Unit1: Fundamentals of Economics, Microeconomics & Macro

Economics and Types of Economies.

1.What is Economics?
Economics is a social science which studies the economic activities of human behavior like
consumption, production, exchange etc. These studies basically explain “the human behavior as a
relationship between given ends and scarce means which have alternative uses”.

2. How can you define economics?

The definitions of economics can be classified into four categories.

Wealth definitions - Adam Smith

Welfare definitions - Marshal
Scarcity definitions - Robin

Wealth definitions
Almost all classical economists followed wealth definition. It is mostly associated with J.B.
Say and Adam smith. Adam smith was called “Father of economics”.

According to the above definitions:-

Economics explains how the wealth is produced, consumed, exchanged and distributed.
Economics is a science of study of wealth only.
This definition deals with the causes behind the creation of wealth.
It only considers material wealth.

Welfare definition:

According to Alfred Marshall’s definition, economics is the study of wealth on the one hand
and more importantly it is the study of human welfare on the other hand.

According to this definition, economics is a social science.

According to definition, goods are classified into two categories
(a) material goods (b) immaterial goods.
According to Alfred Marshall, economics is a normal science.
The top priority is given the welfare of man while secondary priority is given to the
wealth.
Marshall enhanced the status of man from economic man to social man. Economics
related
only some material goods that promote the human welfare

Scarcity Definition/Robbins definitions

“Economics is a science which studies human behavior as a relationship between ends and
scarce means which have alternative uses”. – Robbin
According to the above definition,
Wants are unlimited
Resources are limited.
These resources have alternative uses.
There are problem of choice of these resources.

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3. Differentiate between microeconomics and macroeconomics?

Scope of microeconomics:

The microeconomics not only explains how the price of a good is determined and how the
price per unit of factors of production is determined but it also deals with theories of onomic
welfare. So microeconomics is called “Price theory”

Scope of macroeconomics:
Macro economics studies about the National Income i.e. calculation of the national income,
trends in the national income etc., It also deals with total employment (full employment), total
output etc.

It also studies about trade cycles, Inflation etc., It also deals with theories of economic
growth and macro theory of distribution. It is also called Income and Employment theory.

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4.Describe the central problem faced by all economies.

Due to the scarcity of resources every economy should face some problems. The central
problems faced by all economies can be explained as follows:

What to produce

If the present is given importance, then resources are diverted for the production of
consumer goods. If future is given importance then resources are diverted for the production
of capital goods.

How to produce

This problem is arising because of unavailability of some resources. A country may produce
by using labour intensive technique ‘or’ capital intensive technique, depending upon its man
power and stock of capital.

For whom to produce

A country may produce mass consumption goods at a large (for poor people) ‘or’ goods for
upper classes. It is depend upon policies of the government

5. Explain various types of economy?

A market Economy/ Capitalistic Economy is one in which individuals and private firms make
the major decisions about production and consumption. E.g.: United Kingdom.

A Command Economy/Socialistic Economy is one in which the government makes all

important decisions about production and distribution

Mixed Economy is where public sector, private sector and joint sector coexist and
complement each other. E.g.: India

Laissez – faire Economy is the extreme case of a Market Economy.

Quick Bites

1. According to __________ Economics is the study of science of wealth. ( Adam Smith)

2. According to _______ definition economic is a social science.( Welfare /Marshal)
3. According to ______ top priority is given to man. ( Marshal)
4. Alternative uses of limited resources leads to ______ ( Choices)

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 Unit 2: Supply and Demand

1. Define Law of Demand. Distinguish between individual demand and market demand.

Meaning of Demand
Demand means ‘desire. However, in economics demand means desire backed by the
purchasing power and willing to pay the price.

Law of Demand:
It explains the functional relationship between price and quantity demanded. According to law
of demand when all other things remain constant, if the price rises demand is decreased. If
the price falls demand will be increased.

It means there is an inverse relationship between price and demand. Dx = f [Px]

Demand Schedule:
It shows the various quantities of the goods that are demanded at various levels of prices.
There are two types of demand schedules:

1. Individual Demand Schedule 2. Market Demand Schedule

2. What are all the Types of Demand:

There are three types of demands. They are:

a. Price demand
b. Income demand
c. Cross demand

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a. Price Demand:

Price demand explains the relationship between price of a commodity and demand for that
commodity. There is an inverse relationship between price and demand. So, the price demand
curve slopes downwards from left to right : Dx = f [Px]

b. Income Demand:
Income demand explains the functional relationship between income of consumer and demand for
goods.

Generally if the level of income rises the consumer purchases more of goods. If the level of income
decreases he purchases less quantity goods. It means there is a direct proportional relationship
between income of consumer and demand of goods. So, normally the income demand curve
slopes upwards form left to right. Dx = f [y]

Cross Demand:
It shows the relationship between price of one commodity and demand for another commodity. It
means the demand for one commodity not only depend upon its price but also prices of its
substitute goods and complementary goods: Dx = f [Py]

The cross demand curve is in two types: It is upwards from left to right in the case of substitute
goods and its slope downwards form left to right in the case of complementary goods.

3. Distinguish between change in demand and Change in quantity demanded.

If there is a change in the determinants of a demand that leads to the change in demand. These
changes in demand are of two types. They are 1. Extension and contraction of demand
2.Increase and decrease of demand.

Extension and Contraction of Demand:

When all other things remain constant if there is

a change in the price that leads to the change in
demand. These changes in demand are called
extension and contraction of demand. When the
price is decreased the demand is extended when
the price is increased the demand is contracted.

Increase and decrease of demand

When the price is constant, if there is a change
in the other determinants that lends to change
in
demand. These changes in demand are called
“Increase and decrease of demand”.

a. When the demand is increased, the new

demand curve is formed towards right to old
demand curve ‘or’ preceding demand curve.
b. In the same way when the demand is decreased the new demand curve is formed towards left
to old demand curve ‘or’ preceding demand curve.

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4. State the law of supply. How can you derive market supply curve from individual supply
curve?
The Law of supply explains the functional relationship between price of a good and supply of the
good.

When all other things remain constant, if the price rises supply also increase, if the price falls
supply will be decrease. It means there is direct proportional relationship between price and
supply.

5. Explain how equilibrium price is determined in the interaction of demand and supply.
Equilibrium price means constant price (or)
unchanged price.

It is nothing but demand and supply. It is actually the

price at which the quantity demanded of a commodity
equals the quantity supply. This can be explained by
the following diagram.

Equilibrium price means constant price (or)

unchanged price. It is actually the price at which
the quantity demanded of a commodity equals the
quantity supply. This can be explained by the
following diagram.

State the sentence true or false

In ordinary language demand means desire - True
There is a inverse relationship between income and demand -False
Consumers tastes can influence the demand. - True
Change in the demand due to the change in price is called extension of demand - True
In case of exception of law of demand of the price demand curve slopes downwards from
left to right. - False
Comfort goods have more elastic demand - False
Price discrimination is possible due to elasticity -True
The supply curve in case of land is parallel to x-axis - False
If there is more increase in demand and less increase in supply, then quantity and price
rises - True
If there is more decrease in supply and less decrease in demand then quantity decrease
and price rises - True
For necessary goods demand will be relatively more elastic - True
When government imposes tax on a commodity its supply will shift to the right - False
If the cross price elasticity of demand for two goods is positive, goods are called
substitutes- True

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 Unit 3: Money supply and Inflation

1. Explain the functions of Money?

Money is anything which performs the following four functions:
- Medium of Exchange
- A measure of value
- A store of value over time
- Standard for deferred payments

2.Explain legal Definitions of Narrow and Broad Money?

Money supply, like money demand, is a stock variable. The total stock of money
in circulation among the public at a particular point of time is called money supply. RBI
publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4.

They are defined as follows

M1 = CU + DD
M2 = M1 + Savings deposits with Post Office savings banks
M3 = M1 + Net time deposits of commercial banks
M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings
Certificates)

where, CU is currency (notes plus coins) held by the public and DD is net demand
deposits held by commercial banks.

Demand deposit : Savings and Current Account – Payable on demand.

The word ‘net’ implies that only deposits of the public held by the banks are to be included in
money supply. The interbank deposits, which a commercial bank holds in other commercial
banks, are not to be regarded as part of money supply.

M1 and M2 are known as narrow money. M3 and M4 are known as broad money. These
gradations are in decreasing order of liquidity. M1 is most liquid and easiest for transactions
whereas M4 is least liquid of all. M3 is the most commonly used measure of money supply. It
is also known as aggregate monetary resources.

2. What is mean by inflation?

Meaning: Inflation refers to a situation of increase in the general price level over a period of
time. It is a part of business cycles
.

3. List out the various types of inflation?

Wholesale Price Index (WPI)
Consumer Price Index (CPI)
Gross Domestic Product (GDP) Deflator

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4. what are causes of inflation?
Increase in Money Supply
Deficit Financing
Rise in Population
Fall in Production
Increase in Wages
Administrated Prices
Inflation Across the Border’s
Indirect Tax
Credit Expansion
Black Money

5. What is mean by Demand pull inflation?

Demand-pull inflation is a tenet of Keynesian economics that describes the effects of an

imbalance in aggregate supply and demand. When the aggregate demand in an economy
strongly outweighs the aggregate supply, prices go up. ... This leads to a steady increase in
demand, which means higher prices.

6. What is mean by cost push inflation?

Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost
of wages and raw materials. Cost-push inflation can occur when higher costs of production
decrease the aggregate supply (the amount of total production) in the economy.

7. What are all causes of Inflation? - Primary Causes:

a. When demand for a commodity in the market exceeds its supply, the excess demand will
push up the price (‘demand-pull inflation’).

b. When factor prices rise, costs of production rise (‘Cost – push inflation’)

Let us now discuss in detail the various causes that may bring about inflation.

o Increase in public spending

o Deficit financing of government spending:
o Increased velocity of circulation:
o Population growth:
o Genuine Shortage

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Quick Bites:

1.Which one of the following can not be the cause of the cost-push inflation?

(a) Wage increases not associated with rise in productivity

(b) Rise in profit margin
(c) High import price
(d) Existence of excess demand (Ans)

2.. One of the demand-pull factors that creates inflation in India is

(a) Imposition of GST
(b) Rising deficit finance of the Govt. ( Ans)
(c) Hoarding of essential commodities
(d) None of the above

3. When inflation is caused due to rise cost of Production of goods are services, where
no suitable alternative is available, it is called.
a. Wholesale inflation
b. Demand pull inflation
c. Cost push inflation ( Ans)
d. Consumer inflation

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8.What is deflation in economics?

Deflation is when consumer and asset prices decrease over time, and purchasing power
increases.

Essentially, you can buy more goods or services tomorrow with the same amount of money
you have today.

This is the mirror image of inflation, which is the gradual increase in prices across the economy.

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 Unit No 4: Theories of Interest

1. What do you mean by liquidity preference?

Liquidity preference, in economics, the premium that wealth holders demand for
exchanging ready money or bank deposits for safe, non-liquid assets such as
government bonds

2. What is Keynes theory of liquidity preference?

The Liquidity Preference Theory says that the

demand for money is not to borrow money but the
desire to remain liquid.

In other words, the interest rate is the 'price' for

money. John Maynard Keynes created the Liquidity
Preference Theory in to explain the role of the interest
rate by the supply and demand for money.

3.What is the liquidity trap for Keynes?

A liquidity trap is a situation, described in Keynesian economics, in which, "after the
rate of interest has fallen to a certain level, liquidity preference may become virtually
absolute in the sense that almost everyone prefers holding cash rather than holding a
debt (financial instrument) which yields so low a rate .

3. Explain the various motive for holding money?

o Transaction
o Speculative
o Precautionary

The transactions motive states that individuals have a preference for liquidity to guarantee
having sufficient cash on hand for basic day-to-day needs.

In other words, stakeholders have a high demand for liquidity to cover their short-term
obligations, such as buying groceries and paying the rent or mortgage.
Higher costs of living mean a higher demand for cash/liquidity to meet those day-to-day
needs.

The precautionary motive relates to an individual's preference for additional liquidity if an

unexpected problem or cost arises that requires a substantial outlay of cash. These events
include unforeseen costs like house or car repairs.

Stakeholders may also have a speculative motive. When interest rates are low, demand
for cash is high and they may prefer to hold assets until interest rates rise. The speculative

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 motive refers to an investor's reluctance to tying up investment capital for fear of missing
out on a better opportunity in the future.

4. Explain Hicks and Hansaon Theory of interest?

The Hicks-Hansen analysis is thus an integrated and determinate theory of interest in

which the two determinates, the IS and LM curves, based on productivity, thrift, liquidity
preference and the supply of money, all play their parts in the determination of the rate of
interest.

IS – Investment & Savings

LM – Liquidity & Money.

5.What is the IS and LM curve?

The IS curve depicts the set of all levels of interest rates and output (GDP) at which total
investment (I) equals total saving (S).

The LM curve depicts the set of all levels of income (GDP) and interest rates at which money
supply equals money (liquidity) demand.

The money demand curve, as per Keynesian theory of Interest is downward sloping, because
demand for money is inversely related to rate of interest.

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 Unit 5: Business Cycle

1. What is a Business Cycle?

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around its
long-term natural growth rate. It explains the expansion and contraction in economic activity
that an economy experiences over time.

2. Explain the various stages of Business cycle based on above diagram?

1. Expansion
The first stage in the business cycle is expansion. In this stage, there is an increase in positive
economic indicators such as employment, income, output, wages, profits, demand, and supply
of goods and services.

Debtors are generally paying their debts on time, the velocity of the money supply is high, and
investment is high. This process continues as long as economic conditions are favorable for
expansion.

2. Peak
The economy then reaches a saturation point, or peak, which is the second stage of the
business cycle. The maximum limit of growth is attained. The economic indicators do not grow
further and are at their highest. Prices are at their peak. This stage marks the reversal point
in the trend of economic growth. Consumers tend to restructure their budgets at this point.

3. Recession
The recession is the stage that follows the peak phase. The demand for goods and services
starts declining rapidly and steadily in this phase. Producers do not notice the decrease in
demand instantly and go on producing, which creates a situation of excess supply in the

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market. Prices tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.

4. Depression
There is a commensurate rise in unemployment. The growth in the economy continues to
decline, and as this falls below the steady growth line, the stage is called a depression.

5. Trough
In the depression stage, the economy’s growth rate becomes negative. There is further decline
until the prices of factors, as well as the demand and supply of goods and services, contract
to reach their lowest point. The economy eventually reaches the trough. It is the negative
saturation point for an economy. There is extensive depletion of national income and
expenditure

6. Recovery
After the trough, the economy moves to the stage of recovery. In this phase, there is a
turnaround in the economy, and it begins to recover from the negative growth rate. Demand
starts to pick up due to low prices and, consequently, supply begins to increase. The
population develops a positive attitude towards investment and employment and production
starts increasing.

Employment begins to rise and, due to accumulated cash balances with the bankers, lending
also shows positive signals. In this phase, depreciated capital is replaced, leading to new
investments in the production process. Recovery continues until the economy returns to
steady growth levels.

Quick bites

1.Which of the following is not a feature of the recovery phase in a business cycle?
a. The consumers who had postponed purchase of goods and services still are not
ready to buy goods and services (Ans)
b. Banks come forward to lend at lower interest rates
c. Economic activity starts picking up
d. Increasing income result in increasing demand

2. In which of the following phases, the underemployment of manpower and material is

prevalent in which of the following:
a. Recovery
b. Boom
c. Recession
d. Depression ( Ans)

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 Unit No 6: Indian Economy and various sectors of economy

1. What are the different sectors of Indian economy?

They are three sectors in the Indian economy, they are; primary economy, secondary
economy, and tertiary economy.

2. What is primary sector of Indian Economy?

Primary Sector
Agriculture, Mining, Fishing, Forestry, Dairy etc. are some examples of this sector. It is called
so because it forms the base for all other products. Since most of the natural products we get
are from agriculture, dairy, forestry, fishing, it is also called Agriculture and allied sector

3. Explain in details about secondary sector of Indian economy?

Secondary Sector

It includes the industries where finished products are made from natural materials produced
in the primary sector. Industrial production, cotton fabric, sugar cane production etc. activities
comes under this sector.

Hence its the part of a country's economy that manufactures goods, rather than producing raw
materials

Since this sector is associated with different kinds of industries, it is also called industrial sector.
People engaged in secondary activities are called blue collar workers.

Examples of manufacturing sector:

Small workshops producing pots, artisan production.
Mills producing textiles,
Factories producing steel, chemicals, plastic, car.
Food production such as brewing plants, and food processing.
Oil refinery.

4. Explain in details about teritary sector of Indian economy?

Tertiary Sector/Service Sector

This sector’s activities help in the development of the primary and secondary sectors. By itself,
economic activities in tertiary sector do not produce a goods but they are an aid or a support
for the production.

Goods transported by trucks or trains, banking, insurance, finance etc. come under the sector.

It provides the value addition to a product same as secondary sector.

This sector jobs are called white collar jobs

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