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Subject : Economics - I
A. Definition: The word ‘Economics’ is derived from two Greek words, oikos
(a house) and nemein (to manage) which would mean ‘managing an
household’ using the limited funds available, in the most satisfactory manner
possible. Several economists have defined economics taking different
aspects into account:
of life; it examines that part of individual and social action which is most
closely connected with the attainment and with the use of the material
requisites of well being”.
Science and art are complementary to each other and economics is both a
science and an art. It is science in its methodology and an art in its
application.
C. Methodology
Economic is concept based and technique oriented. The use of concepts and
techniques help us in developing the analytical rigour of the subject.
D. Time Value of Money – The time value of money (TVM) is the concept
that money available at the present time is worth more than the identical
sum in the future due to its potential earning capacity. This core principle of
finance holds that, provided money can earn interest, any amount of money
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one market may have changes in another market and therefore one has to
model every market simultaneously.
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E. Short run versus Long run – Economists analyse their probem with
reference to objectives and constraints. If some constraints or factors are
fixed, while others are variable, it is considered as a short-run analysis. On
the other hand, if all the constraints are variable or adjustable, it is called as
long-run analysis. The economists have to analyze the implications of short
run as well as long run changes on the demand, production and cost
decisions.
a. Government steps in to protect the consumer and see that producer does
not exploit the consumer. Further, there is an increasing production of
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b. The private enterprises close their eyes on social cost of their production.
They are only concerned with the private cost of production. Government
is required to pass legislation related to controlling the social cost.
c. The State lays down the economic framework, laws and rules for
controlling the economic activities. It helps to tackle the problems of
unemployment, inflation, etc. and stabilize the pace of economic growth.
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D. Economic Laws
c. Economic laws are less accurate and lack preciseness and universal
applicability.
d. The aim of economics, like all other sciences, should be to develop laws
or generalizations or principles to understand the past and offer
trustworthy guidance for the future.
E. Government Laws - The government laws are the laws passed by the
parliament. These are based on social norms and customs. They involve a
lengthy procedure of framing having legal implications. These are associated
with maintaining law and order in the society. They are binding on all
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Demand Curve - If you were to plot out how many units you would buy at
different prices, then you've created a demand curve. It graphically portrays
the data in a demand schedule.
Law of Demand – The law of demand governs the relationship between the
quantity demanded and the price. This economic principle describes
something you already intuitively know. If the price increases, people buy
less. The reverse is also true. If the price drops, people buy more. But, price
is not the only determining factor. The law of demand is only true if all other
determinants don't change. In economics, this is called ceteris paribus. The
law of demand formally states that, ceteris paribus, the quantity demanded
for a good or service is inversely related to the price.
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B. Theory of Supply
Meaning of supply – Supply refers to various quantities of a commodity
which a producer will actually offer for sale at a particular time at various
corresponding prices.
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1. Price: Producers will try to obtain the highest possible price whereas the
buyers will try to pay the lowest possible price both settling at the
equilibrium price where supply equals demand.
2. Cost of inputs: The lower the input price the higher the profit at a price
level and more product will be offered at that price.
3. Price of other goods: Lower prices of competing goods will reduce the
price and the supplier may switch to switch to more profitable products
thus reducing the supply.
Law of Supply – The law of supply states that, keeping other factors
constant, an increase in price results in an increase in quantity supplied. In
other words, there is a direct relationship between price and quantity:
quantities respond in the same direction as price changes.
Movement along Supply Curve – Movement along the supply curve will
occur when the price of the good changes and the quantity supplied changes
in accordance to the original supply relationship. In other words, a
movement occurs when a change in quantity supplied is caused only by a
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change in price, and vice versa. This results in a movement along the same
demand curve. Increase in quantity demanded due to a fall in the price of the
commodity is referred to as extension in demand and vice versa. It explains
the law of demand.
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called equilibrium price, and the quantity demanded and supplied at this
price is called the equilibrium quantity. So long as demand and supply
remain unchanged, equilibrium price or quantity will not change.
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E. Concept of Elasticity
a. Elasticity of Demand
EP = Δq/Δp x p/q
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Slope and Elasticity - Slope refers to the steepness of the demand curve.
On the other hand, elasticity of demand measures the relative change in
price and quantity. Elasticity of demand is inversely proportional to the
slope of the demand curve.
Different types of Elasticity of Demand
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There are several factors that affect the supply elasticity of a good or
service, such as nature of commodity, behavior of costs as output varies,
period of production, techniques of production, future price expectations,
number of products produced by an industrial unit, availability of
resources, etc.
A. Total Product - Total product is the overall quantity of output that a firm
produces, usually specified in relation to a variable input. Total product is
the starting point for the analysis of short-run production. It indicates how
much output a firm can produce according to the law of diminishing
marginal returns.
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labour is negative and the MP curve falls below the X-axis. In this stage the
variable factor (labour) is too much relative to the fixed factor.
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that the total costs are shared over the increased output. There are two types
of economies of scale:
G. Diseconomies of scale
These are the problems faced by businesses if they become too large - Lose
touch with the customers, Managers lose touch with the workers,
communication problems because the business is so large.
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1. Nominal Cost and Real Cost: Nominal cost is the money cost of
production. The real costs of production are the pain and sacrifices of labour
involved in the process of production.
2. Explicit and Implicit costs: Explicit costs are the accounting costs or
contractual cash payments which the firm makes to other factor owners for
purchasing or hiring the various factors. Implicit costs are the costs of self-
owned factors which are employed by the entrepreneur in his own business.
These implicit costs are the opportunity costs of the self-owned and self-
employed factors of the entrepreneur, that is, the money incomes which
these self-owned factors would have earned in their next best alternative
uses.
3. Opportunity Cost and Actual Cost: The opportunity cost (or transfer
earnings) of any good is the expected return from the next best alternative
good that is forgone or sacrificed. For example, if a farmer who is producing
wheat can also produce potatoes with the same factors. Then, the
opportunity cost of a quintal of wheat is the amount of output of potatoes
given up. Actual cost refers to the expenditure on producing a given quantity
of a good. It consists of monetary payments made for the hired inputs plus
the imputed value of the inputs and services provided by the firm itself.
Thus, actual cost is the cost of all resources used in producing a particular
good.
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4. Direct Cost and Indirect Cost: A cost that is easily attributable to a cost
object is known as Direct Cost. Indirect Cost is defined as the cost that
cannot be allocated to a particular cost object.
5. Private costs and Social Costs: Private costs are the economic costs which
are actually incurred or provided for by an individual or a firm. It includes
both explicit and implicit costs. Social cost, on the other hand, implies the
cost which a society bears as a result of production of a commodity. Social
cost includes both private cost and the external cost. External cost includes
(a) the cost of free goods or resources for which the firm is not required to
pay for its used, e.g., atmosphere, rivers, lakes etc. (b) the cost in the form of
‘disutility’ caused by air, water, and noise pollution, etc.
6. Total, Average and Marginal Costs: Total cost refers to the total outlays of
money expenditure, both explicit and implicit on the resources used to
produced a given output. Average cost is the cost per unit of output which is
obtained by dividing the total cost (TC) by the total output (Q), i.e., TC/Q =
average cost. Marginal cost is the addition made to the total cost as a result
of producing one additional unit of the product.
7. Fixed Costs and Variable Costs: Fixed costs are the expenditure incurred
on the factors such as capital, equipment, plant, factory building which
remain fixed in the short run and cannot be changed. Therefore, fixed costs
are independent of output in the short run i.e., they do not vary with output
in the short run. Even if no output is produced in the short run, these costs
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will have to be incurred. Variable costs are costs incurred by the firms on the
employment of variable factors such as labour, raw materials, etc., whose
amount can be easily increased or decreased in the short run. Variable costs
vary with the level of output in the short run. If the firm decided not to
produce any output, variable costs will not be incurred.
9. Short-run and Long-run Cost: Short-run costs are the costs which vary
with the change in output, the size of the firm remaining the same. Short-run
costs are the same as variable costs. On the other hand, long-run costs are
incurred on the fixed assets, like plant, building, machinery, land etc. Long-
run cost are the same as fixed-costs. However, in the long-run even the fixed
costs become variable costs as the size of the firm or scale or production is
increased.
1. When MC falls, AC also falls but at lower rate than that of MC. So long
as MC curve lies below the AC curve, the AC curve is falling.
2. When MC rises, AC also rises but at lower rate than that of MC. That is,
when MC curve lies above AC curve, the AC curve is rising.
3. MC intersects AC at its minimum. That is, MC = AC at its minimum.
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When AR falls, MR also falls more than that of AR: TR increases initially at
a diminishing rate, it reaches maximum and then starts falling. Moreover, it
is also clear that when both AR and MR are falling, MR is less than AR. MR
can be zero, positive or negative but AR is always positive.
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In simple terms, market refers to a physical place where goods and services
are exchanged between buyers and sellers at a particular price. However, in
economic sense, market is defined as a set of buyers and sellers who are
geographically separated from each other, but are still able to communicate
to finalize the transaction of a product. The market for a product can be
local, regional, national, or international. Depending on the degree and type
of competition, market structures can be grouped into following categories:
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SMC = MR = AR = SAC.
(2) The MC curve must cut the MR curve from below and after the
point of equilibrium, it must be above the MR. This is the
second order condition.
In the short- run, some firms may be earning supernormal profits and
some incurring losses. This is illustrated in following diagram:
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In the long run, if some firms are earning supernormal profits, new
firms will enter the industry and supernormal profits will be competed
away. If some firms are incurring losses, some of the firms will leave
the industry till all earn normal profits.
c. Equilibrium:
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C. Monopoly
b. Features:
c. Equilibrium:
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Long-run Equilibrium: In the long run, the monopolist has the time to
expand his plant, or to use his existing plant at any level which will
maximize his profit. The barriers to entry allow the profit of monopolist
to continue even in the long-run. However, monopolist need not reach for
an optimal scale of plant at an optimal capacity, even when he earns
normal profits in the extreme possibility. However, no firm can stay in
the business in the long run with losses.
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B. Types of Dumping:
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d. Reciprocal Dumping: The sale by firms from two countries into each
others' markets for prices below they charge at home. So called because
both firms' exports meet the price-discrimination definition of dumping.
3.3 Importance and Impact of Dumping: Dumping affects both the importer
and exporter countries in the following ways:
1. If a producer dumps his commodity abroad for a short period, then the
industry of the importing country is affected for a short while. Due to the
low price of the dumped commodity, the industry of that country has to
incur a loss for some time because less quantity of its commodity is sold.
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competition. But when cheap imports stop or dumping does not exist, it
becomes difficult to change the production again.
4. If the dumped commodities are cheap capital goods, they will lead to the
setting up of a now industry. But when the imports of such commodities
stop, this industry will also be shut down. Thus ultimately, the importing
country will incur a loss.
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7. But a lower fixed tariff duty benefits the importing country if the dumper
delivers the commodity at a lower price.
2. The exporting country also benefits from dumping when the monopolist
produces more commodity. Consequently, the demand for the required
inputs such as raw materials, etc. for the production of that commodity
increases, thereby expanding the means of employment in the country.
which help in the production process, namely land, labor, capital and
enterprise.
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D. Profits – Profit is the difference between total revenue (value of output) and
total cost (value of inputs). The two are determined by demand and supply
conditions respectively.
Net profit or economic profit is the revenue received from the sale of an
output in excess of the opportunity cost of the inputs used. In calculating
economic profit, opportunity costs are deducted from revenues earned. It
represents the sales revenue of the firm in excess of both explicit and
implicit costs.
Normal Profit is the minimum price that must be paid to an entrepreneur for
retaining his services.
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1. Break-even point is the point at which the total revenue of the firm is
equal to total cost. As total cost includes normal profit, the break-even
point does not imply zero profit.
(i) MR = MC
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6. Lack of Specialization.
1. Primary Functions –
2. Secondary Functions –
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3. Contingent Functions –
(d) Liquidity
F. Inflation
Meaning: Inflation is the rate at which the general level of prices for goods
and services is rising and, consequently, the purchasing power of currency is
falling.
Types of Inflation:
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Causes of Inflation:
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Remedies for Inflation: There are three main ways by which inflation can
be controlled by:
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(iii)Price tagging.
G. Deflation
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Effects of Deflation:
2. Debts increase: The real value of debt rises with deflation and higher real
debts can be a big drag on consumer confidence.
3. The real cost of borrowing increases: Real interest rates will rise if
nominal rates of interest do not fall in line with prices.
4. Lower profit margins: Lower prices can mean reduced revenues & profits
for businesses - this can then lead to higher unemployment as firms seek
to reduce costs by shedding labour.
5. Confidence and saving: Falling asset prices such as price deflation in the
housing market hits personal sector wealth and confidence.
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A. Demand for Money - The demand for money is the desired holding of
financial assets in the form of money: that is, cash or bank deposits rather
than investments. The demand for money is affected by several factors,
including the level of income, interest rates, and inflation as well as
uncertainty about the future. The way in which these factors affect money
demand is usually explained in terms of the three motives for demanding
money: the transactions, the precautionary, and the speculative motives.
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B. Supply of Money
Meaning - The money supply is the total value of monetary assets available
in an economy at a specific time. There are several ways to define "money",
but standard measures usually include currency in circulation and demand
deposits.
M1 = Currency with the public which includes notes and coins of all
denominations in circulation excluding cash on hand with banks + Demand
deposits with commercial and cooperative banks, excluding inter-bank
deposits + Other deposits held with the RBI.
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1. Bank rate - Bank rate also known as the discount rate is the official
minimum rate at which the central bank of the country is ready to
rediscount approved bills of exchange or lend on approved securities.
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3. Publicity - RBI uses media for the publicity of its views on the current
market condition and its directions that will be required to be
implemented by the commercial banks to control the unrest.
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4. Direct Action - Under the banking regulation Act, the central bank has
the authority to take strict action against any of the commercial banks
that refuses to obey the directions given by Central bank. There can be a
restriction on advancing of loans imposed by Reserve Bank of India.
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The major components of assets of a bank are cash, money at call and short
notice, bills discounted, loan and advances, investments, bills receivable,
acceptance, endorsements, premises, furniture and other assets, non-banking
assets, etc.
D. Credit Creation
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The deposit multiplier (K) bears an inverse relationship with the cash reserve
ratio (r). As the value of (r) rises, the value of ‘K” falls and vice-versa.
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Types of NBFIs: There are five financial institutions under the full-fledged
regulation and supervision of the Reserve Bank, viz.
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areas and Rs. 120,000 in urban areas. Such loans should not exceed Rs.
50000 and its tenure should not be less than 24 months. Further, the loan has
to be given without collateral. Loan repayment is done on weekly,
fortnightly or monthly installments at the choice of the borrower.
Non-Banking Financial Company – Factors (NBFC-Factors) - Factoring
business refers to the acquisition of receivables by way of assignment of
such receivables or financing, there against either by way of loans or
advances or by creation of security interest over such receivables but does
not include normal lending by a bank against the security of receivables etc.
A. Money Market
Functions
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B. Capital Market
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3. The instruments traded in money market carry low risk, hence, they are
safer investments, but capital market instruments carry high risk.
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4. The liquidity is high in the money market, but in the case of the capital
market, liquidity is comparatively less.
5. The major institutions that work in money market are the central bank,
commercial bank, non-financial institutions and acceptance houses. On
the contrary, the major institutions which operate in the capital market
are a stock exchange, commercial bank, non-banking institutions etc.
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