Economics

A Comprehensive Guide for

Summer Placements
 Acknowledgement

The Economic Compendium prepared by PiE-the Economic club of IIM Udaipur includes macro
and micro economic concepts. It also includes some of the most frequently asked sample questions
along with answers. The compendium also provides the current rates given by RBI along with GD
topics that could be asked during the interview process to test the reader's knowledge of latest
economic happenings

We would like to express our deep and sincere gratitude to Prof. Suma Damodaran for reviewing
the compendium and providing us with valuable feedback which we have tried to incorporate in
the compendium. We want to thank you for taking the time to provide us with your input which
helped us in improving the quality of the compendium.

We would also like to thank the Placement Preparation Committee for giving us this opportunity
to prepare a compendium that would be helpful to the students during their placements.

And lastly, we would like to thank all the members of PiE, for giving their time and input for
making this compendium.

Team PiE

Vinod
Balaji P
Karri Gopal
Deepak Pani
Ankit Bhalla
Ayushi Gupta
Sukriti Taneja
Shruti Kumari
Sourav Kumar
Abhisekh Saha
Mayank Kumar
Anshika Mishra

PiE, the Economics Club, IIM Udaipur

Economics
Economics is the science of scarcity. Scarcity is the condition in which our wants are greater than
our limited resources. Since we are unable to have everything, we desire, we must make choices
on how we will use our resources.

Micro vs. Macro

Microeconomics - Study of small economic units such as individuals, firms, and industries
(competitive markets, labor markets, personal decision making, etc.)
Macroeconomics - Study of the large economy as a whole or in its basic subdivisions (National
Economic Growth, Government Spending, Inflation, Unemployment, etc.)

Positive vs. Normative

Positive Statements- Based on facts. Avoids value judgements (what is).
Normative Statements- Includes value judgements (what ought to be).

Marginal Analysis
In economics the term marginal = additional “Thinking on the margin”, or MARGINAL
ANALYSIS involves making decisions based on the additional benefit vs. the additional cost.

Trade-offs are all the alternatives that we give up whenever we choose one course of action over
others.

The most desirable alternative given up as a result of a decision is known as opportunity cost.

Production Possibilities Curve

A production possibilities graph (PPG) is a model that shows alternative ways that an economy
can use its scarce resources.

Centrally Planned Economies

In a centrally planned economy (communism) the government:
1. owns all the resources.
2. decides what to produce, how much to produce, and who will receive it. Examples: – Cuba,
North Korea, former Soviet Union

Free Market System (aka Capitalism)

Characteristics of Free Market
1. Little government involvement in the economy. (Laissez Faire = Let it be)
2. Individuals OWN resources and answer the three economic questions.
3. The opportunity to make PROFIT gives people INCENTIVE to produce quality items
efficiently.
4. Wide variety of goods available to consumers.
5. Competition and Self-Interest work together to regulate the economy (keep prices down
and quality up).

PiE, the Economics Club, IIM Udaipur

The Invisible Hand
The concept that society’s goals will be met as individuals seek their own self-interest.

The Circular Flow Model

Types of market:
Comparison between Monopoly, Oligopoly, and Perfect competition markets.

Perfect Monopolistic
Parameters Competition Competition Oligopoly Monopoly

Number of firms Large Large Small One

Products Identical Differentiated Similar, No close substitutes

differentiated
Entry, Exit No barriers Free of barriers Some entry barriers Effective entry
Barriers barriers
Market price No control Small control Substantial control Significant control
control

Aggregate Supply
The total quantity of output firms will produce and sell—in other words, the real GDP.

Aggregate Demand
The amount of total spending on domestic goods and services in an economy.

PiE, the Economics Club, IIM Udaipur

Inflation
A quantitative measure of a sustained rise in the general price level of goods and services
in an economy where a unit of currency buys less than it did before. Rising inflation leads
to a decrease in the currency’s purchasing power (meaning a loss in the real value of
money).
There are several types of inflation:
 Deflation: The opposite of inflation; when the general level of prices falls
 Stagflation: Combination of high unemployment and economic stagnation with
inflation
 Hyperinflation: It refers to unusually rapid inflation. In extreme cases, this can
lead to the breakdown of a nation's monetary system.

Fiscal Policies
It is the means through which a country controls its revenues and expenditures to
achieve economic objectives and influence a nation’s economy. The two principal
instruments of fiscal policy are –
 Taxation, and
 Government spending.

Monetary policies
It is the process by which the monetary authority of a currency controls the supply of money, often
targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.
Monetary policy is maintained through actions such as increasing the interest rate, or changing the
amount of money banks need to keep in the vault (bank reserves). The two types of monetary
policy are:

Contractionary – aimed to reduce the rate of monetary expansion to fight inflation. The
policy reduces the money supply in the economy to prevent unsustainable capital investment.
Expansionary – aimed to increase the rate of monetary expansion to stimulate growth in the
economy. Economic growth must be supported by additional money supply.

Gross Domestic Product

GDP is the market value of all the finished goods and services produced
within a country in a particular time period and is a measure of the country’s
economy.
GDP = C + I + G + NX
where -
"C" represents all private consumption or consumer spending, in a nation's
economy

PiE, the Economics Club, IIM Udaipur

 "I" is the sum of all the country's businesses spending on capital
"G" is the sum of government spending
"NX" is the nation's total net exports, calculated as total exports minus
total imports.

Real v/s Nominal GDP

Real GDP is an inflation-adjusted measure that reflects the value of all goods and
services produced by an economy in a given year, expressed in base-year prices.
Nominal GDP, on the other hand, is GDP evaluated at current market prices.
The main difference between the two values is that real GDP is adjusted for inflation
while nominal GDP is not. Generally, for a country with positive inflation, nominal
GDP will often appear higher than real GDP.

Consumer Price Index (CPI): A measure of price changes in consumer goods and
services purchased by households.
Wholesale Price Index (WPI): It represents the price of a representative
basket ofwholesale goods.

Taxes

Direct Taxes are taxes directly paid to the government by the taxpayer. It is a tax
applied to individuals and organizations by the government e.g. income tax,
corporation tax, wealth tax, etc. The individual or organization, upon which the tax
is

levied, is responsible for fulfilling the tax payment, and cannot be shifted to
another individual or entity.

Indirect Taxes are applied to the manufacture or sale of commodities. These are
initially paid to the government by an intermediary, who then adds the amount to
the value of commodities and passes on the total amount to the end user. E.g. sales
tax, service tax, excise duty, etc. Indirect taxes, unlike direct taxes, can be shifted
from one taxpayer to another.

Goods and Services Tax

GST is a comprehensive tax levy on manufacture, sale and consumption of goods
and services at a national level. Through a tax credit mechanism, GST is collected on
value-added goods and services at each stage of sale or purchase in the supply chain.
The system allows the set-off of GST paid on the procurement of goods and services
against the GST, which is payable on the supply of goods or services. However, the
end consumer bears this tax, being the last person in the supply chain. Experts say
that GST is likely to improve tax collections and boost India's economic
development by breaking tax barriers between states and integrating India through a
uniform tax rate.

PiE, the Economics Club, IIM Udaipur

Balance of Payments
Balance of Payments shows a country’s transactions with the rest of the world. It
encompasses all transactions (inflows and outflows) between a country’s residents
and its non-residents involving goods, services and income; financial claims on and
liabilities to the rest of the world, and transfers such as gifts. The two sections of the
BOP are:

1. Current Account BOP measures the inflow and outflow of goods, services, and
investment incomes. The current account comprises the trade balance in goods
and services. The account’s main components are:
a. Trade in goods (visible balance)
b. Trade in services (invisible balance) e.g. insurance and services
c. Investment incomes e.g. dividends, interest, migrant’s remittances
from abroad
d. Net transfers – e.g. International aid

Current Account Deficit: A measurement of a country’s trade in which the value

of goods and services imported exceeds the value of goods and services
exported. The current account also includes net income, such as interest and
dividends, as well as transfers, such as foreign aid, though these components
tend to make up a smaller percentage of the current account than exports and
imports. A current account deficit represents negative net sales abroad.
Developed countries, such as the United States, often run current account
deficits, while emerging economies often run current account surpluses.
Countries, that are very poor, tend to run current account deficits.

2. Financial Account (Capital) BOP measures the outflow and inflow of capital
into the economy. It takes into account the movement of capital, both short term
and long term, and the loan repayments. This includes:
a. Foreign direct investment
b. Purchase of securities by investors
c. Loans by international financial institutions

Balance of Payments Crisis

Also called a currency crisis, it occurs when the current account deficit cannot be
maintained. It leads to a fall in foreign exchange reserves, and the country can no
longer attract sufficient capital flows to finance the current account deficit. Crises
are generally preceded by large capital inflows, which are associated at first with
rapid economic growth. However, a point is reached where overseas investors
become concerned about the level of debt their inbound capital is generating and
decide to pull out their funds. The resulting outbound capital flows lead to a rapid
drop in the value of the affected nation's currency.

PiE, the Economics Club, IIM Udaipur

Balance of Trade
The difference between a country's imports and its exports is termed as Balance of
Trade. Balance of trade is the largest component of a country's balance of payments.
Debit items include imports, foreign aid, domestic spending abroad and domestic
investments abroad. Credit items include exports, foreign spending in the domestic
economy and foreign investments in the domestic economy. A country has a trade
deficit if it imports more than it exports; the opposite scenario is a trade surplus.

Foreign Direct Investment (FDI)

An investment made by a company or entity based in one country, into a company
or entity based in another country. The investing company may make its overseas
investment in a number of ways - either by setting up a subsidiary or associate
company in the foreign country, by acquiring shares of an overseas company, or
through a merger or joint venture. Entities making direct investments typically have
a significant degree of influence and control over the company into which the
investment is made.

Exchange Rate
An exchange rate is the value of one nation's currency versus the currency of another
nation or economic zone.

Spot vs Forward Rate

Exchange rates can have what is called a spot rate, or cash value, which is the current market
value. Alternatively, an exchange rate may have a forward value, which is based on
expectations for the currency to rise or fall versus its spot price. Forward rate values
may fluctuate due to changes in expectations for future interest rates in one country versus
another.

Triangular Arbitrage Opportunity

A triangular arbitrage opportunity is a trading strategy that exploits the arbitrage opportunities
that exist among three currencies in a foreign currency exchange. The arbitrage is executed
through the consecutive exchange of one currency to another when there are discrepancies in
the quoted prices for the given currencies.
A triangular arbitrage opportunity occurs when the exchange rate of a currency does not match
the cross-exchange rate. The price discrepancies generally arise from situations when one
market is overvalued while another is undervalued.

Real vs Nominal Exchange Rate

The nominal exchange rate E is defined as the number of units of the domestic currency that
can purchase a unit of a given foreign currency. A decrease in this variable is termed nominal
appreciation of the currency. (Under the fixed exchange rate regime, a downward adjustment
of the rate Eis termed revaluation.) An increase in this variable is termed nominal depreciation
of the currency. (Under the fixed exchange rate regime, an upward adjustment of the rate E is
called devaluation.)
By contrast, the real exchange rate R is defined as the ratio of the price level abroad and the
domestic price level, where the foreign price level is converted into domestic currency units
via the current nominal exchange rate. Formally, R= (E.P*)/P, where the foreign price level

PiE, the Economics Club, IIM Udaipur

 is denoted as P* and the domestic price level as P. A decrease in R is termed appreciation of
the real exchange rate, an increase is termed depreciation. The real rate tells us how many
times more or less goods and services can be purchased abroad (after conversion into a
foreign currency) than in the domestic market for a given amount. In practice, changes of the
real exchange rate rather than its absolute level are important.

Cash Reserve Ratio (CRR):

It refers to the ratio of demand deposits, time deposits, and cash-on-hand that
commercial banks are required to maintain with RBI. Lowering CRR will leave the
banks with excess reserves towards making loans and would, therefore, increase the
money supply.

Repo Rate:
Repo rate is the rate at which the central bank of a country (RBI in case of India) lends
money to commercial banks in the event of any shortfall of funds. In the event of
inflation, central banks increase the repo rate as this acts as a disincentive for banks to
borrow from the central bank. This ultimately reduces.

Reverse Repo Rate: Reverse repo rate is the rate at which the central bank of a country
borrows money from commercial banks within the country. An increase in reverse repo
rate means that commercial banks will get more incentives to park their funds with the
RBI, thereby decreasing the supply of money in the market.

Bank Rate: This is the rate at which RBI lends money to banks or financial institutions.
The Bank rate signals RBI’s long-term view of the economy and outlook for interest
rates. If the bank rates were to increase, banks would increase lending rates to their
customers to maintain their profit margins.

Difference between Business and Industry

Business is established when an individual or a group of individuals decide to start
something on their own. Legal formalities like registration are to be fulfilled. Business
involves production and exchange of goods and services, for example-production of
soaps, shampoos, TV sets etc. The person who performs the activities related to business
is called a businessman.

Industry on the other hand is that part of business activities which works for the production of

want satisfying goods with the help of material resources readily available. It creates form utility

of goods. The work of the industry is to use the natural resources and bring them into such a

form that is useful for further use. For example—farms, factories, mines etc.

The Rise of E-Commerce

E-commerce, or business on the internet and other computer networks, can be between

PiE, the Economics Club, IIM Udaipur

 businesses (B2B), between forms and consumers (B2C), or between firms and the
government (B2G). Over the past decades, e- business has provided various methods
for buyers and sellers to transact, and exploiting the full potential of developments can
have profound impacts in both individual sectors and the overall macroeconomic
performance and economic policies. At the aggregate level,
 productivity and economic growth rise,
 efficiency in supply and distribution,
 lower transaction costs,
 low barriers to entry, and
 improved access to information.
In the B2B context, higher efficiency comes from exchanges via lower procurement costs and
better supply chain management.

Application Based Questions

1) The executive of a company suggested to increase the price of the product and said that
increasingthe price would not decrease the company’s revenue. What was the executive’s
reasoning?
Ans: The concept of Price Elasticity of demand has to be used to answer this question.
Price Elasticity of Demand (Ped): Price Elasticity of Demand is the extent of responsiveness of the
demand of the good X to the changes in the price of X, when other demand determinants are held
constant.
Total Revenue = Price * Quantity
Marshall suggested the following
• When with a change in price the total revenue remains unchanged, demand is unitary elastic (Ped =
1)
• When with a rise in price the total revenue falls, or with a fall in price the total revenue rises then
demand is relatively elastic, i.e., Ped is > 1. That is, the proportionate change in demand is greater
than that of price. (In other words, when price and revenue move in opposite directions, then Ped > 1
• When with a rise in price, the total revenue rises or with a fall in price, the total revenue falls, then
demand is relatively inelastic, i.e., Ped < 1
Therefore, suppose the current price of good X is Rs. 20 and at this price, the demand for the good X
is 50 units. Then Total Revenue= 20* 50= Rs. 1000
Consider that the good has a Ped of less than 1, in that case, if the price is increased by 5 units, the
demand would fall by less than 5 units. So, new price =Rs 25 and demand at this price is 48 units.
Then, Total Revenue= 25*48= Rs. 1200
Thus, increasing the price of the product will not decrease the company’s revenue, only if the
product sold by the company has a relatively inelastic demand, i.e., Ped<1

Some extra reading on Price Elasticity of Demand:

Importance of the Concept of Price elasticity of Demand:

1. It is significant for private producers to measure their profits. Producers increase the prices of those
luxury products whose demand is inelastic in order to increase the profits. When prices of consumer

PiE, the Economics Club, IIM Udaipur

 goods for which price is inelastic is raised their demand will not fall much and producers will gain.
2. Importance for policy makers - if high rates of commodity taxes are imposed on goods with higher
price then the government will not be able to raise significant revenues because commodity taxes
raise prices of the concerned commodity and when prices rise people tend to buy lesser of the goods.
Thus the govt. will get lesser revenues. But if the demand for highly taxed commodities is inelastic
then a tax induced price rise will not reduce the demand much and the government will be able to
collect significant amount of revenues.
3. Import and export policy- just like domestic taxation policies the import and export taxes will affect
the imports and exports with higher and lower price elasticity of demand.
4. For determining subsidies- if govt. has to declare subsidies for those necessary commodities where
demand doesn’t rise much even when prices are lower. And producers of these commodities may
suffer losses if govt. doesn’t support them by providing subsidies. e.g.- some agricultural crops. Many
farmers remain poor because the demand intensity for certain crops is lower and farmers have to sell
them at extremely low prices.

2) Comment on how the marginal cost of digital goods such as e-books, music, etc are different
from thatof physical goods?
Ans: Marginal Cost: It is the addition made to the total cost by producing an additional unit of
output. MC= TC of n units – TC of n-1 units.
In case of digital goods, the marginal cost is almost negligible or zero, i.e., no additional cost is incurred
in producing another similar unit of the good. This is because of the easy replication of the digital
goods.
For example: It may cost some fixed money up front to record a song, but once you’ve got the final
track it’s nearly zero added cost to make duplicates.
Some business model examples of Zero marginal cost:
Usually, all the platform business models have a zero marginal cost when there is an increased demand
for their products or service. This is because, Platform business models facilitate the exchange of value
between two or more user groups, typically a consumer and a producer. One of the most powerful
aspects of platform business models is their ability to scale without increasing costs. The cost to serve
one additional customer is basically zero.
Consider Uber vs. traditional taxi companies. For a traditional taxi company to add another taxi to its
fleet, a car and license need to be acquired at significant cost. Instead of shouldering that setup cost,
Uber can add another taxi to its inventory at almost no cost by enabling people to share their existing
cars, all coordinated via the internet.
Airbnb does the same for renting properties vs. acquiring more physical space. When Airbnb wants to
add more rooms, it just needs someone to create a new listing on its website. This costs the platform
next to nothing. It doesn’t have to build rooms or acquire companies – it needs to acquire users
Similarly, Amazon has built an online platform for others to buy, sell and distribute product. Adding
products, buyers and sellers to the Amazon platform is an example of zero marginal cost. Amazon
accrues almost zero cost to add buyers, sellers and products to its platform.

3) How are the digital monopolies different from the traditional monopolies?

Ans: Companies such as Google, Facebook, Apple, Microsoft, etc., hold dominant, if not monopoly,
positions in the digital world. However, these companies are different from those of traditional

PiE, the Economics Club, IIM Udaipur

 monopolies on the following factors:
A) Pricing: Classical Economics states that a monopolist has the ability to control the prices and can
misuse its position of dominance and charge a higher price from the consumers as the consumer
cannot find a comparable service elsewhere. However, in the case of digital monopolies, the services
are made free to the public at the point of use. There is a lack of ‘trading relationship’ among the
digital monopolies and the user, and when the dominant provider is not charging for its services, it is
difficult to argue that the concern still holds or that the provider is misusing its position of
dominance.

B) Network Effect: The network effect is a phenomenon whereby increased numbers of people or
participants improve the value of a good or service.

The Internet is an example of the network effect. Initially, there were few users on the Internet
since it was oflittle value to anyone outside of the military and some research scientists.

However, as more users gained access to the Internet, they produced more content, information,
and services. The development and improvement of websites attracted more users to connect and
do business with each other. As the Internet experienced increases in traffic, it offered more
value, leading to a network effect.

Natural monopolies are ‘those which are created by circumstances, and not by law’, such as
water, railways, and fixed line telephones. However, in the case of digital monopolies, their
survival and growth depend upon the network effect. For example: Facebook would be a far less
useful serviceif fewer people used it.

C) Choice: It has been argued that traditional monopolies usually reduce consumer choice. However,
digital monopolies help in enabling consumer choice. Google search is successful because many
people believe it is the most effective way to navigate information and helps them filter an over-
abundance of choice.

Q4) How did McDonald’s battle recession?

Chief among the Great Recession’s winners was McDonald’s whose sales growth in 2008 was
greater than in 2006 and 2007. While many restaurants scaled back, it opened nearly 600 stores in
2008. And the chain has notched same-store-sales growth in each of 2009’s first seven months.
This can be explained through the concept of business cycles and how they occur and affect
various businesses.
Business cycles are a type of fluctuation found in the aggregate economic activity of nations. A
cycle consists of expansions occurring at about the same time in many economic activities,
followed by similarly general recessions. This sequence of changes is recurrent but not periodic.
A recession is a specific sort of vicious cycle, with cascading declines in output, employment,
income, and sales that feed back into a further drop in output, spreading rapidly from industry to
industry and region to region.

PiE, the Economics Club, IIM Udaipur

 On the flip side, a business cycle recovery begins when that recessionary vicious cycle reverses
and becomes a virtuous cycle, with rising output triggering job gains, rising incomes, and
increasing sales that feed back into a further rise in output. The recovery can persist and result in
a sustained economic expansion only if it becomes self-feeding, which is ensured by this domino
effect driving the diffusion of the revival across the economy.
McDonald's was experiencing downturn during the early 2000s but in late 2007 and early 2008,
when the US had slipped into recession, due to reduced incomes, people grew cost conscious and
started cutting down on their visits to expensive restaurants. They opted for fast food restaurants
like McDonald's as they offered value for money. To cater to the people hit by recession,
McDonald's revamped its 'dollar menu' and also launched several new additions to its existing
menus. McDonald's also expanded its coffee business in the US market and priced its coffee
related products competitively. With all these initiatives, McDonald's was successful in reporting
higher revenues and profits in a recessionary environment.

Q5) If you are keen on working in the Metals Sector, say, Vedanta, how would you choose a
new country to enter?
There are three key economic indicators to consider before entering a new market
internationally.

1. Gross Domestic Product

 Gross domestic product (GDP) is the value of the goods and services produced in an economy.
The lunch you bought at the corner restaurant, the money your government pays to firefighters

PiE, the Economics Club, IIM Udaipur

 and teachers, the funds a company spends to build its new headquarters, the value of a vehicle
manufactured in your country and sold abroad—all of these are part of GDP.

 It’s generally a good sign for business when GDP is growing, but there’s nuance in the number: If
a country’s GDP isn’t growing as fast as its population, GDP per capita isn’t rising. That means
the standard of living for the people, and their purchasing power, isn’t increasing.

2. Unemployment Rate

 A country’s unemployment rate is the number of people who are not working divided by the
number of people who are working, or actively looking for work. A high unemployment rate can
signal that a country’s economy is struggling and may give you pause when considering an
investment.

 An unemployment rate of zero, however, isn’t necessarily ideal for business. Considering the way
unemployment is calculated, those who are changing jobs for better opportunities within a
thriving economy are considered unemployed for any time they spend between positions. With
low unemployment, companies have to spend more to lure candidates to work at their firms, and
those costs often get passed along to consumers in the form of higher prices, which leads to
inflation.

 When evaluating potential markets to enter, consider what the country’s unemployment rate
could mean for your business.

3. Inflation

 Inflation represents the rate at which the general price level in an economy is rising. If you
operate a business in a country with high inflation, the prices you pay for your inputs will
increase, and the value of any cash savings you have, or money you’ve lent to others, will erode.

 Despite these drawbacks, rising inflation can be good if you borrow money at a fixed interest
rate to establish or expand your business. Thriving economies often have some inflation. As long
as it’s stable and predictable, you’ll be able to plan for it in your budgeting and pricing decisions.

PiE, the Economics Club, IIM Udaipur

Basic RBI Rates:

Rates Basic Points

Repo Rate 4.90
Reverse Repo Rate 3.35
Standing Deposit Facility (SDF) 4.65
Bank Rate 5.15
Base Rate 7.75/8.80

Note: The current rate would be changing based on the economic conditions. Students are advised
to check the current rates before attending the interview.
Link: https://dbie.rbi.org.in/DBIE/dbie.rbi?site=home

Some relevant topics for GD

1) Russia-Ukraine Conflict
2) Sri Lanka Economic Crisis
3) Impact of falling rupees on Indian economy
4) Should Politics and Business be mixed?
5) Privatization of Banks leads to less NPA?
6) Privatization of PSU leading to less corruption?
7) Central Bank Digital Currency and Future of Monetary Policy
8) Is India ready for Cashless Economy?

PiE, the Economics Club, IIM Udaipur