Return Potential: Over a medium to long-term.Dr. 3.Ranga Sai All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. 2. There are number of options available for an investor offered by a mutual fund. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.

A brief history of the Insurance sector The business of life insurance in India in its existing form started in India in the year 1818 with the establishment of the Oriental Life Insurance Company in Calcutta. Choice of Schemes: Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. 8. 7. The operations of Mutual Funds are regularly monitored by SEBI. the proportion invested in each class of assets and the fund manager's investment strategy and outlook.Ranga Sai 6. you can sell your units on a stock exchange at the prevailing market price or avail of the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically. you can systematically invest or withdraw funds according to your needs and convenience. 10. regular withdrawal plans and dividend reinvestment plans.Dr. 9. Liquidity: In open-ended schemes. Flexibility: Through features such as regular investment plans.e. Transparency: You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme.Well Regulated: All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. June 2009) 82 . With close-ended schemes. you can get your money back promptly at net asset value related prices from the Mutual Fund itself. Insurance in India Over a period of almost two centuries the insurance sector in India has transformed from being an open competitive market to nationalization and back to a liberalized market again.f. Economics (w. Some of the important milestones in the life insurance business in India are: First Year BMM Semester I.

with a capital contribution of Rs... the New India Assurance Company Ltd. frames a code of conduct for ensuring fair conduct and sound business practices. Economics (w. a wing of the Insurance Association of India. set up. • 107 insurers amalgamated and grouped into four companies viz. 5 crore from the Government of India.f. LIC Act. The General insurance business in India. June 2009) 83 . on the other hand.. the first general insurance company established in the year 1850 in Calcutta by the British. 1972 nationalized the general insurance business in India with effect from 1st January 1973. • 1957: General Insurance Council. the Oriental Insurance Company Ltd. LIC formed by an Act of Parliament. • 1928: The Indian Insurance Companies Act enacted to enable the government to collect statistical information about both life and non-life insurance businesses. the National Insurance Company Ltd. • 1972: The General Insurance Business (Nationalization) Act.Dr. and the United India Insurance Company Ltd. GIC incorporated as a company. • 1968: The Insurance Act amended to regulate investments and set minimum solvency margins and the Tariff Advisory Committee set up. • 1938: Earlier legislation consolidated and amended to by the Insurance Act with the objective of protecting the interests of the insuring public. the first company to transact all classes of general insurance business. • 1956: 245 Indian and foreign insurers and provident societies taken over by the central government and nationalized. First Year BMM Semester I.Ranga Sai • 1912: The Indian Life Assurance Companies Act enacted as the first statute to regulate the life insurance business. can trace its roots to the Triton Insurance Company Ltd. viz.e. Some of the important milestones in the general insurance business in India are: • 1907: The Indian Mercantile Insurance Ltd. • 1956.

In India. till August. accounting and legal services sectors by 1st January. the First Year BMM Semester I. 2000. when the market opened up. June 2009) 84 . Economics (w. The reforms were aimed at: • creating a more efficient and competitive financial system • requirements of the structural changes • insurance is an important part of the overall financial system The Insurance Regulatory and Development Authority Reforms in the Insurance sector started with Insurance Regulatory and Development Authority Bill in 1999. when the market opened up. RN Malhotra Committee was formed in 1993 to evaluate the Indian insurance industry and recommend its future direction. 2000. 2005 to global competition. India is required to open up the insurance. The banking and accountancy sector opened up without much to-do.e. banking.Dr. As a part of its WTO obligations. banking. The opposition has been in the legal and insurance sectors. The Malhotra committee was set up with the objective of complementing the reforms initiated in the financial sector. India was required to open up the insurance. 2005 to global competition.f. till August. As a part of its WTO obligations. The Insurance Regulatory and Development Authority is responsible in framing regulations and registering the private sector insurance companies. the insurance business had been completely controlled by the state through the Life Insurance Corporation of India and the General Insurance Corporation of India. In India. accounting and legal services sectors by 1st January. the insurance business had been completely controlled by the state through the Life Insurance Corporation of India and the General Insurance Corporation of India.Ranga Sai Insurance sector reforms Malhotra committee In India.

This was called the laissez faire system in classical economics. public finance has evolved as fiscal science with expanding Government functions and responsibilities. d. where the Sate had limited functions. Regulatory functions 3. public finance dealt with the financial operations of the Government. Economics (w. 1. To perform these functions the Government has several fiscal tools 1. Promotional function 5. This is the essence of an inclusive economy. 2000. Public expenditure First Year BMM Semester I. employment. prices and flow of foreign exchanges. defense against external aggression and judiciary 2. money supply.Ranga Sai insurance business had been completely controlled by the state through the Life Insurance Corporation of India and the General Insurance Corporation of India. Stabilization functions: The Government stabilized prices. The Government now has the extended functions. Social security: The Government has emerged as an agency of social security and social justice. Traditional functions: Under traditional functions the Government provides police for law and order. Regulatory functions: The Government regulates. when the market opened up. Introduction to public finance Traditionally. Social security 1. till August. Taxation 2. equitable Sectoral growth an d justice 5. goods for stable growth 3.Dr. public finance meant taxation public expenditure. and exchange rate for sustained growth 4. Traditional functions 2. investment. Presently. In the classical system. Stabilization functions 4. June 2009) 85 . Promotional function: The Government may need to promote activities as per the policy of equitable regional growth.f.e.

equalize income and generate resources. 2. Fiscal/budgetary management: Fiscal management gives rise to fiscal policy. Tax is a compulsory payment to be made by citizens with out quid-pro-quo. social welfare programs and similar 3. Indirect tax is levied on commodities. It helps in reducing inflationary pressures. Taxation Direct and Indirect taxes Tax constitutes an important source of revenue. or cost or the burden of tax is shared by the seller and the buyer. the Government is not liable to offer any thing in return for the tax received. It means no exchange like transaction. Economics (w. 4. June 2009) 86 . Direct tax and indirect tax Direct tax refers to tax on income and sources of income.f. It is called direct because it is levied directly on the income at source. Tax is an useful component of fiscal policy.Ranga Sai 3.e. Taxation: It is source of revenue for the Government. Public Expenditure: The Government spends money for several purposes like creating infrastructure. The Debt can be raised to reduce monetary pressures as well. There are two types of tax. Fiscal/budgetary management 1. The income after taxation is called disposable income. Public debt 4. Taxes are levied for raising revenue for financing public expenditure. It reduces the income of the people. granting subsidies.Dr. Public debt: Incase the expenditure exceeds revenue the Government resorts to debt. Tax is a burden. It is also helps in equating income distribution. This is an important instrument for attaining a large variety of macro economic objectives. First Year BMM Semester I. So it is essential that tax is designed with care in such a way that it continues to generate revenue and yet acceptable to public. It is a fiscal tool. It becomes apart of the price.

It prompts the tax payer understand and participate in the fiscal exercise. Indirect tax Indirect tax is popular among developing economies as it can generate larger revue as compared with direct tax. June 2009) 87 . The burden of tax falls on all the citizens • Indirect tax is considered as a part of consumption expenditure or cost. • Direct tax can be levied at source of income. However • Direct tax levies a direct burden. • Direct tax can be made progressive. evade tax and corruption. direct tax accounts for greater share of tax revenues. So the tax liability is certain.Ranga Sai The Government uses a combination of direct and indirect taxes to raise revenue. Direct tax • Direct tax is levied on the income.e. • Direct tax can offer concessions and exemptions. so it may not be acceptable by the tax payer. Economics (w. It easily accepted by people. Direct tax may be resisted due to lower incomes. Direct and indirect taxes have their own merits and demerits. First Year BMM Semester I. which may not be easy with indirect tax. So the burden is not clear and direct. Indirect tax becomes more acceptable because of its nature and characteristics.Dr.f. • Direct tax has educational value. • Indirect taxes are universal. Countries with large income inequalities and low incomes. so it can not be evaded. • Tax evasion is easy in case of non salary and business incomes. • If the tax burden is larger there is an urge to resist tax. • In advanced countries. That is charging higher tax from higher income groups and lower tax rates from lower income groups. direct tax fails to generate large revenue.

In total the amount of tax collected as a proportion of GDP is called the taxable capacity. • Indirect tax can not be made progressive.Ranga Sai • The burden of indirect tax is spread over large number of transitions. It is the tax liability that has public acceptance. It is an action plan that facilitates allocation of resources in India. However. However. it is in proportion to spending. while spending (repaying public debt and interest) the incomes may go to higher incomes. is a case of duplication. • Indirect tax reduces consumer surplus. In this process the tax payer spend without receiving any utility. the governments levy tax for raising revenue for development purposes. • Indirect tax can not be easily evaded. the incomes form poorer sections are diverted to richer groups.f. stating the current plan and projecting it over a specified period of time in future. First Year BMM Semester I. in fact. Levy of direct and indirect tax. Economics (w. In developing economies it is as 40 percent.e. The Union Budget According to Dimock “A budget is a financial plan summarizing the financial experience of the past. • It is proved that direct tax implies larger burden on the public as compared with the same amount of direct tax.” The Indian Budget is a schematic plan of India's financial and operational goals.Dr. so the burden is not felt heavily at any point of time. • It causes wrong redistribution of incomes. The tax may be collected from poorer sections. This way. Tax is added to price and the consumer pays it. June 2009) 88 . It always propositional. • The burden of indirect tax falls heavily on the lower income groups. • Indirect tax covers consumption • It generates largest revenue compared with any other source of revenue. In India it is around 28 percent.

Types of public expenditure: Public expenditure can be classified in terms of its revenue yielding capacity. Revenue Budget: The revenue budget primarily comprises Government revenue receipts like tax and expenditure met from the revenue. also known as the Union Budget.Dr. 1. non-tax revenue. excise and service tax.e. June 2009) 89 . these are taxes where the burden of tax falls on the person on whom it is levied. the burden on the rich and the poor is alike. These are largely taxes on expenditure and include Customs. we come to the next important receipt item in the revenue account. Income tax (on corporates and individuals). Economics (w. is primarily made up of the Revenue Budget and Capital Budget. self financing nature or direct welfare. Moving on. The tax revenues principally constitute yields of taxes and other duties imposed by the Government of India. That is why governments strive to raise a higher proportion of taxes through direct taxes. Capital Budget: The capital budget primarily comprises capital receipts and payments. Sources of revenue Tax Revenues Direct Tax Traditionally. These are largely taxes on income or wealth. Indirect Tax In the case of indirect taxes the incidence of tax is usually not on the person who pays the tax. Indirect taxes are considered regressive. Productive and unproductive expenditure First Year BMM Semester I. railways and others) and dividends and profits received from public sector companies.f.Ranga Sai The Government of India Budget. Non-tax Revenues The most important receipts under this head are interest payments (received on loans given by the government to states. are direct taxes.

On the other hand. that expenditure would go under the capital account. On the receipts side.Dr.e. this is also split into revenue and capital components. The capital component of the non-plan expenditure is relatively small with the largest allocation going to defense.Ranga Sai The expenditure is called productive when the expenditure yields revenue and is self financing. Capital expenditure on economic overheads falls under this group. defense and pension. interest payment on public debt and the expenditure on calamity and disaster management and relief fall under this group. subsidies. like the receipts from the sale would go under capital account. June 2009) 90 . 2. Unproductive expenditure is the one which does not yield any revenue. if the government gives someone a loan from which it expects to receive interest. Salaries.f. 3. Plan and non plan expenditure Plan expenditure This is essentially the Budget support to the central plan and the central assistance to state and Union Territory plans. Economics (w. If the government sells shares (disinvests) in public sector companies. It does not directly generate welfare. salaries. subsidies and interest payments are good examples of revenue expenditure. Non-plan Expenditure This is largely the revenue expenditure of the government. On the expenditure side. Revenue and capital expenditure Revenue Receipt/Expenditure: All receipts and expenditure that in general do not entail sale or creation of assets are included under the revenue account. Like all Budget heads. Defense expenditure. anything that does not result in creation of assets is treated as revenue expenditure. In respect of all the funds the government has to prepare a Revenue Budget (detailing revenue receipts and revenue expenditure) First Year BMM Semester I. The biggest item of expenditure is interest payments. Capital Receipt/Expenditure: All receipts and expenditure that liquidate or create an asset would in general be under capital account. taxes would be the most important revenue receipt.

This indicates the real posit ion of the government finances after having paid off the interest burden. budgetary deficit is covered mainly by creation of new money (called deficit financing). Creation of new money leads to an increase in the money supply and consequently to inflationary rise in prices. it has to borrow money from the public to meet the shortfall. It can be looked upon as the sum of budgetary deficit and borrowings and other liabilities of the government. Some economist believe that Budgetary deficit does not reflect the true picture of a government’s deficit because it is an accounting entity which can be easily manipulated.e. In India.Dr. June 2009) 91 . primarily disinvestment proceeds) fall short of its entire expenditure.f. In other words. The excess of total expenditure over total non-borrowed receipts is called the fiscal deficit. Budgetary Deficits Budgetary deficit is nothing but the difference in total government earnings (receipts) and the total government expenditure. Types of Deficits Fiscal Deficits Fiscal deficit is one of the more comprehensive measures of government’s deficit. Primary Deficits The revenue expenditure includes interest payments on government's earlier borrowings. When the government's non-borrowed receipts (revenue receipts plus loan repayments received by the government plus miscellaneous capital receipts. The primary deficit is the fiscal deficit less interest payments.e. fiscal deficit reflects the indebtedness of the government i. Economics (w. the country’s ability or the inability to repay loans. First Year BMM Semester I. A shrinking primary deficit would indicate progress towards fiscal health.Ranga Sai and a capital budget (capital receipts and capital expenditure). The concept of primary deficit was introduced for the first time in the budget of 1993-94. International Monitory Fund (IMF) usually looks at the country’s fiscal deficit to determine how healthy the economy is.

Prudent fiscal management requires that government does not borrow to consume. 4. the government would have to borrow.e. When revenue disbursement exceeds receipts. Balance of payments can also project the development status of the economy in terms of industrial growth. in the normal course. Balance of payments emerge as an important feature of modern international trade. This it shows the extent of deficit financing (creation of new money) on the part of government. Introduction to external sector: Balance Of Payments Balance of payments is a systematic record of transactions between one country and rest of the world during a period of time. This is an important control indicator. economic stability and national income.f. but if it is small compared to the size of the economy then it is not such a bad thing. Economics (w. terms of trade and strength of the currency.Ranga Sai The fiscal deficit may be large. Such borrowing is considered regressive as it is for consumption and not for creating assets. June 2009) 92 . currency movements. the revenue deficit should be zero. It results in a greater proportion of revenue receipts going towards interest payment and eventually.Dr. Monetized Deficit Monetized deficit is indicated by the increase in holdings of treasury bills by the Reserve Bank of India and its contribution to the market borrowings of the government. The merchandise may be private or First Year BMM Semester I. Balance of payments is a record of transactions under two different heads: 1. All expenditure on revenue account should ideally be met from receipts on revenue account. a debt trap. whereby the country can evaluate its position in terms of international trade. Current account: It deals with the movements of merchandise (goods) by way of exports and imports. Revenue deficits The excess of disbursements over receipts on revenue account is called revenue deficit.

f.Ranga Sai Governmental. Each one of these items have a credit or debit depending on the principles of double entry book keeping. So there is a spill over of deficits of current acceptant into capital account. insurance. On current account there can be deficit or surplus. depending on the nature of transactions.It can be again classified as short term and long term capital movements. reflecting the overall position of all the international transactions. Important ratios: First Year BMM Semester I. It is an important indicator because it will highlight the foreign exchange commitments of the country with respect to each country and currency. Other items are non-monetary gold and miscellaneous head for non-classified current transactions. and foreign remittances are called as the invisibles because it involves foreign exchange flows but has no physical movement of goods. The difference between exports and imports determine the position of balance of trade. June 2009) 93 . debt servicing is the repayment of principle and interest and non-monetary gold is the payments made in terms of gold. The position on the merchandise account is called the balance of trade. Capital movements can be private. the balance of payments will have the deficit or surplus. monetary gold and miscellaneous. Amortization is the loan liquidated. debt servicing. Other items include amortization. World Bank and others). Merchandise is a major item on the current account. tourism. The remittances can be in or out of the country. Other items appearing under current account include : Transportation. governmental or institutional ( IMF.e. The deficits of the current account will be financed by the capital account. Capital account can show a deficit or a surplus revealing the strength of the economy.Dr. Economics (w. These capital transactions will also have a debit or credit depending on the directions of flows. Finally. Capital account : It deals with capital movements between one country and rest of the world. 2.

It is the difference between exports + all private capital inflows AND imports + all private out flows. Basic balance: This is the difference between exports + inflow of long term capital AND imports + out flow of private capital. 2. With increasing demand for currency and inelastic supply of gold the currency standard change. Liquidity balance deals with the difference in the official exchange holdings over a given period of time. It is the position of an economy in terms of merchandise on current account. Liquidity balance: In international trade. During gold standards the exchange rate remained fixed because gold was a neutral commodity which had no seasonality in supply or demand. June 2009) 94 . The fixed exchange rate provides stability of value in international transaction. High liquidity balance improves the credit worthiness of a country. It gives a clear picture of the balance of payments position pertaining to a given time period. During the reign of gold standards the currencies were fully convertible into gold. 4. Determination of Exchange Rates: The gold standard method determines the exchange rate up to the end of II world war.f. Official settlement balance: It is a gross indicator of financial position arising out of the balance of payments. It is an important indicator because it will highlight the foreign exchange commitments of the country with respect to each country and currency. It is measure of gross movements in currencies in and out of the economy. This facilitates international transactions and liquidity.Dr. First Year BMM Semester I. Balance of trade: Balance of trade is an important indicator of the efficiency of export sector and import substitution sector.e. liquidity is a major consideration in international payments. 3. Economics (w.Ranga Sai 1.

Such flexible exchange rate mechanism makes an economy open to the external sector can be brought about with domestic policy. The domestic rates of inflation and monetary policy determines international exchange rate. the FOREX market has no physical location and no central exchange. It is the relationship between two monetary units. Foreign Exchange Market in India Foreign exchange consists of trading one type of currency for another. The currency is how valued on the basis of its purchasing power. the seller agrees to sell at a certain amount of foreign exchange to be delivered at a future date at a price agreed upon in advance. Economics (w. In a forward market when the bargain is settled. The purchasing power is worked out on the basis of prices existing in the economy for the basket of consumption. the Forward Market. There is another important market. First Year BMM Semester I. Similarly the buyer of exchange will receive the foreign exchange he has bought immediately.Dr. corporations and individuals trading one currency for another. The FOREX market is the world's largest financial market. Foreign Exchange Rate Exchange rate is the price of one currency expressed in terms of another.Ranga Sai The gold standard was replaced with paper Standards. It operates "over the counter" through a global network of banks. operating 24 hours a day with enormous amounts of money traded on a daily basis.f. With the exchange rate becomes highly flexible and floating. June 2009) 95 . The spot and forward exchange markets In a spot transaction the seller of exchange has to deliver the foreign exchange he has sold 'on the spot' (usually within 2 days). Exchange rate is the medium though which one currency is exchanged for another. The price determines domestic value of currency as well as exchange rate. With the changing price the exchange rate also freely changes. Unlike other financial markets.e.

viz. It involves no interest payment.f. It has entered the country in various forms. The linkage between the spot and forward exchange rates come from the actions of three groups of economic agents who use the market. used has been both for long . It has been composed of different types of capital. with higher limits of investment in selected areas. arbitrageurs.term purposes & short term needs. It has given rise to a number of problems. First Year BMM Semester I. and speculators. can arrest the economic development of developing countries like India. hedgers. such as technology.e. a buyer agrees to buy certain amount of foreign exchange at a future date at a predetermined price. nine months (270 days) and one year (360 days). if properly diverted and utilized. short term capital has a maturity of more than a years. Categories and Composition Foreign capital so far. In India equity participation by foreigners is permissible up to 51 percent of the capital of a project. mostly from the developed countries has been playing an important role in the development of the Indian economy. both on govt. up gradation and exports. Foreign capital has played an important role in the early stages of industrialization of most of the advanced countries of today like countries of Europe & North America. Commonly used forward contracts are for duration of one month(30 days) 3 months (ninety days). the most serious being that of debt servicing. June 2009) 96 . There is a general view that foreign capital. short term capital has maturity of a one year or less. The amount of capital under various types has been different & has varied over times. Forms of Foreign Capital Foreign capital. account and private account.six months (180 days). but only a share in the profit to the extent of shares owned by foreigners.Ranga Sai Similarly. Long term capital refers to capital that has maturity of more than a year. Foreign Direct investment Foreign capital which enters the country in the form of equity capital is termed as Foreign Direct investment (FDI). Economics (w.Dr.

Non -resident foreign citizen of Indian origin are treated on equal terms as the Non -resident Indian citizens. a non resident Indian is one who has gone out of India for business. the country can get funds as equity capital known as direct . etc. etc. In India equity participation by foreigners is permissible up to 51 percent of the capital of a project. Equity or share capital.Ranga Sai Foreign aid Broadly foreign capital is of two types 1. Non . The part of loan available at soft or concessional terms is known as external assistance or foreign aid. employment.f. but only a share in the profit to the extent of shares owned by foreigners. excluding any instruments classified as direct investments or reserve assets.investment involves no interest payment.Dr. for an uncertain period of time. service. India opened up its economy and allowed Foreign Portfolio Investment (FPI) in its domestic stock markets. Portfolio investment includes international investments in equity and debt securities issued by unrelated non-resident entities. First Year BMM Semester I. June 2009) 97 . Equity / Direct Investment Besides loan capital or debt. Since then. Loan capital or debt 2. The period of repayment is usually long. The rate of interest is normally below the market rate. FPI has emerged as a major source of private capital inflow in this country. with higher limits for investment in selected areas such as technology up-gradation exports. Economics (w. Non Resident Indian Under the foreign exchange regulation Act (FERA).Resident of Indian origin are those who have an Indian citizenship and an Indian passport or having Indian Parent or Indian wife or husband. Portfolio Investment In 1992.e. profit.

bonds.Ranga Sai Portfolio investment includes flows through issuance of ADRs or GDRs. • FPI affects domestic capital market. or equipment. June 2009) 98 . which usually denote ownership of equity and investment by FIIs. more than 50 percent of foreign investment in India came in the form of FPI. in the form of property. FPI can be much more volatile than FDI. plants. Economics (w. For a country on the rise. none of which entails active management or control of the securities' issuer by the investor. First Year BMM Semester I. FPI can bring about rapid development. However. India is still depends on FPI than Foreign Direct Investment (FDI) as a source of foreign investment. On the other hand. offshore funds and others. FPI (Foreign Portfolio Investment) represents passive holdings of securities such as foreign stocks. creating many new jobs and significant wealth. sometimes just by failing to meet the expectations of international investors. Most concretely. thus covering the liabilities under portfolio investments. Advantages • Inflow of FPI can provide a developing country non-debt creating source of foreign investment.e.Dr. when a country's economic situation takes a downturn. helping an emerging economy move quickly to take advantage of economic opportunity. or other financial assets.f. • Increased inflow of foreign capital increases the allocative efficiency of capital in a country. For the period 1992 to 2005. Portfolio Investment is very easy to sell off the securities and pull out the foreign portfolio investment. Hence. It gives an upward thrust to the domestic stock market prices. the large flow of money into a country can turn into a stampede away from it. it may take the form of buying or constructing a factory in a foreign country or adding improvements to such a facility. Foreign Direct Investment refers to international investment in which the investor obtains a lasting interest in an enterprise in another country.

Due to liberalization now exchange rate and interest rates in the financial markets are determined freely. This is done by systematically privatization of public sector. These reforms made India a global economy. trade and social sector to make the economy more competitive. Privatization : Privatization refers to inducing more and more of private participation in public sector activities. and market forces to operate. The economic changes had a effect on the overall growth of the economy.Ranga Sai II India in a globalized world Globalization in India The Indian economy was in major crisis in 1991 when foreign currency reserves went down to $1 billion and inflation was as high as 17 percent. By liberalization.e. compete in the international markets in terms of flow of goods capital or other resources. The new economic reform.commonly called as disinvestment. the Government allows more freedom. That was the time when India underwent a major policy change. Liberalization. Globalization: Globalization refers to adopting such changes which will enable the country freely.f. Such disinvestment brings in private cap[ital and also allows private managerial competence and skills. June 2009) 99 . Such polices of globalization may need pening up of economy for competition. and liberalizing external policy.Dr. Liberalization: Liberalization refers to deregulation of Governmental controls. MRTP Act and huge customs duty and import restrictions. participation in international organizations like WTO. Economics (w. Privatization and Globalization aimed at making India grow faster and globally competitive. Up to 1991 Indian industry was under the control regime of the Government by way of Industrial licensing. First Year BMM Semester I. popularly known as. Several reforms were initiated with regard to industrial.

development of integrated townships. enhancement of FDI limits in private sector banking. Some of the recent initiatives taken to further liberalize the FDI. privatization and liberalization policies are moving along as well. which expansion earlier restricted capacity • The removal of quantitative restrictions on imports. Now there are only three industries reserved for the public sector • Abolition of the (MRTP) Act. First Year BMM Semester I.e. • Disinvestment-In order to make the process of globalization smooth. Under the privatization scheme.Ranga Sai The Policy Privatization. • Non Resident Indian Scheme for foreign direct investment as available to foreign investors/ Companies are fully applicable to NRIs as well. only six industries are under compulsory licensing mainly on accounting of environmental safety and strategic considerations • Allowing Foreign Direct Investment into industries without any limit on the extent of foreign ownership. most of the public sector undertakings have been/ are being sold to private sector • Abolishing Industrial Licensing At present. tea plantation . • To open Industries Reserved for the Public Sector to Private Participation. Liberalization. and Globalization can be seen as: • Devaluation: The first step towards globalization was taken with the announcement of the devaluation of Indian currency by 18-19 percent against major currencies in the international foreign exchange market.f. Economics (w. include opening up of sectors such as Insurance . defense industry. June 2009) 100 .Dr.

which can be used for economic reconstruction. and the introduction of foreign/private sector competition. Merits and Demerits of Globalization Merits of Globalization are as follows: • There is an International market for companies and for consumers there is a wider range of products to choose from. June 2009) 101 . it could indirectly lead to a subtle form of colonization. Summary • In respect of market capitalization. India ranks fourth in the world. • Technological development has resulted in reverse brain drain in developing countries. condition of agriculture has not improved. The share of agriculture in the GDP is only 17 percent.e. • Increase in flow of investments from developed countries to developing countries. capital markets.f. • For smaller developing nations at the receiving end. First Year BMM Semester I.Ranga Sai • The reduction of the peak customs tariff from over 300 per cent prior to the 30 per cent rate that applies now. • But even after globalization. • Greater and faster flow of information between countries and greater cultural interaction has helped to overcome cultural barriers. and insurance sectors. • Wide-ranging financial sector reforms in the banking. • There is an underlying threat of multinational corporations with immense power ruling the globe. including the deregulation of interest rates.Dr. strong regulation and supervisory systems. Economics (w. The Demerits of Globalization are as follows: • The outsourcing of jobs to developing countries has resulted in loss of jobs in developed countries. • The number of landless families has increased and farmers are still committing suicide. • There is a greater threat of spread of communicable diseases.

Dr. Agreement on Agriculture 3. intellectual property rights. and • Expanding the production of and trade in goods and services. General Agreement on Trade and Tariff (GATT) was the forum for managing trade barriers. The WTO has 148 members. and 3. General Agreement on Tariffs and Trade 1994 2. accounting for over 97 percent of world trade. Agreements under WTO WTO prescribes several conditions governing trade agreements in agriculture. Economics (w. Agreement on Trade-Related Investment Measures 4. June 2009) 102 . 1. To provide a dispute settlement mechanism. • Ensuring large and steadily growing real incomes and demand. 2. Main functions of the WTO: 1. and international disputes.Ranga Sai WTO and India From 1947 to 1994.f.e. General Agreement on Trade in Services 5. • Ensuring full employment. To oversee implementing and administering WTO agreements. The World Trade Organization (WTO) was established on 1st January 1995. Agreement on Trade-Related Intellectual Property Rights General Agreement on Tariffs and trade (GATT) (for goods). To provide a forum for negotiations. service sector. Around 30 others are negotiating membership. . These are given as agreements. Protection to Domestic Industry through Tariffs: First Year BMM Semester I. These objectives are laid down so as to achieve certain global objectives like: • Raising standards of living. 1.

Dr.Ranga Sai

a. The General Agreement on Tariffs and Trade (GATT) covers international trade in goods. The workings of the GATT agreement are the responsibility of the Council for Trade in Goods (Goods Council) which is made up of representatives from all WTO member countries. GATT requires the member countries to protect their domestic industry/production through tariffs only. b. It prohibits the use of quantitative restrictions, except in a limited number of situations. 2. Binding of Tariffs: The member countries are urged to a. Eliminate protection to domestic industry/ production by reducing tariffs and removing other barriers to trade in multilateral trade negotiations. b. The reduced tariffs are bound against further increases by listing them in each country's national schedule. c. The schedules are an integrated part of the GATT legal system. 3. Most Favored-Nation (MFN) Treatment: a. The rule lays down the principles of non-discrimination amongst member countries. b. Tariff and other regulations should be applied to imported or exported goods without discrimination among countries. c. Exceptions to the rules i.e., regional arrangements subjected to preferential or duty free trade agreements, Generalized System of Preferences (GSP) where developed countries apply preferential or duty free rates to imports from developing countries. 4. National Treatment Rule: The rule prohibits member countries from discriminating between imported products and domestically produced like goods in the matter of internal taxes and in the application of internal regulations. General Agreement on Trade in Services (GATT) Services sector represent the fastest growing sector of the global economy and account for two thirds of global output, one third of global employment
First Year BMM Semester I, Economics (w.e.f. June 2009) 103

Dr.Ranga Sai

and nearly 20 per cent of global trade. General Agreement on Trade in Services provides for the following: • Commitments on market access and national treatmentIndividual countries’ commitments to open markets in specific sectors. GATS does not require any service to be deregulated. • International payments and transfers - Once a government has made a commitment to open a service sector to foreign competition, it must not normally restrict money being transferred out of the country as payment for services supplied. • Progressive liberalization - The goal is to take the liberalization process further by increasing the level of commitments in schedules. • Movement of natural persons - individuals’ rights to stay temporarily in a country for the purpose of providing a service. • Financial services - protection of investors, depositors and insurance policy holders, and to ensure the integrity and stability of the financial system. • Telecommunications - Governments must ensure that foreign service suppliers are given access to the public telecommunications networks without discrimination Trade-Related Aspects of Intellectual Property Rights (TRIPS), The areas covered by the TRIPS Agreement • Copyright and related rights • Trademarks, including service marks • Geographical indications • Industrial designs • Patents • Layout-designs (topographies) of integrated circuits • Undisclosed information, including trade secrets (a) Copyrights and related rights; • Protection of computer programs as literary works and of compilations of data. • Recognition of computer programs, and cinematographic works • Recognition of a 50 years’ minimum.
First Year BMM Semester I, Economics (w.e.f. June 2009) 104

Dr.Ranga Sai

(b) Trade marks; • Protectable subject matter includes any sign, combination of signs capable of distinguishing the goods or services from others. Registration depends on distinctiveness end use. • • Rights on the owners of registered trademark conferred to prevent third party not having his consent, from using in course of trade relating to identical goods/ services. • The minimum term of protection is seven years, indefinitely renewable. (c) Geographical Indications; • Legal means shall be provided to prevent use of an indication in a manner that misleads the public or when it constitutes unfair competition, and to invalidate a trademark if the public is misled as to the true place of origin. • Additional protection is conferred on geographical indications for wines and spirits • Obligations only relate to geographical indications that are protected in their country of origin. (d) Industrial Designs; • Protection to new or original designs. • Protection for textile designs through industrial design or copyright law. • Exclusive rights can be exercised against acts for commercial purposes, including importation. • Minimum Term of Protection is ten years. (e) Patents; • Patents shall be granted for any inventions, whether products or processes, in all field of technology, provided they are new. • The term of protection shall be at least 20 years from the date of application. (f) Layout designs of integrated circuits; • Protection shall extend to layout designs as such and to the industrial articles that incorporate them.
First Year BMM Semester I, Economics (w.e.f. June 2009) 105

This is 24 percent for developing countries. and edible oils at 300 First Year BMM Semester I. so long as payments are linked to production-limiting programs. if the information is secret. • Undisclosed information is to be protected against unfair commercial practices.Dr. Tariffication means all nontariff barriers like quotas.Ranga Sai • Term of protection is a minimum of 10 years notification. Total Aggregate Measure of Support (Total AMS) shall be 13 percent. Market access: This involves tariffication. has commercial value and is subject to steps to keep it secret. 3.f. from the total support given 1986-88. (g) Protection of undisclosed information (trade secrets). developing countries are permitted untargeted subsidized food distribution to meet requirements of urban and rural poor. The Blue Box contains subsidies which can be increased without limit. June 2009) 106 . In operation WTO prescribes a four fold approach: • Green Box: It contains fixed payments to producers for environmental programs. variable levies. discretionary licensing and state trading measures need to be placed with tariffs. India and WTO: India has undertaken is to bind its tariffs on primary agricultural products at 100 per cent.e. Export subsidies: Export subsidy expenditure to be reduced to 36 per cent and for developing countries is 24 percent. processed foods at 150 per cent. so long as the payments are not a part of current production • Blue Box: Minimum support price and direct payments to agriculture • Special and differential box: Investment subsidies • Amber Box: Contains domestic subsidies that governments have agreed to reduce but not eliminate. 2. Agreement on Agriculture (AoA) WTO Agreement on agriculture covers 1. minimum support prices. and reduction in tariff and access opportunities. Economics (w. As special differential treatment. Domestic support: Policies are subject to reduction.

rural development and employment • There is a need to create opportunities for expansion of agricultural exports with meaningful market access in developing counties. floral products • Share of Indian agriculture in world market is negligible except rice • Subsidies of rich nations does not effect Indian exports • Indian products are cost effective • No fear of Indian markets being flooded by imports • It is important to protect food and livelihood security to alleviate poverty. discussed cuts in tariff. All annual conference of WTO experienced protests and demonstrations from the third world countries. So all the agreements have been undergoing reviews in different conferences. Development in various Ministerial meetings WTO has been blames to be pro developed nations. June 2009) 107 . Further.Ranga Sai per cent. • Green box is considered with development box • Agricultural exports do not get direct subsidy. vegetables. It is felt universally. Economics (w. environment and labour issues. • Cancun conference 2003 brought out the issues of liberalization of agriculture and new multilateral issues. • Hong Kong conference 2005. (25535) 24-04-2010 First Year BMM Semester I. In each of these conferences major agreements have been made to improve acceptability of WTO regime. India’s share in total agricultural exports from developing Asia is 8 per cent • Maintains quantitative restrictions due to Balance of Payments reasons • No commitment regarding market access. • The Doha Declaration 2001.Dr. • Indirect subsidy by way of exemption of export profit from Income tax • Subsidies on cost of freight on export shipment of fruits.f. public health.e. brought new round of negotiations on agricultural subsidies. that free trade regime benefits only the developed countries.

Com Second Year B.net First Year BMM Semester I. June 2009) 108 .Com Accounting and Finance I Semester First Year B.Com Banking and Insurance II Semester Second Year BCom Accounting and Finance IIISemester Based on University of Mumbai curriculum Available for free and private circulation At www. vazecollege.Com First Year B.com and www.e.Ranga Sai Other books in this series Business Economics Paper I Business Economics Paper II Business Economics Paper III B. rangasai.A.Dr.Com Banking and Insurance I Semester Macro Economics First Year B. Micro Economics First Year B. Economics (w.Com Third Year Micro Economics First Year B.f.

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