Economics

Economics
Introduction to Economics
Scarcity of resources and the fact that the resources have alternative uses
lead to the problem of rational management of resources. It is the Problem of
allocation of resources to alternative uses. The subject matter of Economics
revolves around the core problem of rational management of resources.
Definition of Economics: Economics is the study of economic issues (or
economic problem) arising out of the fact that resources are scarce in relation
to our needs / desire and the scarce resources have alternative uses. It
focuses on the rational management of scarce resources in a manner such
that our economic gains are maximized.
Introduction to Economics
At the micro level, an individual maximizes economic gain when he maximizes
his satisfaction as a consumer, and maximizes his profit as a producer from
the given resources. At the macro level, country maximizes its economic gains
when social welfare is maximized along with the rapid pace of economic
growth.
Economics is divided into two parts:

Microeconomics and Macroeconomics
Microeconomics: When economic problems or economic issues are studied

considering small economic units like an individual consumer, or an individual
producer, it is referred as microeconomics. At the level of an individual
economic unit (producer or a consumer), the basic economic problem is the
problem of choice related to allocation of scarce resources to alternative
uses.
Vital components of Microeconomics:

1) Theory of Consumer Behaviour: It analyses how a consumer allocates his
income to different uses so that he maximizes his satisfaction.
2) Theory of Producer Behaviour: It analyses how a producer exercises his
choice on the use of different inputs and how he decides what to produce and
how much. The producer focuses on the maximization of profit.
3) Theory of Price: It studies how price of goods are determined in the
commodity market and how prices of factors of production are determined in
the factor market.
Macroeconomics: Macroeconomics refers to the study of economic problems

or economic issues at the level of an economy as a whole. The central issues
in macroeconomics relate to the overall level of employment, growth rate of
National output, the general price level and stability of the economy.
Difference between Microeconomics and Macroeconomics:

1) Microeconomics studies economic problem at the level of an individual- an
individual firm, an individual household or an individual consumer whereas
Macroeconomics studies the central problem at the level of the economy as a
whole.
2) Study of Microeconomics assumes that macro variables remain constant.
Example- it is assumed that aggregate output is given when we are studying
determination of output and price of an individual firm or industry. Wherever,
Macroeconomics assume that micro variables remain constant. Example -
distribution of income remains constant when we are studying the level of
output in the economy.
3) Microeconomics is basically concerned with determination of output and

price for an individual firm or industry whereas macroeconomics is basically
concerned with determination of aggregate output and general price level in
the economy as a whole.
Central Problems of Economy: Economic activities include production,

consumption, investment, and exchange. Resources are scarce and choices
are many. The basic economic problem is the problem of choice, which is also
known as the problem of resource allocation. It has three aspects:
1) What to produce?
2) How to produce? and

3) For whom to produce?
These are popularly known as Central Problem of an Economy.
What to produce? (Problem of choice):
What goods and services are to be produced- Capital goods or consumer
goods. It cannot be 'either-or' choice. Capital goods are essential to increase
production capacity. Consumer goods are essential to promote quality of life.
If more of consumer goods is produced, the present generation enjoys good
quality of life. But less production of Capital Good means that we are reducing
production capacity for the future generation.
How to produce? (Problem of Choice):

'How to produce' refers to the technique of production. Broadly there are two
techniques of production:1) Labour Intensive Technique, and (ii) Capital
Intensive Technique.
Labour Intensive Technique employs greater use of Labour than Capital while
Capital intensive technique employs greater use of Capital than Labour.
While Capital intensive technique promotes efficiency and accelerates the
pace of growth, Labour Intensive technique promotes employment.
For whom to produce?(Problem of Choice): For Rich or for Poor.
Solution of Central Problems in Different Economies:

Solution of Central Problems in Market Economy (free economy):
Under this economy producers are free to decide ‘what, how and for whom
to produce’. Their decision is based on the basis of supply and demand forces
in the market.
What to Produce? The producer will produce goods which are more in
demand and less in supply. Such goods offer high price and high profit to the
producers.
How to Produce? The producer will use those inputs which keep their cost of
production as low as possible.
For Whom to Produce? The producer will produce goods for those people
who can afford to pay high price. Poorer section of the society are often
ignored.
Centrally planned economy: In a centrally planned economy, decisions

relating to what, how and for whom to produce are taken by government.
All decisions are taken with a view to maximizing social welfare. Those goods
and services will be produced which the government finds most useful for the
society. The production technique will be such that it is socially most
desirable.
For example -Labour intensive Technology will be preferred in situation of
mass employment. Social Justice is given highest priority.
Mixed Economy: It has merits of Market Economy and Centrally Planned

Economy, both. Decisions regarding what, how and for whom to produce are
taken on the basis of market forces as well as on the basis of social
considerations. In certain areas producers are free to take their decisions with
a view to maximizing their profit. In certain other areas, decisions are taken
entirely on the basis of social considerations.
Example- In India producers are free to produce clothes to maximizing their

profit. But Railway is the Monopoly of the government to provide transport
services at nominal rate.
Production possibility curve (PPC):

Production Possibility Curve is a curve showing alternative production
possibilities of two goods with the given resources and technique of
production.
This table shows the different possibilities of production of Potato & Tomato:
Goods Production Possibilities
A B C D E
Tomato (in Quintal) 0 10 20 30 40
Potato (in Quintal) 100 90 70 40 0
Production possibility curve is drawn on the assumption that:
1) the given resources are fully utilised, and
2) technology remains constant.
Reason for Shifting of Production Possibility Curve:

a) Resources are reduced: If we decrease the resources, we can produce less
of both the goods. Accordingly, PPC shifts to the left.
b) Resources are increased/Technology is improved for the production of

both Goods: If these cases, we can produce more of both the goods.
Accordingly, PPC shift to the right.
Reason for Rotation of Production Possibility Curve:
Change in Technology for the production of one commodity: From the below
mentioned graph (1st case), we can see that due to improvement in
technology for the production of Good X, the production of Good X increases
from q to q1 whereas the production of Good Y remains the same.
Graph:
Some basic problems of Macroeconomics: Problem of unemployment,

problem related to GDP growth, problem of inflation and deflation, problem
of funds for investment & problem related to exchange rate and Balance of
Payments are some basic problems of macroeconomics.
Types of Goods produced in the economy:
1) Final goods and intermediate goods
2) Capital goods and consumer goods
Final Goods are those goods which are ready for use by their final users.
Based on the nature of their use, final goods are divided into two types:
a) Consumer Goods: Such final goods are purchased by the consumer (by the
end user) for final consumption.
b) Capital Goods: Such goods are purchased by the producer and are
generally used as a fixed asset in the process of production.
Intermediate Goods are those goods which are purchased by one firm from
the other form as raw material or as goods for resale. Example: Mobile
purchase from stockist by wholesaler is an intermediate good because the
mobile is purchased for resale.
Note: Intermediate goods are not included in the estimation of national

product on national income. Otherwise, it would lead to 'double counting'.
Note: The same good maybe final or intermediate: While classifying a good as
final or intermediate, what matters is, the end use of goods. Example: Milk
used for making ice cream is an intermediate good. Whereas, milk used for
making tea at home is a final good.
Consumer Goods: Consumer Goods are meant for final consumption. These
are ready for use by their final users. Consumer Goods are broadly classified
as:
1) Durable Consumer Goods: These goods can be used for several years and
are of high value. Example- washing machine, car, etc.
2) Semi-durable Consumer Goods: Such goods can be used for a period
around one year. Example- clothes, crockery, etc.
3) Non-durable single use consumer goods: such goods are used in one go and
are of relatively low value. Example - bread, milk, etc.
Capital Goods: These are the final goods which are used as fixed asset of the
producers. These are used in production for several years and are of high
value.Example-machinery.
Note: While identifying goods as Capital goods, we must check there end
user. Example - a car with a tourist company is a Capital good, but with a
consumer household is a durable use consumer good.
Demand & Elasticity of Demand
Demand for a commodity is the desire to buy a commodity backed

with sufficient purchasing power and the willingness to spend it.
At higher purchasing price quantity demanded will be low, and at
lower price quantity demanded will be high.
Demand Vs Quantity Demanded: Demand refers to different
possible quantities to be purchased at different possible prices of a
commodity. On the other hand, quantity demanded refers to a
specific quantity to be purchased against a specific price of the
commodity.
Demand Schedule: Demand schedule is a table relating to price
and quantity demanded.
Price of Quantity
Wheat/Kg (In Demanded (In Kg)
Rs)
9 8
10 7
11 6
12 5
13 4
14 3
15 2
Demand Curve and its Slope: Demand curve is simply a graphic

representation of demand schedule showing how quantity
demanded of a commodity is related to its own price.
NOTE: Slope of demand curve is constant because demand curve is
a straight line. Negative sign indicates inverse relationship
between price and quantity demanded of commodity.
Slope of demand curve: It shows the ratio between change in

price corresponding to a unit change in quantity demanded of a
commodity. Demand curve normally slopes downward, indicating
inverse relationship between price of a commodity and its
quantity demanded.
Law of demand: The law of demand states that, other things being
equal, quantity demanded increases with a decrease in own price
of the commodity, and vice versa.
We can say, there is an inverse relationship between quantity
demanded of a commodity and its own price, other things remain
constant.
Exceptions to the law of demand:

1) When quality of a product is judged by its price.
2) Articles of distinction: Some articles are in demand only because
their prices are very high. If their prices fall, their demand will
shrink. Example: Platinum Jewellery, Sports Car.
3) Giffen goods: These are highly inferior goods. When price of
such commodities decreases, their demand also fall.
Note: Demand curve slopes upward when law of demand fails.
Movement along a demand curve:

It means moving up or down the demand curve. When we move
up the curve, it is a situation of contraction of demand (Buying less
in response to increase in own price of the commodity). When we
move down the curve, it is a situation of extension of demand,
that means, buying more on less price.
Downward movement along the demand curve (Extension of

Demand):
Extension of demand refers to increase in quantity demanded of a
commodity due to a fall in own price of the commodity.
Shifts in demand curve:

Forward shift in Demand Curve - Increase in Demand: Forward
shift in demand curve refers to increase in demand. In this
situation own price of the commodity remains constant. Thus,
increase in demand occurs when quantity demanded of a
commodity increases because of the factors other than own price
of the commodity.
Backward shift in Demand Curve - Decrease in Demand:

It is a situation when quantity demanded of a commodity
decreases, although the own price of the commodity is constant.
Hence, we can say, decrease in demand occurs when quantity
demanded of a commodity decreases because of the factors other
than own price of the commodity.
Causes of increase in demand (Forward shift of demand curve):
1) When consumers income increases.
2) Price of complementary goods falls.
3) Price of substitute goods rises.
4) When availability of commodity is expected to reduce in near
future.
5) When taste of the consumer shifts in favour of the commodity.
Note:
1. If price of substitute goods increases, the demand of the
commodity will increase. Therefore, demand curve of the
commodity will shift to the right.
2. If price of complementary goods increases, the demand for the
commodity will decrease. Therefore, demand curve of the
commodity will shift backward (to the left).
Relationship between income and demand:

1) Normal Goods: In case of normal goods there is a positive
relationship between income and demand. Thus, if income
increases, demand increases.
2) Inferior goods: In case of inferior goods, the demand decreases
as income of buyer increases. Negative relationship.
Concept of Price Elasticity of Demand:

Degree of change in quantity demanded in response to change in
own price of the commodity is the subject matter of elasticity of
demand.
Measurement of Price Elasticity of Demand:
1) Proportionate or Percentage Method: Elasticity of demand

= Percentage change in quantity demanded to the
percentage change in price.
2) Geometric Method: Geometric method measures price

elasticity of demand at different points on the demand curve.
Perfectly Elastic Demand [𝑬𝒅 = ∞]: A perfectly elastic demand

refers to the situation when demand is infinite at a particular price
but even the slightest rise in price causes the quantity demanded
to be zero.
Perfectly Inelastic Demand [𝑬𝒅 = 0]: A perfectly inelastic demand
refers to the situation when change in price causes no change in
the quantity demanded.
Unitary Elastic Demand [𝑬𝒅 = 1]: Elasticity of demand is equal to 1

at all points of demand curve when demand curve is rectangular
hyperbola.
Factors Affecting Price Elasticity of Demand:
1) Nature of Commodity: Goods of necessities like textbooks,

vegetables, salt, kerosene oil, matchboxes have less elastic
(elasticity less than 1) demand. Luxuries like costly furniture,
big screen TV, etc. have elasticity more than one.
Availability of Substitutes: Goods having close substitute
have more elastic demand. Example: Tea & Coffee are close
substitutes. If the price of tea rises drastically, the customer
will shift to coffee. Cigarettes or liquor doesn’t have close
substitute. So, if price rises, the demand will not be very
low. So, the demand for such goods is less elastic.
2) Diversity of Uses: If a commodity has variety of uses, it will
have elastic demand. For example, milk can be used to feed
babies, make tea, coffee, lassi, paneer, etc. In case price of
milk increase, consumer will limit its use to feeding babies.
Postponement of Use: If consumption of a good can be
postponed, the demand will be elastic. For example, if price
of petrol rises to Rs. 200/ liter, consumer will defer
purchasing of car.
Cross Elasticity of Demand: A change in the demand for good in

response to a change in the price of another good represents
Cross Elasticity of Demand of the former good to the later good.
Ec=
Ec = Cross Elasticity
Qx = Original Quatity demanded of X
ΔQx = Change in Quantity Demanded of X
Py = Original Price of Goods Y
ΔPy = Change in Price of Y
Supply
Supply Vs Stock: Supplies refer to the part of the stock that the
firm is presently prepared to sell at a given price. Stock of a
commodity refers to the total quantity of the commodity which at
any given time is available with the firm for purpose of sale in the
market.
Supply is measured per unit of time period where as stock is
measured at a point of time.
Supply and Quantity Supplied: Quantity supplied refers to a

specific quantity of a commodity producers are ready to sell at a
specific price of the commodity. Supply on the other hand refers
to the entire schedule showing various quantities offered for sale
at different possible prices of the commodity.
Supply schedule: It is a table showing various quantities of a
commodity offered for sale at different possible prices of that
commodity.
Price of Goods (P) Quantity of Goods

Supplied (Q) (Units)
(Rs.)
5 0
10 15
15 30
20 50
Note: The full chart given above is supply schedule, because it

contains different quantities (0, 15, 30, 50) offered for sale at
different possible prices (5,10,15,20). Then, what is quantity
supplied? Quantity supplied refers to specific quantity producer is
ready to sell at a specific price. From the above chart, we can say
that 15 units of quantity is supplied at Rs. 10. Similarly, we can say
that 0 unit of quantity is supplied at Rs.5.
Supply Curve: Supply curve is a graphic presentation of supply
schedule showing various quantities of a commodity offered for
sale at different possible prices of that commodity. Higher quantity
is offered at higher price of the commodity.
Slope of supply curve: Slope of supply curve refers to the ratio

between change in price and change in quantity supplied. It is
constant because supply curve is a straight line.
Where ∆P = Change in Price,

∆Q = Change in Quantity
The ratio is constant because Supply Curve is aStraight Line.
Factors on which supply of a commodity depend: The supply of a

commodity mainly depends on the own price of the commodity,
price of related goods, goal of the firm, number of firms in the
industry, business expectation, government policy, price of factors
of production and State of Technology.
Law of supply: Law of supply states that, other things remaining

constant, there is a positive relationship between own price of a
commodity and its quantity supplied. Thus, more is supplied at
higher price and less at the lower price.
Assumptions of law of supply:

1) No change in the price of related goods.
2) No change in business expectations.
3) No change in the price of factors of production.
4) No change in the goal of the firm.
5) No change in government policy related to price and production
of the commodity.
6) No change in the technique of production.
Thus, the law of supply assumes that all determinants of supply of
a commodity, other than own price of the commodity, remain
constant.
Exceptions to the law of supply:

1) Goods of social distinction (like diamond jewellery) supply
remains limited even if the price rises.
2) A seller may sell perishable commodity even at lower price.
3) This law does not apply wholly to agricultural produce whose
supply is governed by natural factors.
Movements along a supply curve: If we move down the supply

curve, supply contracts. If we move up the supply curve, supply
extends.
Extension of Supply: Extension of supply occurs when quantity
supplied of a commodity increases due to increase in own price of
the commodity.
Contraction of Supply: Contraction of supply occurs when quantity

supplied of a commodity decreases due to decrease in own price
of the commodity.
Shift in supply curve: Shift can be forward shift and backward

shift.
Forward Shift in Supply Curve – Increase in Supply: In the
situation of Forward shift the quantity supplied of a commodity
increases even though own price of the commodity remains
constant.
Backward Shift in Supply Curve – Decrease in Supply: In the

situation of Backward shift, the quantity supplied of a commodity
decreases even though own price of the commodity remains
constant.
Forward & Backward Shift are caused by factors, other than own
price of the commodity.
Causes of increase in supply:

1) Improvement in technology which results into fall in the cost of
production.
2) Reduction in factor prices, causing a fall in cost of production
3) High business expectation.
4) Increase in number of firms in the industry.
5) Shift in goal of the firm from price maximization to sales
maximization. Clearance sale
6) Decrease in taxation such as excise duty.
Price Elasticity of Supply: Price elasticity of supply measure the

degree of Extension or contraction of supply in response to a given
change in own price of the commodity. There are two methods to
measure Price Elasticity of Supply:
1) Proportionate method or percentage method: According to
this method, elasticity of supply is the ratio between
percentage change in quantity supplied and percentage
change in the price of the commodity.
Es = Percentage in Quantity Supplied/ Percentage Change in Price
2) Geometric Method: Geometrically, elasticity of supply depends

on the origin of the supply curve.
Situation 1) Es=1: A straight line supply curve, shooting from
origin, always shows Es=1.
Situation 2) Es›1: A positively sloped supply curve starting from Y-

axis always shows Es›1.
Situation 3) Es‹1: A positively sloped supply curve starting from x
axis always shows Es‹1
Perfectly Inelastic Supply Curve (Zero Elasticity of Supply): A

vertical straight line supply curve, showing constant supply, no
matter what the price is. Supply is constant even at zero price.
Infinite elasticity of supply: It refers to a horizontal straight line
supply curve. It shows infinite supply corresponding to a particular
price of the commodity. Even a small change in price will cause an
infinite change in quantity. Thus, supply of the commodity reduces
to zero if price falls.
Economics-Production
Production Function and Returns to a Factor

Concept of Production Function: Output requires input. Capital,
land and Labour are common inputs for the Production of goods
and services. Let's take an example: 10 units of capital and 5 units
of labour are required to produce 100 units of the commodity.
This relationship between physical inputs and physical output is
known as Production function.
Production function is purely a technical relation and not an
economic relation.
Factors of Production are classified as:

1)Fixed Factors: Fixed Factors are those the application of which
does not change with the change in output in short period.
Example: Land, Building, Machinery
2) Variable Factors: Variable Factors are those the application of
which vary (or change) with the change in output. Example–
Labour. Use of Variable Factor is zero when output is zero, it
increases as output increases.
Note: (1) Short Run is a period of time when production can be

increased only by increasing the application of Variable Factors.
Fixed Factors remain constant.
(2) Long Run is a period of time when the distinction between
Fixed Factor and Variable Factor vanishes. All Factors are Variable
Factors.
3) Short Period Production Function is Variable proportion type
Production function while the Long Period Production Function is
constant proportions type Production Function.
In Short Period Production Function, Factor Ratio (L:K) must
change at different levels of output. This is because one Factor is
constant all through the production process.
In the Long Period Production Function, Factor Ratio remains
constant. It can be 5:4 when output= 40 units, and 10:8 when
output = 80 units. Thus, Short Period Production Function is called
Variable Proportions Type Production Function while the Long
Period Production Function is called Constant Proportions Type
Production Function.
Example on AP, MP and TP:
No. of Total Product(TP) Average Product Margianl Product (MP)

Labours (AP)
1 3 3 3
2 10 5 7
3 24 8 14
4 36 9 12
5 40 8 4
6 42 7 2
7 42 6 0
8 40 5 -2
Total Product, Marginal Product and Average Product of the

Variable Factor:
Total Product (TP) of Variable Factor: It is the sum total of output
produced by all the units of a Variable Factor along with some
constant amount of the Fixed Factors used in the process of
Production. Let’s take Labour as Variable Factor and Land as Fixed
Factor. If we take 5 labours and their individual output is 15, 12,
13, 8, 20 units of the commodity, then
TP = 15 + 12 + 13 + 8 + 20 = 68 units.
Marginal Product: Marginal Product refers to change in Total

Product when one more unit of Variable Factor is used. In this case
Fixed Factor remains constant.
If we increase 1 labour and the output increases from 20 units to
23 units, in this case the Marginal Product = 23-20 = 3 units.
Average Product: Average Product is output per unit of the
Variable Factor.
AP=TP/Quantity of Variable Factors
Explanation: A) Marginal Product is change in Total Product when

one more unit of Variable Factor is used.
From the above example we can see that when there was no
Labour involved, TP was 0.
When 1 unit of Labour is employed, TP = 3 unit
MP= 3-0 =3 units
When 2 units of Labour is employed, TP = 10
MP= 10-3 = 7 units
This way, MP is calculated in the above table.
Note: We can see from the table that initially MP increases. As

more and more units of Labour (Variable Factor) are employed,
MP starts decreasing and then it becomes negative.
Negative Marginal Product: When there is excess employment, it

reduces overall efficiency of the workers, because of which
Marginal Product will be negative. In such situation, Total Product
increases when some workers are withdrawn.
No. of Labours Total Product(TP) Average Product (AP) Margianl Product (MP
1 3 3 3
2 10 5 7
3 24 8 14
4 36 9 12
5 40 8 4
6 42 7 2
7 42 6 0
8 40 5 -2
The law of Variable proportion (law of diminishing return): When

Total output or production of a commodity is increased by adding
units of a variable input, while the quantities of other inputs are
held constant, then MP of the Variable Factor initially rises and
then falls after reaching a certain level of employment of the
Variable Factor.
1 3 3 3
2 10 5 7
3 24 8 14
4 36 9 12
5 40 8 4
6 42 7 2
7 42 6 0
8 40 5 -2
It is clear from the above Graph that:
1) When Marginal Product increases, Total Product increases at an
increasing rate. This is situation of increasing return to a factor.
2) When Marginal Product decreases, Total Product increases at
decreasing rate. This is a situation of diminishing return to a
factor.
3) When Marginal Product becomes negative, Total Product starts
declining. This is a situation of negative returns to a factor.
Causes of Increasing Return to a Factor:

1) Fixed Factors are fully utilized: Initially Fixed Factors are
underutilized. Addition of Variable Factors leads to better
utilization of Fixed Factor.
2) The coordination between the Fixed Factor and Variable Factor
improves.
Causes of Diminishing Returns to a Factor:

1) Fixed Factor is constant. If we keep on increasing Variable
Factors, Fixed Factor gets over utilized and loses its efficiency.
2) If we keep on increasing Variable Factor, Ideal Factor ratio is
disturbed.
Note: Law of Variable Proportion will not work if:

a) There is improvement in technology used in the process of
Production.
b) Some substitute of Fixed Factor is discovered.
Relation between Marginal Product &Total Product:

● As long as Marginal Product increases, Total Product
increases at increasing rate.
● When Marginal Product starts diminishing, Total Product
increases at diminishing rate.
● When Marginal Product is zero, there is no addition to Total
Product. At zero Marginal Product, Total Product is
maximum.
● When Marginal Product is negative, Total Product starts
declining.
1 3 3 3
2 10 5 7
3 24 8 14
4 36 9 12
5 40 8 4
6 42 7 2
7 42 6 0
8 40 5 -2
Relation between Marginal Product &Average Product:

● As long as Marginal Product> Average Product, Average
Product increases.
● Average Product decreases when Marginal Product <
Average Product
● Average Product is at its maximum when AP = MP. Thus MP
curve cuts AP curve at its top.
● Marginal Product may be zero or negative but Average
Product continues to be positive.
Producer's Equilibrium: The main aim of producer is to

maximize his Profit. A producer strikes his equilibrium at the
level of output when Profit is maximized. Any other level of
output will yeald lower Profit.
Profit = Total Revenue –Total Cost.

Total Cost = Total Variable Cost +Total Fixed Cost
As Fixed Cost is Fixed, Profit will increase or decrease if Total
Variable Cost will increase or decrease.
Gross Profit = Total Revenue – Total Variable Cost
Net Profit = Total Revenue - Total Cost
In economics, the Profit are of 3 types:
1) Abnormal Profit or Extra Normal Profit,
Total Revenue>Total Cost
2) Normal Profit
Total Revenue =Total Cost
3) Sub-normal Profit (loss)
Total Revenue <Total Cost
Normal Profit: Normal return that a producer expects from its

capital invested in the business. If this minimum return is not
available, he will withdraw his capital from the existing use and
shift if to some different use.
Producers Equilibrium: Producers Profit is maximized (or a

producer strikes his equilibrium) when two conditions are
satisfied:
1) Marginal Revenue = Marginal Cost
2) Marginal Cost is greater than the Marginal Revenue beyond
the point of equilibrium output.
Concept of Cost
Cost
Producer Incur Cost. Cost means input. Broadly, there are two types of
inputs:
1) Factor inputs (land, labour,capital and enterpreneurship, called
Factor of Production)
2) Non-Factor inputs (raw material).
Explicit Cost: Expenditure incurred by the producer on the purchase

or hire of inputs from the market is called explicit Cost.
Implicit Cost: Expenditure incurred on the use of self-owned inputs is
called implicit Cost.
In economics, Total Cost = Implicit Cost+ Explicit Cost
In economics, Cost is always measured as Opportunity Cost.
Opportunity Cost: of an activity is measured in terms of the total

sacrifice involved in undertaking activity. Opportunity Cost is the value
of a factor in its best alternative uses.
Short run Costs: In Short run, some Costs are fixed and some are
Variable. So, total Cost have two components, 1) Fixed Costs & 2)
Variable Cost
Therefore, TC=TFC+TVC
1) Fixed Cost: Cost related to the use of Fixed Factors is known as

Fixed Cost.
These are also called supplementary costs, or overhead cost or indirect
cost. These costs do not change with the change in Output. Even when
Output is zero, Fixed Cost remains the same. Eg: Rent, wages of
permanent staff & cost of plant & machinery.
Total Fixed Cost
Units of Output Total Fixed Cost (Rs.)
0 1000
1 1000
2 1000
3 1000
4 1000
2) Variable Cost/Prime Cost/Direct Cost: Variable Costs are those

costs which are related to the use of Variable Factors of Production.
As Output increases, Variable Cost increases and as the Output
decreases, Variable Cost decreases. When Output is zero, Variable Cost
is zero. Example: Cost of wages of casual labour.
Total Variable Cost
Units of Output Total Variable Cost (Rs.)
0 0
1 11
2 19
3 25
4 29
5 33
6 39
Total Variable Cost
Units of Output Total Variable Cost (Rs.)
0 0
1 11
2 19
3 25
4 29
5 33
6 39
Initially total Variable Cost increases at a Deminishing rate:

Thus, less and less additional Cost is incurred for every additional unit
of Output. This is because of increasing Returns to a Factor. It is a
situation when Marginal Product of the Variable Factor tends to
rise; Marginal Cost of the Variable Factor tends to fall; less and
less of additional cost is incurred for producing every additional unit of
Output. Total Variable Cost is increasing at a decreasing rate, because
additional cost of producing every successive unit tends to fall.
Eventually total Variable Cost increases at an Increasing rate:

This is because of the law of Deminishing Returns. Marginal Product of
the Variable Factor tends to fall. Thus, Marginal Cost tends to rise.
Total Variable Cost tends to increase at an increasing rate so that more
and more of additional Cost (MC) is incurred for every additional unit of
Output.
Fixed Cost, Variable Cost and Total Cost:
Total Cost = Total Fixed Cost + Total Variable Cost.
Total Fixed Cost is constant at all level of Output.
Total Variable Cost increases as Output increases.
Output (Units) Fixed Cost (Rs.) Variable Cost Total Cost (Rs.)
(Rs.)
0 10 0 10
1 10 9 19
2 10 17 27
3 10 23 33
4 10 27 37
5 10 31 41
6 10 37 47
From Graph we can see that Total Cost is parallel to Total Variable
Cost. It shows that the difference between total Cost and total Variable
Cost= Total Fixed Cost is constant.
Average Cost (AC): Cost per unit of Output is called Average Cost.
Average fixed Cost: Is the Fixed Cost per unit of Output

Note: We have taken Total Fixed Cost to be Rs. 10 in the above chart.
Therefore for 1 unit the Average Fixed Cost = Rs.10, for 2 units the
Average Fixed Cost = Rs. 5, for 3 units the Average Fixed Cost = Rs.
3.33, and so on. So, the Average Fixed Cost graph will be Rectangular
Hyperbola as shown below:
This Curve slopes downwards to the right. Downward slope of

Average fixed Cost shows that Average fixed Cost decreases as Output
increases. Average Fixed Cost Curve is a Rectangular Hyperbola. It
means that Average Fixed Cost × Output (which is equal to Total Fixed
Cost) is constant at all levels of Output.
Average Variable Cost: Variable Cost per unit of Output.
Output in units Variable Cost (Rs.) Average Variable Cost

(Rs.)
1 10 10
2 18 9
3 24 8
4 29 7.25
5 34 6.8
6 40 6.6
7 48 6.9
8 62 7.7
Note: Initially Average Variable Cost (AVC) falls and after reaching a
certain limit it rises. AVC falls when Returns to a Factor are increasing,
while AVC rises when Returns to a Factor are diminishing. This is what
Law of Variable Proportion states.
Note: Average Cost Curve & Average Variable Cost Curve is u-shaped.
Graphically, Average Cost is the vertical summation of Average Variable
Cost and Average Fixed Cost at different levels of Output.
This Curve slopes downwards to the right. Downward slope of
Average fixed Cost shows that Average fixed Cost decreases as Output
increases. Average Fixed Cost Curve is a Rectangular Hyperbola. It
means that Average Fixed Cost × Output (which is equal to Total Fixed
Cost) is constant at all levels of Output.
Average Variable Cost: Variable Cost per unit of Output.
Output in units Variable Cost (Rs.) Average Variable Cost

(Rs.)
1 10 10
2 18 9
3 24 8
4 29 7.25
5 34 6.8
6 40 6.6
7 48 6.9
8 62 7.7
Note: Initially Average Variable Cost (AVC) falls and after reaching a
certain limit it rises. AVC falls when Returns to a Factor are increasing,
while AVC rises when Returns to a Factor are diminishing. This is what
Law of Variable Proportion states.
Note: Average Cost Curve & Average Variable Cost Curve is u-shaped.
Graphically, Average Cost is the vertical summation of Average Variable
Cost and Average Fixed Cost at different levels of Output.
Average Cost= Average Fixed Cost + Average Variable Cost
Marginal Cost (MC): Marginal Cost is the change in Total Cost when
an additional unit of Output is produced.
Output (Units) Total Variable Cost (Rs.) Marginal Cost (Rs.)
0 0 0
1 250 250
2 430 180
3 570 140
4 670 100
5 750 80
6 850 100
7 1000 150
8 1180 180
9 1430 250
10 1730 300
Note: Marginal Cost initially decreases and then increases.
Note: Marginal-Cost Graph is U-shaped in accordance with the Law of
Variable Proportions. Initially, Marginal Cost falls. It is because Marginal
Product tends to rise when there are increasing Returns to a Factor.
Subsequently, Marginal Cost tends to rise. It is because Marginal
Product tends to fall when there are Diminishing Returns to a Factor.
Note: Marginal Cost is Variable Cost as additional cost cannot be Fixed
Cost. It can only be Variable Cost. Therefore, the sum total of Marginal
Cost corresponding to different units of Output becomes Total
Variable Cost.
TVC = ∑MC
From 1 to 5 units of output, the Sum of Marginal Cost (∑MC) =
0+250+180+140+100+80 =750 = TVC at 5 units of output.
Total area under Marginal Cost Curve, corresponding to any level of
Output measure total Variable Cost of that level of Output.
Relation between Average Cost & Marginal Cost:
Output Total Cost (Rs.) Average Cost = Marginal Cost (Rs.)

(Units) (Fixed+Variable) TC/Q (Rs.)
0 0 ∞ 0
1 250 250 250
2 430 215 180
3 570 190 140
4 670 165 100
5 750 150 80
6 850 141.67 100
7 1000 142.86 150
8 1180 147.5 180
9 1430 158.89 250
10 1730 173 300
From the above data & the corresponding graph we can see
that:
 When Average Cost is falling, Marginal Cost<Average Cost
 When Average Cost is rising, Marginal Cost>Average Cost
 When Average Cost is constant, Marginal Cost= Average Cost
 Marginal Cost is always to the left of Average Cost, and cuts
Average Cost from its lowest point.
Relation between Total Cost and Marginal Cost:

1) Marginal Cost is estimated as the difference between total cost of
two successive units of Output.
2) When Marginal Cost is Deminishing, total Cost Rises at Deminishing
rate.
3) When Marginal Cost is rising, total Cost increases at increasing rate.
Marginal Cost is the rate of total Cost.
Note: The difference between Total Cost and Total Variable Cost is
constant.
Utility
Utility: Amount of satisfaction obtained from consuming goods and services

is called utility. In other words, want satisfying power of a good is called
utility.
Demand for a commodity depends on the utility of that commodity to a

consumer. If more utility= Consumer willing to pay higher price.
If less utility= Consumer willing to pay lower price.
Utility is the want satisfying power of a commodity. OR
Utility is satisfaction and it is subjective in nature.
Utility is not Usefulness: A consumer may get satisfaction from

consumption of liquor, tobacco etc. which are not useful at all.
Characteristics of Utility:
1. Utility is subjective in nature.
2. Utility is relative in nature.
3. Utility is different from usefulness.
Two important theories of Utility:
1. Cardinal Utility Analysis: This concept is based on the assumption

that utility (satisfaction from the consumption of a commodity) can be
measured in terms of cardinal numbers, such as 1, 2, 3, 4, etc. These
numbers are called Utils or units of Utility. Thus 4 utils of utility is
greater than 3 utils of utility.
2. Ordinal Utility: Ordinal concept of utility suggests that utility cannot

be measured in terms of units. It can be ranked or compared as high
or low. So, according to Ordinal Utility approach Consumer behavior is
based on consumer preferences.
Total Utility & Marginal Utility Concept:
Total Utility- It is the sum of utility derived from different units of a

commodity consumed by a consumer. TU = Sum of all MUs Or
TU= ∑ MU
Marginal Utility (MU)- It is the additional utility derived by consumer from

the consumption of an additional unit of a commodity.
MU = TUn– Tun-1 OR
MU = Change in TU / Change in units
Relationship between TU & MU:
1. TU= ∑ MU
2. Till MU remains +ve, TU increases.
3. When MU is zero, TU is maximum.
4. When MU is –ve, TU decreases.
Decreasing MU implies that TU is increasing at a decreasing rate.
Indifference Schedule: It refers to a schedule that shows various

combinations of two goods which give equal amount of satisfaction to the
consumer.
Four combination of fruits & clothing are given below. Each combination
offers the same level of satisfaction to the consumer. Whether you offer
combination A to a customer, or combination B, or combination C, or
combination D, the customer gets same utility (satisfaction). So, the customer
is indifferent across all the combinations.
Indifference Curve: An Indifference curve shows various combinations of

two commodities which give equivalent satisfaction to the consumer.
On indifference curve each point shows a combination of two goods, offering
the same level of satisfaction to the consumer.
Properties of Indifference Curves:
1. An indifference curve slopes downward from left to right, i.e. it has a

negative slope.
2. Indifference curves are always convex to the origin.
3. Higher IC yield higher satisfaction: An IC which lies above and to the

right of another IC gives a higher level of satisfaction than the lower
one.
4. Two indifference curves never intersect each other.
5. Indifference curve will not touch either axes- Based on the assumption
that consumer wants both commodities.
NOTE:-An Indifference curve is also known as Iso- Utility Curve.
The Law of Diminishing Marginal Utility-
According to the Law of Diminishing Marginal Utility, as a consumer takes

more and more units of a good, the extra (additional) satisfaction that he
derives from an extra (additional) unit of a good goes on falling. OR
As more and more units of a commodity are consumed, marginal utility

derived from every additional unit must decline. It happens in respect of all
goods and services. It is, therefore, called ‘Fundamental Law of Satisfaction’
or ‘Fundamental Psychological Law’.
Limitations of Law of DMU:
1. Homogeneous Units
2. Standard Units of consumption: Eg. A cup of tea, not a spoon of tea.
3. 3. Continuous consumption: Not that one unit of commodity is

consumed now, and the other tomorrow.
4. 4. The law fails in the case of prestigious goods.
Consumer Surplus:
Marshall defined Consumer Surplus as “excess price which a consumer

would be willing to pay rather than go without a thing over that which he
actually does pay.”
Limitations:
It cannot be measured precisely.
In case of necessities the MU of earlier units are infinitely large.
Affected by availability of substitutes.
It cannot be measured in terms of money.
Budget Line (Price line)- A budget line shows all those combinations of two
goods which the consumer can buy spending his given income on the two
goods at their given price.
● All those combinations which are within the reach of the consumer
(assuming that he spends all his money income) will lie on the budget
line.
● Any point outside the given price line, will be beyond the reach of the
consumer.
● Any combination lying within the line, shows under utilization by the
consumer of his income.
● Rekha has only Rs.100 to spend on her two passions in life: buying
books and attending movies. If all books cost Rs. 5.00 each and all
movies cost Rs. 2.50 each, the graph below shows the options open to
Rekha. The budget line is a frontier showing what Rekha can attain.
The cost of a book is $5.00 or two movies. Spending money on a
product means that money cannot be used to purchase another
product.
Properties of Budget Line:
● It is negatively sloped line.
● The slope of budget line is equal to the price ratio of two commodities.
● It is a straight line.
Consumer’s Equilibrium:
A consumer is in equilibrium when he is deriving maximum possible

satisfaction from the goods and therefore is in no position to rearrange his
purchases of goods.
The consumer will be in the state of equilibrium when the following

condition is fulfilled:
The marginal utility of commodity X in terms of rupees is equal to the price of

commodity X in rupees.
[MUx (in ₹) = Px (in ₹)] Or
MUx (in utils) = Px (in ₹)
The consumer will be in the state of equilibrium when the following condition
is fulfilled:
The marginal utility of commodity X in terms of rupees is equal to

the price of commodity X in rupees. [MUx (in ₹) = Px (in ₹)]
Or Mux (in utils) = Px (in ₹) or MU of Commodity X (in utils) = Px (in

₹)
Indifference Curve Vs Budget Line:
● Indifference Curve shows the taste and preferences of the consumer.
● Budget Line tells us what the household can do (purchase).

Notes by: Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775
Market
Based on the degree of competition or number of firms in the

market, a market can be:
1) Perfect Competition
2) Monopoly
3) Monopolistic Competition
4) Oligopoly
Perfect Competition: Under Perfect Competition Market there is a

large number of sellers and buyers of a commodity, and no
individual buyer or seller has any control over its price.
Features of Perfect Competition market:

1) Large number of small buyers and sellers of a commodity:
2) Homogeneous Product
3) Perfect knowledge:
4) Freedom of entry and exit
5) Independent decision making
6) Perfect mobility
Thus:
1) A firm under Perfect Competition is a price taker, not a price
maker. The reason being, large number of firms, homogeneous
product and perfect knowledge by buyer and seller regarding
product availability and product price.
2) Demand curve of the firm under Perfect Competition is perfectly
elastic.
3) Only normal profit in the long run.
Monopoly: In Monopoly form of market there is a single seller of a

product with no close substitute. As there is only one producer of a
product in the market, the distinction between the firm and
industry disappears. Example: Railway in India
Features of Monopoly:
1) One seller and large number of buyers. The seller may be alone,
or there may be a group of partners or a joint stock company or a
state.
2) Under Monopoly, there are some restrictions on the entry of new
firms. The restriction can be through patent rights, excessive control
over technique, etc.
3) No close substitute of a product.
4) The firm has full control over price. It can fix whatever price it
wishes to fix for its product.
5) Price discrimination: A Monopoly firm can charge different price
from different buyers. It is called price discrimination.
Demand curve for a Monopoly firm: Firms demand curve under

Monopoly firm slopes downward, showing an inverse relation
between price and quantity. More is sold at a lower price and less
is sold at a higher price. Full control over price under Monopoly does
not mean that the monopolist can sell any amount at any price.
Monopoly market structure may arise in any of the following

ways:
1) If the government grant license for the production of a particular
commodity only to one producer.
2) If a patent right is secured for a new product, it amounts to

monopoly right regarding the shape, design or characteristic of
product.
3) If the competing firm forms cartel, the group as a whole secure
Monopoly.
Monopolistic competition: In this form of market there are many

sellers of the product, but the product of one is a little different
from that of the other. Thus, there are many sellers, selling a
differentiated product. Example: Firms Producing different brand of
shirt, that is Peter England, Lacoste, Charlie Outlaw, etc.
Monopolistic competition combines the feature of Monopoly and
Perfect Competition. Trademark, brand name, etc give some
Monopoly power to the firm.
Features:
1) Large number of buyers and sellers and size of each firm is small.
Each firm has a limited share of the market.
2) Product differentiation is a vital feature of monopolistic market.
Rival firm sells product which are not perfect substitute, but close
substitute of each other. Example: Britannia biscuit and Parle
biscuit.
3) Heavy advertisement expenditure (heavy selling cost) is an
important feature of monopolistic competition.
4) Downward sloping demand curve: Partial control over price leads
to downward sloping demand curve.
5) Non-price competition: Even when product differentiation allows
the firm to pursue their independent price policy, they often avoid
getting into price war. They focus on non-price competition.
6) Firms are free to enter or leave the industry. However, product

of some firms may be legally patented. Thus, new firms have no
absolute freedom of entering the market.
7) Goods, services and factors of production lack perfect mobility.
Thus, different prices prevail for the same factor or for the same
product.
8) Sellers and buyers of the product lack perfect knowledge about
the market because of product differentiation. This leads to
consumer exploitation by way of higher price for the low quality
product.
Oligopoly: It is a form of market in which there are a few big firms

and a large number of buyers of a commodity. Example: Airlines,
Car producers, etc.
Features of Oligopoly:
1) Small number of big firms
2) Heavy advertising to generate brand loyalty.
3) Brand loyalty makes demand for the product relatively less
elastic. So, firms are able to generate extra normal profits.
4) Cut throat competition.
5) High degree of interdependence: In oligopoly market, there are
small number of firms. The firms are highly interdependent on each
other.
6) Difficult to trace firm's demand curve: Competing firms are highly
interdependent. When a firm lower its price,, demand for it may not
increase, because rival firms may lower its price more, because of
which the buyer shifts to the Rival firm.
This implies that there is no specific response of quantity demand
to change in price. This makes it impossible to draw any specific
demand curve for a firm under oligopoly.
7) Formation of cartels: To avoid competition, oligopoly firms often

form cartels. Under it, output and prices are fixed by different firms
as a group. A Cartel takes full control of the market. It makes
Monopoly profits. Thus Collusive Oligopoly is like a Monopoly form
of the market.
8) As there are entry barriers for new firms which are generally
created through patent rights, the existing firms keep on making
extra normal profit in long run.
9) Non-price Competition: Under oligopoly, firm avoids price
competition. Instead, they focus on non-price competition.
Example: Coke and Pepsi in India.
Notes by:Tej Pratap Singh
National Income
Income can be of two types: 1) Factor Income and 2) Transfer
Income.
Factor Incomes are related to Factors of production (land, labour,
capital and entrepreneurship). Households are the owner of
Factors of Production. Producers hire / purchase the Factor
services from the households. In return, the households receive
payments from the producers. These payments are called Factor
payments. For households, these are Factor Incomes.
Factor Incomes are: Compensation of employees (labour), rent

(land), interest (capital) and profit (entrepreneurial skills).
Transfer payments are unilateral payments, like charity or grants.

These are not related to any kind of work rendered by the owners
of the Factors of production.
Note: While estimating National Income, we include only Factor
payment. Transfer payments are not included.
Who are Normal Residents of a country?

A person residing in a country for a period of one year or more
(ordinarily residing) and whose centre of economic interest lies in
that country is a Normal Resident of the country.
Who Are Normal Resident Of A Country
1) Normal Resident of a country may or may not be a citizen of
that country. Example- If an Indian is living in Dubai for more
than 1 year and his economic interest lies in Dubai, he
would be deemed as Normal Resident of Dubai.
2) International Organization such as WHO and IMF in a
country are not to be taken as Normal Resident of that
country. However, Indians working in these organizations

are taken as Normal Residents of India.
Note:
3) Members of the armed forces, official, diplomats, etc are
treated as the Normal Resident of the country to which they
belong to and not of the country in which they are employed.
4) Border workers or persons who cross the border between two
countries daily or regularly in order to work in 1 countries are the
residence of the country in which they live, not of the country in
which they are working.
The following persons are not treated as Normal Residents of the

country:
❏ Crew members of foreign vessels.
❏ Commercial traveler.
❏ Foreign visitor visiting for the purpose of recreation, medical

treatment, sports, holiday etc.
Example of Normal Residents in India:

1. Ambassador for India in rest of the world.
2. Indians employed in World Health Organisation, IMF in
India.
3. Indians employed in foreign embassies in India.
4. A foreign citizen living in India for a period of more than a year
other than those for studies or medical treatment.
Non-Resident of India includes:
1. Ambassador in India from rest of the world
2. Foreigners working in Indian Embassy in Dubai, USA.
3. Foreigner working in WHO, IMF office of India.

4. A foreign technical expert working in India for less than 1
year.
Domestic Income: Domestic Income is the sum total of Factor

Incomes (compensation of employees + rent + interest+ profit)
generated within the domestic territory of a country (no matter
who generates it- Normal Resident or non-resident).
National Income: National Income is the sum total of Factor

Incomes (compensation of employees + rent + interest+ profit)
generated by Normal Resident of a country (no matter where it is
generated- within the domestic Territory or outside).
Conversion of Domestic Income into National Income:National

Income= Domestic Income + Factor Income earned by our
Residents from rest of the world - Factor Income earned by non-
residents in our domestic territory
Or
National Income = domestic Income+ Net Factor Income from
abroad,
where, Net Factor Income from Abroad =
Factor Income earned by our residents from rest of the world -
Factor Income earned by non-residents in our domestic territory
Domestic Territory of a country: Domestic Territory of a country

includes:
1. Territory lying within the political frontiers including
territorial waters of a country.
2. Ships and aircraft operated by Residents of the country

across different parts of the world.
3. Fishing vessels and oil and natural gas rigs operated by the
Residents of the country in the International waters.
Example - Fishing boats of Indian fishermen operating in
International water.
4. Embassies, consulates and military establishment of the
country located abroad. Example- Indian Embassy in Nepal
part of the domestic territory of India and the Nepal
Embassy in India is a part of domestic Territory of Nepal.
Note: Domestic territory does not refer to the areas of
ownership beyond political frontier of a nation. It only refers to
areas of operation where our persons and our capital can
circulate freely to serve our economic interest. Factor Income
generated within the domestic Territory of a nation amounts to
domestic Income.
Gross Domestic Product (GDP) is the monetary value of all the

finished goods and services produced within a country's borders in
a specific time period. Though GDP is usually calculated on an
annual basis, it can be calculated on a quarterly basis.
There is no difference between Domestic Income and Domestic
product. The two are identical as all production is ultimately
converted into Factor Incomes.
Net domestic product= GDP - Depreciation
GDPMP: Refers to the market value of final goods and services
produced within the Domestic Territory of a country during an
accounting year, including depreciation.
GDPFC: The sum total of Factor Incomes generated within the

Domestic Territory of a country in an accounting year, including
depreciation.
GDPFC= Compensation of employees + Rent + Interest + Profit +
Depreciation
NDPMP: Refers to the market value of final goods and services

produced within the domestic Territory of a country in an
accounting year excluding Depreciation.
NDPFC: Refers to the sum total of Factor Income generated within

the Domestic Territory of a country during an accounting year
excluding Depreciation.
National Disposable Income: Refers to the Net Income at market

price available to a country for disposal. It is the sum of National
Income (NNPFC), Net Indirect Taxes and Net Current Transfers from
the rest of the world.
Nominal GDP: Estimation of GDP at current prices is called

Nominal GDP. GDP at current price is the market value of the final
goods and services produced within the Domestic Territory of a
country in an accounting year.
Nominal GDP =Quantity × Price Per Unit
Thus, GDP can increase when there is increase in either quantity or
price. If it increases owing to increase in quantity alone, it is called
real increase in GDP. If it increases due to increase in price alone, it
is called monetary increase in GDP. Monetary increase in GDP
without an increase in the output is of no use. It does not cause
any increase in the flow of goods and services in the economy.
Real GDP: Estimation of GDP at constant prices is called Real GDP.

GDP at constant prices is the market value of the final goods and
services produced within the domestic territory of a country in an
accounting year, as estimated using the base year prices. Base year
is the year of comparison.
Real GDP = Q*P
Q= Quantity of final goods and services produced during an
accounting year.
P= Prices prevailing during the base year.
Real GDP increases only when quantity increases, because Price is
constant. If real GDP increases, flow of goods and services in the
economy increases. Thus, more goods and services are available to
the Resident of a country. It implies the quality of life should
improve.
Method of measuring National Income:

1. Product Method: In this method, final goods and services
produced in a country during the year (GDP) is obtained and
net income earned in foreign boundaries by nationals is
added and depreciation is subtracted.
1) Income Method: In this method, a total of net income

earned by working people in different sectors is obtained.
Incomes of both categories of people - paying taxes and not
paying taxes are added to obtain National Income. In
Income method National Income is obtained by adding
receipt of total rent, total wages, total interest and total
profit.
National Income = Total Rent + Total Wages + Total
Interest + Total Profit
2) Consumption Method: National Income is obtained by

adding total consumption and total savings. General data of
saving and consumption are not available easily. Therefore,
expenditure method is generally not used for estimating
National Income.
Note: In India, a combination of Production Method and
Income Method is used for estimating National Income.
Note: In India, a combination of Production Method and
Income Method is used for estimating National Income.
Since 1955, the National Income estimates are being
prepared by Central Statistical Organisation. Central
Statistical Organisation (located in Delhi) has divided Indian
economy into three basic sectors for the purpose of
evaluation of various data. They are:
1. Primary Sector: Agriculture, fishing, mining and quarrying

2. Secondary Sector: Manufacturing, power generation, gas
and water supply.
3. Tertiary Sector: Transport, communication and trade,
banking, insurance, computer software, public
administration, defence and external trade.
Note: National Income does not include Income from illegal
activities, black money and income of work done without
remuneration like domestic work by housewives.
The Central Statistical Office is responsible for coordination

of statistical activities in India, and evolving and maintaining
statistical standards.
National Sample Survey Organisation/ Office (NSSO): It
conducts the regular socio-economic surveys. It comes
under Ministry of statistics of the Government of India.
Poverty & Unemployment
What is Unemployment?
Unemployment occurs when a person who is actively searching for
employment is unable to find work.
Unemployment is often used as a measure of the health of the
economy.
The most frequent measure of unemployment is the
unemployment rate. It is calculated as the number of unemployed
people divided by the number of people in the labor force.
Types of Unemployment in India

1) Seasonal Unemployment:
It is an unemployment that occurs during certain seasons of the
year. Eg. Agricultural labourers in India rarely have work
throughout the year.
2) Disguised Unemployment:
a) It is a phenomenon wherein more people are employed than
actually needed.
b) It is found in the unorganised sectors & agricultural sector of
India.
3) Structural Unemployment:
a) It is a category of unemployment arising from the mismatch
between the jobs available in the market and the skills of the
available workers in the market.
b) Many people in India do not get job due to lack of skills

required by industry.
4) Technological Unemployment:
a) It is loss of jobs due to changes in technology.
b) In 2016, World Bank data predicted that the proportion of
jobs threatened by automation in India is 69% year-on-year.
5) Cyclical Unemployment:
 It is result of the business cycle, where unemployment rises
during recessions and declines with economic growth.
 Cyclical unemployment figures in India are negligible. It is a
phenomenon that is mostly found in capitalist economies.
6) Frictional Unemployment:
 The Frictional Unemployment refers to the time lag
between the jobs when an individual is searching for a new
job or is switching between the jobs.
 In other words, an employee requires time for searching a
new job or shifting from the existing to a new job, this
inevitable time delay causes the frictional unemployment. It
is often considered as a voluntary unemployment because it
is not caused due to the shortage of job, but in fact, the
workers themselves quit their jobs in search of better
opportunities.
7) Vulnerable Employment:
 This means, people working informally, without proper job
contracts. These persons are deemed ‘unemployed’ since
records of their work are never maintained.
 It is one of the main types of unemployment in India.
National Sample Survey Office (NSSO), an organization under

Ministry of Statistics and Programme Implementation (MoSPI)
measures unemployment in India.
Causes of Unemployment
• Large population.
• Low or no educational levels and vocational skills of working
population.
• Inadequate state support.
• Workers associated with informal sector are not captured in
any employment data. Ex: domestic helpers, construction
workers etc.
• The syllabus taught in schools and colleges, being not as per
the current requirements of the industries.
Causes of Unemployment
• Inadequate growth of infrastructure and manufacturing
sector, restricts employment potential of secondary sector.
• Low productivity in agriculture sector combined with lack
of alternative opportunities for agricultural worker which
makes transition from primary to secondary and tertiary
sectors difficult.
• Regressive social norms that deter women from
taking/continuing employment.
Impact:
• Problem of poverty.
• Increase in crime rate in the country.
• Unemployed persons can easily indulge into antisocial
activity. This makes them lose faith in democratic values of
the country.
• Unemployed people end up getting addicted to drugs and
alcohol or attempts suicide, leading losses to the human
resources of the country.
• It also affects economy of the country For instance, 1
percent increase in unemployment reduces the GDP by 2
percent
Steps Taken by Government:

• Integrated Rural Development Programme (IRDP) was
launched in 1980 to create full employment opportunities in
rural areas.
• Training of Rural Youth for Self-Employment
(TRYSEM): This scheme was started in 1979 with objective
to help unemployed rural youth between the age of 18 and
35 years to acquire skills for self-employment. Priority was
given to SC/ST Youth and Women.
• Mahatma Gandhi National Rural Employment Guarantee
Act (MNREGA):
• It is an employment scheme that was launched in
2005 to provide social security by guaranteeing a
minimum of 100 days paid work per year to all the
families whose adult members opt for unskilled
labour-intensive work.
• This act provides Right to Work to people.
• Pradhan Mantri Kaushal Vikas Yojana (PMKVY), launched in
2015 has an objective of enabling a large number of Indian
youth to take up industry-relevant skill training that will help

them in securing a better livelihood.
• Start Up India Scheme, launched in 2016 aims at developing
an ecosystem that promotes and nurtures entrepreneurship
across the country.
• Stand Up India Scheme, launched in 2016 aims to facilitate
bank loans between Rs 10 lakh and Rs. 1 crore to at least
one SC or ST borrower and at least one women borrower
per bank branch for setting up a greenfield enterprise.
• Unemployment trap is a situation when unemployment
benefits discourage the unemployed to go to work. People
find the opportunity cost of going to work too high when
one can simply enjoy the benefits by doing nothing.
POVERTY
• Poverty is a state or condition in which a person or

community lacks the financial resources and essentials for a
minimum standard of living. Poverty means that the income
level from employment is so low that basic human needs
can't be met.
• In India, 21.9% of the population lives below the national
poverty line in 2011.
• In 2018, almost 8% of the world’s workers and their families
lived on less than US$1.90 per person per day (international
poverty line).
Types of Poverty:
Absolute Poverty: A condition where household income is below a

necessary level to maintain basic living standards (food, shelter,
housing).
In October 2015, the World Bank measured absolute poverty to
$1.90 a day.
Relative Poverty: It is defined from the social perspective that is

living standard compared to the economic standards of population
living in surroundings. Hence it is a measure of income inequality.
Poverty Estimation in India:

• Poverty estimation in India is carried out by NITI Aayog’s
task force through the calculation of poverty line based on
the data captured by the National Sample Survey Office
under the Ministry of Statistics and Programme
Implementation (MOSPI).
• Poverty line estimation in India is based on the
consumption expenditure and not on the income levels.
• Poverty is measured based on consumer expenditure
surveys of the National Sample Survey Organisation.
Head-count ratio: Poverty is measured by the poverty ratio, which

is the ratio of the number of poor to the total population
expressed as a percentage. It is also known as head-count ratio.
• Alagh Committee (1979) determined a poverty line based
on a minimum daily requirement of 2400 and 2100 calories
for an adult in Rural and Urban area respectively.
• Subsequently different committees; Lakdawala Committee
(1993), Tendulkar Committee (2009), Rangarajan
committee (2012) did the poverty estimation.
• As per the Rangarajan committee report (2014), the

poverty line is estimated as Monthly Per Capita Expenditure
of Rs. 1407 in urban areas and Rs. 972 in rural areas.
Causes of Poverty in India

• Population Explosion
• Low Agricultural Productivity
• Inefficient Resource utilisation
• Low Rate of Economic Development
• Unemployment
• Lack of Capital and Entrepreneurship
• Colonial Exploitation
• Climatic Factors
Poverty Alleviation Programs in India

• Integrated Rural Development Programme (IRDP): It was
introduced in 1978-79 and universalized from 2nd October,
1980, aimed at providing assistance to the rural poor in the
form of subsidy and bank credit for productive employment
opportunities through successive plan periods.
• Jawahar Rozgar Yojana/Jawahar Gram Samridhi
Yojana: The JRY was meant to generate meaningful
employment opportunities for the unemployed and
underemployed in rural areas through the creation of
economic infrastructure and community and social assets.
• Rural Housing – Indira Awaas Yojana: The Indira Awaas
Yojana (LAY) programme aims at providing free housing to
Below Poverty Line (BPL) families in rural areas and main
targets would be the households of SC/STs.
• Food for Work Programme: It aims at enhancing food

security through wage employment. Food grains are
supplied to states free of cost, however, the supply of food
grains from the Food Corporation of India (FCI) godowns has
been slow.
• National Old Age Pension Scheme (NOAPS): This pension is
given by the central government. The job of implementation
of this scheme in states and union territories is given to
panchayats and municipalities. The states contribution may
vary depending on the state. The amount of old age pension
is ₹200 per month for applicants aged 60–79. For applicants
aged above 80 years, the amount has been revised to ₹500 a
month according to the 2011–2012 Budget. It is a successful
venture.
• Annapurna Scheme: This scheme was started by the
government in 1999–2000 to provide food to senior citizens
who cannot take care of themselves and are not under the
National Old Age Pension Scheme (NOAPS), and who have
no one to take care of them in their village. This scheme
would provide 10 kg of free food grains a month for the
eligible senior citizens. They mostly target groups of
‘poorest of the poor’ and ‘indigent senior citizens’.
• SampoornaGramin Rozgar Yojana (SGRY): The main
objective of the scheme continues to be the generation of
wage employment, creation of durable economic
infrastructure in rural areas and provision of food and
nutrition security for the poor.
• Mahatma Gandhi National Rural Employment Guarantee
Act (MGNREGA) 2005: The Act provides 100 days assured
employment every year to every rural household. One-third
of the proposed jobs would be reserved for women. The
central government will also establish National Employment
Guarantee Funds. Similarly, state governments will establish
State Employment Guarantee Funds for implementation of
the scheme. Under the programme, if an applicant is not

provided employment within 15 days s/he will be entitled to
a daily unemployment allowance.
• National Rural Livelihood Mission: Aajeevika (2011): It
evolves out the need to diversify the needs of the rural poor
and provide them jobs with regular income on a monthly
basis. Self Help groups are formed at the village level to help
the needy.
• National Urban Livelihood Mission: The NULM focuses on
organizing urban poor in Self Help Groups, creating
opportunities for skill development leading to market-based
employment and helping them to set up self-employment
ventures by ensuring easy access to credit.
• Pradhan Mantri Kaushal Vikas Yojana: It will focus on fresh
entrant to the labour market, especially labour market and
class X and XII dropouts.
• Pradhan Mantri Jan Dhan Yojana: It aimed at direct benefit
transfer of subsidy, pension, insurance etc. and attained the
target of opening 1.5 crore bank accounts. The scheme
particularly targets the unbanked poor.
Balance of Payment
Balance of Payment: Balance of Payment is a statement of

account showing all monetary transactions of a country with the
rest of the world during a period of time.
The monetary transaction may arise out of:
1. Export and Import of goods
2. Export and Import of services
3. International sale and purchase of financial assets (bonds &
stocks)
4. International sale and purchase of real assets (plant &
machinery).
Note: These economic transactions are done by individuals, firms
and the government of a country.
Components of BOP Account:

1. Current Account,
2. Capital Account and
3. Official Reserve Account.
1. Current Account: Current Account records:

a) export and import of goods (visibles).
b) export and import of services (invisibles).
c) Current Transfers: Current Transfers refer to ‘transfer for free’.
These are unilateral transfers by way of gifts, grants and workers’
remittances.
2. Capital Account: Capital Account shows a Capital Expenditure

and Income for a country. Capital Account is the account which
records all such transactions between residents of a country and
rest of the world which causes a change in the ownership of
assets.
It does not involve Export and Import of Goods and Services
between one country and rest of the world.
Thus Capital Account BOP transactions mainly relate to:
1) Physical assets which remain in the economy but ownership
of which changes on account of their international sale and
purchase.
2) Financial assets, the ownership of which changes on account
of international sale & purchase.
3) Current Account BoP shows nation’s net income arising out
of the exports of goods and services (as well as net current
transfers), the capital account BoP shows net change in the
country’s ownership of assets in relation to rest of the
world.
Capital Account BoP include:
1) Borrowings: External Commercial Borrowings & External
Assistance.
2) Investments: Portfolio Investments & FDI
BUDGET
UNION BUDGET OF INDIA

• Article-112
• Presented on the last working day of February by the
Finance Minister of India in Parliament.
Components of the Budget:

• 1)Revenue Budget also called Revenue Account
• 2) Capital Budget also called Capital Account
• Revenue Budget includes Revenue Receipts and Revenue
Expenditure of the government.
• Capital Budget includes Capital Receipts and Capital
Expenditure of the government.
Revenue Receipts:
1) These receipts do not create any corresponding liability for
the government. Eg: Tax Receipts.
2) These receipts do not cause any reduction in assets of the
government.
Revenue Receipts are further classified as Tax Receipt and Non-Tax
Receipt.
Capital Receipts:
1) These receipts create a liability for the government. Eg:
Loans.
2) These receipts cause reduction in assets of the government.
Eg: Money received by selling shares of a company.
Thus Capital Receipt can be Recovery of Loans, Borrowings &
Disinvestment, etc.
Revenue Expenditure:
1) It does not create any asset for the government. Eg: Salary.
2) It does not create any reduction in liability of the

government.
Eg: 1. Wage bill of the government.
2. Interest Payment.
3. Expenditure on Subsidies.
Capital Expenditure:
1) It creates assets for the government. Eg: Purchasing Equity
of a company by the government.
2) It causes reduction in liabilities of the government. Eg:
Repayment of loan.
Eg:
1. Purchase of land, building, etc.
2. Expenditure on purchase of shares.
3. Purchase of machinery and shares.
4. Loans by Central Government to State Government.
Budget Deficit: Budget Deficit refers to a situation when budget

expenditures of the government are greater than the budget
receipts.
There are three important types of Budget Deficit, with reference
to Government of India:
1) Revenue Deficit
2) Fiscal Deficit &
3) Primary Deficit
Revenue Deficit: Revenue Deficit is the excess of revenue

expenditure over revenue receipts.
Revenue Deficit = Revenue Expenditure – Revenue Receipt
Fiscal Deficit: Fiscal Deficit is the excess of total expenditure

(Capital Expenditure + Revenue Expenditure) over total receipts
(Capital Receipt + Revenue Receipt other than borrowing).
Fiscal Deficit = Budget Expenditure – Budget Receipt other than
borrowings
It is also called Gross Fiscal Deficit.
Gross Fiscal Deficit can also be calculated as:
Borrowing From RBI + Borrowing From Abroad + Net borrowing at
home
Primary Deficit: Primary Deficit is the difference between fiscal

deficit and interest payment.
Primary Deficit = Fiscal Deficit – Interest Payment
Primary Deficit indicates government borrowings on account of
current year expenditures and current year receipts of the
government.
Money & Banking
RESERVE BANK OF INDIA

• It is the Central Bank of the country.
• Established on Apr 1, 1935 with a capital of Rs.5 crore.
• Nationalized on Jan 1, 1949 as govt. acquired the private share
holdings.
Governor of RBI:
Current Governor- Shaktikanta Das
1st Governor-Sir Smith (1935-37)
1st Indian Governor : CD Deshmukh (1948-49)
The Reserve Bank's affairs are governed by a Central Board of
Directors.
The board is appointed by the Government of India in keeping
with the Reserve Bank of India Act, 1934.
The Board is appointed for a period of 4 years.
Constitution of Central Board Of Directors:

Official Directors:
Full-time : Governor and not more than four Deputy Governors
Non-Official Directors
 Nominated by Government: 10 Directors from various fields
and two government Official
 Others: four Directors - one each from four local boards.
Note: The headquarters of local boards of RBI are in Mumbai,

Kolkata, Chennai and New Delhi. The members of the local boards
of RBI are appointed by the Central Government for a term of four
years.
Functions Of Reserve Bank Of India:

• Issue of Notes: Regulates issue of bank notes above 1 rupee.
One rupee notes issued by Ministry of Finance are also circulated
through it.
• Banker to the Government: Acts as the banker, agent and
advisor to the Govt. of India.
• Banker's Bank: The Reserve Bank performs the same function
for other banks as the other banks ordinarily perform for their
customers.
• Controller of Credit: The Reserve Bank undertakes the
responsibility of controlling credits created by the commercial
banks.
• Custodian of Foreign Reserves: For the purpose of keeping the
foreign exchange rates stable, the Reserve Banks buys and sells
the foreign currencies and also protects the country's foreign
exchange funds.
• It formulates and administers the monetary policy.
• Acts as the agent of the Government of Indian in respect to
India's membership of the IMF and the World Bank.
• No personal accounts are maintained and operated in RBI.
Cash Reserve Ratio (CRR): Current CRR = 4.5%.

CRR is the amount of funds that banks have to deposit with RBI.
The objective of CRR is to make sure that bank maintains minimum
level of liquidity against their liabilities so that they don’t run short
of money in case of excess demand of funds.
It is one of the key instruments used by the Central Bank (RBI) to

inject or suck out liquidity from the market. If RBI increases CRR,
banks have to deposit more money with RBI. So, Bank will have
less money to distribute as loan which will drain out excessive
money from the system. RBI can cut CRR when it wants to boost
lending system and increase liquidity in the banking system.
Statutory Liquidity Ratio (SLR):Current SLR = 18%

SLR specifies the minimum amount that banks must invest in
government securities.
Repo Rate: Current Repo Rate = 4.9%

Repo Rate can be defined as an amount of interest that is charged
by the Reserve Bank of India while lending funds to the
Commercial Banks.
The Repo Rate in India is controlled by the Reserve Bank of India.
A decline in the repo rate can lead to the banks bringing down
their lending rate which is beneficial for retail loan borrowers
which helps in improving the growth and economic development
of the country.
Reverse Repo Rate: Current Rate: 3.35%

The reverse repo rate is the rate of interest that is provided by the
Reserve bank of India while borrowing money from the
commercial banks.
In other words, we can say that the reverse repo is the rate
charged by the Commercial Banks in India to park their excess
money with RBI for a short-term period. Reverse Repo Rate is an
important instrument of the monetary policy which control the
money supply in the country.
Regional Rural Bank:

• Set up in 2 October 1975.
Main Objective: to develop the rural economy by providing credit

and encouraging other productive activities in the rural areas.
Key Features of Regional Rural Bank:

The paid-up capital of each rural bank is Rs.25 lakh, 50% of which
is contributed by the Central Government, 15% by the State
Governments and 35% by the Sponsoring Public Sector
Commercial Banks which are responsible for the actual setting up
of the RRBs.
The functions of the (Regional Rural Bank) RRB are as follows:

(1) Granting of loans and advances to small and marginal farmers
and agricultural labourers, whether individually or in groups, and
to co-operative societies, agricultural processing societies, co-
operative farming societies, primarily for agricultural purposes or
for agricultural operations and other related purposes;
(2) Granting of loans and advances to artisans, small
entrepreneurs and persons of small means engaged in trade,
commerce and industry or other productive activities within its
area of co-operation; and
(3) Accepting deposits.
Bank and Other Financial Institutions:

1. Industrial Credit and Investment Corporation of India Bank
(ICICI Bank):
Objective: to encourage and assist industrial units of the nation. It

has been converted into a bank later.
2. Small Industries Development Bank Of India (SIDBI): Objective:
Promotes small scale sector industries.
3. National Bank Of Agriculture And Rural Development
(NABARD):
Objective: Gives credit facilities to farmers.
4. Export-Import Bank Of India (EXIM):
Objective: Grants deferred credit to Indian exporters in order to
operate in the international market.
5. Industrial Finance Corporation of India LTD. (IFCI):Objective:
Arrange medium and long term credit for various industrial
enterprises of the country.
6. National Housing Bank (NHB):
Objective: Extending financial assistance to eligible institutions in
the housing sector by way of refinance and direct finance.
7.Non-Banking Financial Companies (NBFCS): Non-Banking
Financial entities comprise NBFCs, mutual benefit financial
companies (Nidhi Companies), and mutual benefit companies
(potential nidhi companies). Department of Company Affairs
regulates the mutual benefit financial companies and mutual
benefit companies but RBI regulates NBFCs.
Functions of Commercial Banks:
Primary functions:
• Collection of deposits
• Making loans and advances
Collection of deposits: The primary function of commercial banks

is to collect deposits from the public. Such deposits are of three
main types: current, saving and fixed.
Loans and Advances: Commercial banks have to keep a certain
portion of their deposits as legal reserves. The balance is used to
make loans and advances to the borrowers. Individuals and firms
can borrow this money and banks make profits by charging
interest on these loans.
Secondary functions:
• Agency services
• General utility services
1. Agency Services: The customers may give standing instruction
to the banks to accept or make payments on their behalf. The
relationship between the banker and customer is that of Principal
and Agent. The following agency services are provided by the
bankers:
a. Payment of rent, insurance premium, telephone bills,
installments on hire purchase, etc. The payments are made from
the customer’s account. The banks may also collect such receipts
on behalf of the customer.
b. The bank collects cheques, drafts, and bills on behalf of the
customer.
c. The banks can exchange domestic currency for foreign
currencies as per the regulations.
d. The banks can act as trustees / executors to their customers.
For example, banks can execute the will after the death of
their clients, if so instructed by the latter.
General Utility Services: The commercial banks also provide

various general utility services to their customers. Some of these
services are discussed below:
1. Safeguarding money and valuables: Locker
2. Transferring money
3. Merchant banking: Many commercial banks provide merchant
banking services to the investors and the firms.
The merchant banking activity covers project advisory services and
loan syndication, corporate advisory services such as advice on
mergers and acquisitions, equity valuation, disinvestment,
identification of joint venture partners and so on.
4. Automatic Teller Machines (ATM):
5. 5. Traveler’s cheque: A traveler’s cheque is a printed cheque
of a specific denomination. The cheque may be purchased
by a person from the bank after making the necessary
payments. The customer may carry the traveler’s cheque
while travelling. The traveler’s cheques are accepted in
banks, hotels and other establishments.
6. 6. Credit Cards
Payment Bank:
We can define a Payment Bank in India as a type of bank which is a
non-full service niche bank. A bank licensed as a Payments Bank
can only receive deposits and provide remittances. It cannot carry
out lending activities. Thus, Payment Banks can issue ATM/debit
cards, but cannot issue credit cards as they are not empowered to
carry out lending activities.
RBI in its guidelines says “the objectives of setting up of payments

banks is to ensure financial inclusion by providing:
(i) small savings accounts and
(ii) payments/remittance services to migrant labour workforce,

low income households, small businesses, other unorganised
sector entities and other users.
Example: Paytm, Mobikwik, Airtel Payment Bank, etc.
Securities and Exchange Board of India (SEBI Act, 1992)

Current Chairman- Ms. Madhabi Puri Buch.
She is assisted by 4 whole-time members and 3 part-time
members.
• SEBI is a statutory body.
• Establishment Date: April 12, 1992
• Headquarters of SEBI – Mumbai
• . The regional offices of SEBI are located in Ahmedabad,
Kolkata, Chennai and Delhi.
• Before SEBI came into existence, Controller of Capital Issues
was the regulatory authority.
Structure:
• SEBI Board consists of a Chairman and several other whole
time and part time members.
• SEBI also appoints various committees, whenever required
to look into the pressing issues of that time
Goods & Service Tax (GST)

The Constitution (101st Amendment) Act, 2016
Main Features of GST:

• Applicable On supply side: GST is applicable on ‘supply’ of
goods or services as against the old concept on the
manufacture of goods or on sale of goods or on provision of
services.
• Destination based Taxation: GST is based on the principle of
destination-based consumption taxation as against the
present principle of origin-based taxation.
• Dual GST: It is a dual GST with the Centre and the States
simultaneously levying tax on a common base. GST to be
levied by the Centre is called Central GST (CGST) and that to
be levied by the States is called State GST (SGST).
• Central GST to cover Excise duty, Service tax etc, State GST
to cover VAT, luxury tax etc.
• Integrated GST to cover inter-state trade. IGST per se is not
a tax but a system to coordinate state and union taxes.
• GST Council (Article 279A)

• GST Council to be formed by the President.
• It's Chairman is Union Finance Minister of India with
ministers nominated by the state governments as its
members.
• The council is devised in such a way that the centre
will have 1/3rd voting power and the states have 2/3rd.
• The decisions are taken by 3/4th majority.
Reforms Brought About by GST

• Creation of common national market: By amalgamating a
large number of Central and State taxes into a single tax.
• Mitigation of cascading effect: GST mitigated ill effects of

cascading or double taxation in a major way and paved the
way for a common national market.
• Reduction in Tax burden: From the consumers’ point of
view, the biggest advantage would be in terms of reduction
in the overall tax burden on goods.
• Easier to administer: Because of the transparent and self-
policing character of GST, it would be easier to administer.
Fiscal Responsibility & Budget Management

Act, 2003
Fiscal Responsibility and Budget Management Act, 2003:

Concerned over the deterioration in the fiscal situation, in 2000,
the Government of India had set up a Committee to recommend
draft legislation for fiscal responsibility.
• The Act envisages the setting of limits on the Central
government’s debt and deficits.
• It limited the fiscal deficit to 3% of the GDP.
• It was mandated by the act that the following must be
placed along with the Budget documents annually in the
Parliament:
1. Macroeconomic Framework Statement
2. Medium Term Fiscal Policy Statement and
3. Fiscal Policy Strategy Statement
The main features of the legislation are:

1. Central Government to take appropriate measures to reduce
the fiscal deficit and revenue deficit so as to eliminate revenue
deficit by March 31, 2008 and thereafter build up adequate
revenue surplus.
2. The revenue deficit and fiscal deficit may exceed the targets
specified in the rules only on grounds of national security or
national calamity or such other exceptional grounds as the Central
Government may specify.
3. The Central Government shall not borrow from the Reserve
Bank of India except by way of advances to meet temporary excess
of cash disbursements over cash receipts.
4. Central Government to take suitable measures to ensure

greater transparency in its fiscal operations.
5. Central government to lay in each financial year before both
Houses of Parliament three statements viz., Medium Term Fiscal
Policy Statement, Fiscal Policy Strategy Statement and
Macroeconomic Framework Statement along with the Annual
Financial Statement and Demands for Grants
6. Finance Minister to make a quarterly review of trends in
receipts and expenditure in relation to the Budget and place the
review before both Houses of Parliament.
Committees on the Fiscal Responsibility and Budget

Management Act:
In the year 2016, the NK Singh committee was set up by the
government to review the performance of the FRBM Act and
suggest the necessary changes to the provisions of the act. The
recommendations of the committee was that the government
must target a fiscal deficit of 3 percent of the GDP in years up to
March 31, 2020, subsequently cut it to 2.8 percent in 2020-21 and
2.5 percent by 2023.
CAG- Constitutional Provision & DPC
First CAG- V. Narhari Rao

Current CAG- Shri Girish Chandra Murmu
Article 148:
 CAG of India would be appointed by President. CAG can be removed
from office in a manner and on grounds like Judge of a Supreme Court.
 Third schedule has the oath of affirmation for CAG
 Salary and other conditions of work to be defined by a Law made by
the Parliament. Salary specified in second schedule
 Once left office, CAG is not eligible for a Union Government jobs or
State Government jobs.
 Conditions of service of persons serving in the Indian Audit and
Accounts Department and the administrative powers of the Comptroller
and Auditor-General are prescribed by President after consultation with
CAG, subject to any law by parliament.
 Expenses and salary of CAG and CAG office is charged from
Consolidated Fund of India.
Article 149: Duties and Powers of CAG include checking accounts of

Union and States and / or other body prescribed in the Law made by the
Parliament.
Article 150: The accounts of Union and States will be kept in such a
way that is prescribed by the President on advice of the CAG.
Article 151:
 Report of CAG of Union Accounts to be submitted to President who
causes them to be laid before each house of parliament
 Report of CAG of State Accounts to be submitted to Governor who
causes them to be laid before state legislature.
CAG’s (DPC) Act, 1971

As per the provisions of the constitution, the CAG’s (DPC) (Duties,
Powers and Conditions of Service) Act, 1971 was enacted. As per the
various provisions, the duties of the CAG include the audit of:
 Receipts and expenditure from the Consolidated Fund of India and of
the State and Union Territory having legislative assembly;
 Trading, manufacturing, profit and loss accounts and balance sheets,
and other subsidiary accounts kept in any Government department;
 Accounts of stores and stock kept in Government offices or
departments;
 Government companies as per the provisions of the Companies Act,
1956;
 Corporations established by or under laws made by Parliament in
accordance with the provisions of the respective legislation;
 Authorities and bodies substantially financed from the Consolidated
Funds of the Union and State Governments;
 Anybody or authority even though not substantially financed from the

Consolidated Fund, the audit of which may be entrusted to the C&AG;
 Grants and loans given by Government to bodies and authorities for
specific purposes; and
 Entrusted audits e.g. those of Panchayati Raj Institutions and Urban
Local Bodies under Technical Guidance & Support (TGS).
Audit Reports by CAG:

The C&AG presents one or more volumes of his Audit Reports to
Parliament/State legislatures and Union Territories with legislative
assemblies under the sectors as shown in the following graphics:
Powers of CAG in context with the companies:

The Companies Act, 1956 empowers the C&AG to:
 Appoint/ re-appoint the auditors of a Government company;
 Direct the manner in which accounts shall be audited;
 Give such instructions to the auditors in regard to any matter relating to
audit;
 To conduct a supplementary or test audit of the accounts; and
 To comment upon or supplement the audit report of the statutory
auditors.
An Audit Advisory Board has been set up under the Chairmanship of the
C&AG, which consists of eminent persons in diverse fields. Its structure
is as follows:
 Chairman is CAG
 Member Secretary is Director General (Audit) in the office of the
C&AG
 Deputy Comptroller and Auditors General [ex-officio members]

 Other members eminent personalities in diverse fields. Term is 2 years
for each.
Current procedure of Appointment of CAG

At present, the Comptroller and Auditor-General of India is appointed
by the President of India following a recommendation by the Prime
Minister.
Finance Commission (Article 280)
Finance Commission was established in the year 1951 under

Article 280 of the Indian Constitution by the President of India. It
was formed to define the financial relations between the centre and
the state.
The objective of forming the Finance Commission was to
allocate resources of the revenue between the Union and the State
Governments in India adequately.
Composition of Finance Commission of India:

1. One Chairman-: The Chairman is the person who heads the
Commission. The Chairman of the Finance Commission is
selected among persons who have had the experience of
public affairs.
2. Four Other Members-: Four other members are selected
among persons who- are, or have been, or are qualified as
judges of High Courts of India, or have knowledge of finance,
or have vast experience in financial matters and are in
administration, or have knowledge of economics
3. One Secretary
Note: All the appointments are made by the President of India.
A member can be disqualified on the following grounds- when a
member is found to be of unsound mind, is involved in a vile act or
if his interests are likely to affect the functioning of the
Commission.
The tenure of the office of the Member of the Finance Commission
is specified by the President of India. The members can also be
re-appointed.
The members shall give part time or whole time service to the
Commission as scheduled by the President.
The salary of the members of the Finance Commission is
according to the provisions led down by the Constitution of India.
Powers, Functions and Responsibilities

The Commission has been given adequate powers in the
exercise of its function and within its area of activity. It has all the
powers of the Civil Court. It can call any witness, or can ask for the
production of any public record or document from any court or
office. It can ask any person to give information or document on
matters as it may feel to be useful or relevant. It can function as a
civil court in discharging its duties.
Functions: The Finance Commission is required to make
recommendations to the president of India on the following matters:
• The distribution of the net proceeds of taxes to be shared between
the Centre and the states, and the allocation between the states of
the respective shares of such proceeds.
• The principles that should govern the grants-in-aid to the states by
the Centre (i.e., out of the consolidated fund of India).
• The measures needed to augment the consolidated fund of a state
to supplement the resources of the panchayats and the
municipalities in the state on the basis of the recommendations
made by the state finance commission.
• Any other matter referred to it by the president in the interests of
sound finance.
The commission submits its report to the president. He lays it before
both the Houses of Parliament along with an explanatory
memorandum as to the action taken on its recommendations.
Advisory Role: The recommendations made by the Finance

Commission are only of advisory nature and hence, not binding on
the government. It is up to the Union government to implement its
recommendations on granting money to the states.
Accounting Principles & Assumptions
Generally Accepted Accounting Principles

• Basic assumptions underlying the theory and practice of financial accounting
• Broad working rules for all accounting activities and developed by the accounting
profession.
The Basic Accounting Concepts are:

1. Accounting Entity Concept-: According to this Assumption business is treated as
unit or entity apart from its Owner, Creditors and others. Even the Proprietor of
the business is considered to be separate and distinct from the business which he
controls. He is treated as a Creditor to the extent of his Capital.
2. Money Measurement Concept-: In Accounting, only those business transactions

and events which are of financial nature are recorded.
3. Going Concern Concept: According to this Assumption the business will exist for
a long period and transactions are recorded from this point of view. There is
neither the intention nor the necessity to wind up the business in the
foreseeable future.
4. Cost Concept (Historical Cost Concept)-: Under this Concept assets are recorded
at the price paid to acquire them and this cost is the basis for all subsequent
accounting for the Asset.
5. Dual Aspect Concept: Dual Aspect Principle is the basis for Double Entry System
of Bookkeeping. All business transactions recorded in accounts have two aspects
debit side and credit side.
6. Accounting Period Concept: The accounts are closed at regular intervals. Usually
a period of 365 days or one year is considered as the Accounting Period.
7. Revenue Realisation Concept: According to this Concept, Revenue is considered

as the Income earned on the date when it is realised. Unearned or unrealized
income should not be taken into account.
8. Accrual Concept: According to this concept, revenues are recognized when they
become receivable though cash is not received, and the expenses are recognized
when they become payable though no cash is paid immediately.
9. Matching Concept-: Matching the revenue earned during an Accounting period with
the cost associated with the period to ascertain the result of the business concern is
called the Matching Concept. Matching Concept is the basis for finding accurate
profit for period.
Profit or income is calculated primarily with the help of 2 items:

Revenue & b) Expense items.
Profit = Revenue – Expense
For profit (loss) determination, the revenue and the expense incurred to earn the
revenue must belong to the same accounting period.
10. Verifiable and Objective Evidence Concept-: This Principle requires that each
recorded business transactions in the books of accounts should have an
adequate evidence to support it.
MODIFYING PRINCIPLES: -
1. Cost benefit Principle-: This modifying Principle states that the cost of
applying a principal should not be more than the benefit derived from it.
2. Materiality Convention-: The Materiality Convention requires all relatively

relevant information should be disclosed in the Financial Statements. The
immaterial information are either left out or merged with other items.
3. Consistency Convention-: The same accounting practices will be used for

similar items from one accounting period to another. The aim of Consistency
Convention is to preserve the compatibility of Financial Statement.
4. Prudence Convention (Conservatism Convention)-: Prudence Convention

takes into consideration all prospective losses but leaves all perspective
profits. The essence of this Principle is "anticipate no profit and provide for all
possible losses".
5. Full Disclosure Concept-: Accounting Statements should disclose fully and

completely all the significant information.
Introduction to Accounting
Why Accounting is required?
The businessman wants to know:-
1. What has happened to his business?

2. What are the earnings and expenses?
3. What is result of the business transactions?
4. How much amount is receivable from customers to whom goods have been sold on
credit? etc.
Definition: Accounting is defined as the process of identifying, and communicating

economic information to permit informed judgement and decisions by users of the
information.
Accounting Embraces the Following Functions:

1.Identifying-: From the source documents.
2.Recording-: In Journal or Subsidiary Books
3.Classifying-: To group the transactions of similar type at one place, that is, in
Ledger accounts.
3.Preparing Trial Balance to verify the arithmetical accuracy of the accounts.
4.Summarising-: Preparation of Profit and Loss Account and Balance Sheet.
5.Analysing-: The purpose of analysing is to identify the financial strength and weakness of
the business.
6. Interpreting
7.Communicating-: Result is communicated to the interested parties.
Accounting Overview:
When a businessman starts his business activities, he records the day-to-day transactions in
the journal. From the Journal the transactions further move to the Ledger where accounts
are written up.
To prove the accuracy of the work done, these balances of Ledgers are transferred to a
statement called Trial Balance. Preparation of Trading and Profit and Loss Account is the
next step. The balancing of Profit and Loss account gives the net result of the business
transactions. To know the financial position of the business concern Balance Sheet is
prepared at the end.
Users of Accounting Information-:

1. Internal user -: Those individuals or groups who are within the organization like:
a) Owners-: to know the Profitability and financial soundness of the business.

b) Management- to take the decisions to manage the business efficiently.
c) Employees and Trade Unions- to form judgement about the earning capacity of the
business since their remuneration and bonus depend on it.
2. External user -: Those individuals or groups who are outside the organisation like
creditors, investors. Some of them are:
a) Present investor- to know the position and prosperity of the business in order to ensure
the safety of their investment.

b) Potential investor-: To decide whether to invest in the business or not.
c) Government & Tax Authorities-: To know the earning in order to assess the tax
liabilities of the business.
d) Regulatory Agencies
e) Researchers
f) Banks-: To determine whether the principal and the interest thereof will be paid in
when due.
Limitations Of Financial Accounting:

1. Accounting is not fully exact: Although most of the transactions are recorded on the basis
of evidence, some estimates are also made for ascertaining Profit or Loss.
2. Accounting does not indicate the realisable value. Balance Sheet does not show the
amount of cash which the firm may realise by the sale of all the assets, because many assets
are not meant to be sold.
3. Accounting ignores the qualitative elements. Accounting is confined to monetary
matters only.
4. Accounting may lead to window dressing: Window dressing means manipulation of
account.
5. Financial Accounting does not provide detailed analysis.
Basic Accounting Terms
Transactions: Those activities of a business which involve transfer of money or goods or

services between two persons or two accounts.
Cash Transactions: Cash Receipt or Cash Payment is involved in the transaction.

Example: Ram buys goods from Shyam paying the price of goods by cash immediately.
Credit Transactions: Cash is not involved immediately but will be paid later or received
later.
Proprietor: A person who owns a business is called Proprietor. He contributes Capital to the
business with the intention of earning Profit.
Capital: An amount invested by Proprietor (Owner) in his business.
Drawing: Drawing is the amount of cash or value of goods withdrawn from the business by
the proprietor for his personal use. It is deducted from the Capital.
Asset: Properties of every type belonging to the business.
Example: Cash, Plant & Machinery, Furnitures, Bank Balance, etc.
Tangible Assets: Assets having physical appearance. It can be seen and touched. Example:
Plant & Machinery, Cash, etc.
Intangible Assets: Assets having no physical existence but their possession give rise to some
sort of rights & benefits to the owner. It cannot be seen and touched. Example: Goodwill,
Patent, Copyright, etc.
Liabilities: Financial obligations of a business. These are the amount which a business owes
to others. Example: Loan from Bank or other persons, Creditors for goods supplied, Bank
overdraft, etc.
Debtors: A person which receives goods or service without giving money immediately but is
liable to pay in future is a debtor.
Example: Mr. A bought goods on credit from Mr. B for Rs. 10,000. Mr. A is debtor to Mr. B
till he pays the value of the goods.
Creditors: A person who gives a benefit without receiving money but he will take it in future
is a Creditor.
Purchases: Purchases refer to the amount of goods bought by a business for resale or for
use in the production.
Cash Purchases & Credit Purchases
Purchase Return or Return Outward:

When goods are returned to supplier due to defective quality or not as per the terms of
purchase, it is called Purchase Return.
Sales: Amount of goods sold that are already bought or manufactured by the business.
Cash Sale:
Credit Sale:
Sales Return or Return Inwards: When goods are returned by customers due to defective
quality or not as per the terms of sale, it is called Sales Return.
Stock: Stock includes goods unsold on a particular date.
Opening Stock:
Closing Stock:
Revenue: Revenue means amount receivable or realized from sale of goods and earning
from interest, dividend, commission, etc.
Expense: It is an amount spent in order to produce and sell the goods and service. Example:
Purchase of Raw Material, Payment of Salaries, etc.
Income = Revenue - Expense
Single Entry & Double Entry System
1.Single Entry System is an incomplete, inaccurate, unscientific and
unsystematic system of book keeping.
2.The double aspects of business transactions are not recorded.
3.It maintains only personal and cash accounts. Real and nominal accounts
are not maintained. Therefore Balance Sheet & Profit & Loss Account cannot
be prepared.
4.Trial Balance cannot be prepared.
Date Particulars Revenue Expenses
8 April Salary Rs. 3,000
25 April Purchase of Goods Rs 18000
27 May Sale of Goods Rs 10890
5.It is a defective double entry system used by small trading concerns.

6.True financial position & Performance of the business cannot be
ascertained.
7.This system lacks uniformity as it is a mere adjustment ofdouble entry
system, according to the convenience of the individual. Therefore, profit
under this system is only an estimate.
8.Not accepted by tax authorities.
9.For information one has to depend on original vouchers. For example to
know total purchases and sales, one has to depend on copies of invoices.
10.All business transactions are notrecorded in the books of account. Some of
them are recorded in the books of accounts, certain transactions are noted in
the diary and some of them are in the memories.
11.Comparison with previous years performance is not possible.
12.Difficulty in obtaining loan
13.Difficult to locate frauds
14.Difficult to determine the price of the business

15.Suitable for small traders.
Double Entry System:
The basic principle of the system is, for every Debit, there must be a
corresponding Credit of equal amount and for every Credit, there must be a
corresponding Debit of equal amount.
Features of Double Entry System
• Every business transaction affects two accounts
• Each transaction has two aspects that is Debit and Credit.
• It is based upon Accounting assumptions concepts and principles.

• Helps in preparing Trial Balance which is a test of arithmetical accuracy
in Accounting.
• Preparation of Final Accounts with the help of Trial Balance.
Advantages of Double Entry System
• Scientific system
• Complete record of transaction
• Check on the accuracy of accounts: By the use of this system the

accuracy of the Accounting work can be established by the
preparation of Trial Balance.
Advantages of Double Entry System

• Ascertainment of profit or loss: The profit earned or loss occured
during a period can be ascertained by the preparation of profit and
loss account.
• Financial position: The financial position of the concern can be

ascertained through the preparation of balance sheet.
• Comparative study: The result of 1 year may be compared with those
of previous years and the reasons for change may be ascertained.
• Helps in decision making: The management may be able to obtain
sufficient information for its work, especially for making decisions.
Weaknesses can be detected and remedial measures may be applied.
• Detection of fraud: The systematic and scientific recording of business
transactions on the basis of this system minimise the chances of fraud.
System Of Accounting
• Cash System Of Accounting
• Accrual System Of Accounting
Classification of Accounts &
Golden Rules Of Accounting
Classification of Accounts:
1. Personal accounts- The accounts that relates to person.
Personal accounts include the following:
Natural Person-: Accounts which relate to individual. For eg. Amit’s
Account, Shyam's Account etc.
Artificial Persons-: Accounts which relate to firms or institutions or
corporations etc. Eg., Pepsico India Ltd., State Bank Of India, Life
Insurance Corporation of India, etc.
Representative Persons-:Eg. prepaid insurance account,
outstanding salary account.
Note-: The proprietor being an individual, his Capital Account and his
Drawing Account are also Personal Account.
Real Accounts-: Accounts relating to properties and assets which are

owned by the business concern. Real accounts include tangible and
intangible accounts. For example, land, building, goodwill, purchases.
Nominal Accounts-: These accounts do not have any existence,

form or shape. They relate to incomes and expenses and gains and
losses of a business concern. For example, salary account, dividend,
discount, etc.
Salary Account
Electricity Bill Account
Rent Account
Proprietor’s Account
Patents Account
Golden Rules Of Accounting
Personal Account: Debit the receiver, Credit the giver.
Real Account: Debit what comes in, Credit what goes out.
Nominal Account: Debit all expenses and losses, Credit all incomes
and gains.
Note: The classification of accounts and Golden Rules of Accountancy
should be remembered very well.
Ledger
Accounting involves recording, classifying and summarising
financial transactions. Recording is done in the Journal and
classification of the recorded transactions is done in the Ledger.
The Journal doesn't provide all the information regarding a
particular account at one place. Hence, to know the summary
of individual accounts Ledger is prepared.
The book which contains a classified and permanent record of
all the transactions of a business is called the Ledger.
Ledger is a main book which is also called the 'Book of
Secondary Entry', because the transactions are finally
incorporated in the Ledger.
Advantage:
1. Complete information at a glance.
2. Helps in preparing Trial Balance.
3. It facilitates the preparation of final accounts for ascertaining
the Operating Result and the Financial Position of the business
concern.
Posting
The process of transferring the entries recorded in Journal or
the Subsidiary Books to the respective accounts opened in the
Ledger is called Posting. (writing entries in Ledger is called
Posting).
Accounting Equation
Accounting Equation is based on dual aspect concept.
According to Accounting Equation, the total Liabilities (claims)
will be equal to the total Assets of the business concern.
Asset=Capital+Liabilities
Assets= Equity
Q.) Aman started business with Rs. 50,000 as capital.

We can express this transaction in the form of accounting
equation as follow:
Asset = Capital + Liabilities
Cash = Capital + Liabilities
50,000=50,000+ 0
Aman purchased furniture for cash Rs. 5,000.
The accounting equation is as follow:

Cash + Furniture = Capital + Liabilities
50,000 + 0 = 50,000 +0
(-)5,000 + 5000 = 50,000 +0
There are two approaches to Double Entry Transactions:
1.Accounting Equation Approach
2.Traditional Approach
Accounting Equation Approach:

The rules may be summarised as follows:
1.Increase in assets are debits;
Decrease in assets are credits.
2. Increase in capitals are credit;
Decrease in capitals are debit
3.Increase in liabilities are credit;
Decrease in liabilities are debit
4.Increase in incomes and gain are credit;
Decrease in incomes and gain are debits.
5.Increase in expenses and losses are debited;
Decrease in expenses and losses are credits.
In traditional approach, all the Accounts are classified into the

following three types.
a. Personal Accounts
b. Real Account
c. Nominal Accounts
Journal
Accounting Equation
Accounting Equation is based on dual aspect concept. According to
Accounting Equation, the total Liabilities (claims) will be equal to
the total Assets of the business concern.
Asset= Capital +Liabilities
Assets= Equity
Q.) Aman started business with Rs. 50,000 as capital.
We can express this transaction in the form of accounting
equation as follow:
Cash = Capital + Liabilities
50,000=50,000+ 0
Q.) Aman purchased furniture for cash Rs. 5,000.

The accounting equation is as follow:

Cash + Furniture = Capital + Liabilities
50,000 + 0 = 50,000 +0
(-)5,000 + 5000 = 50,000 +0
There are two approaches to Double Entry Transactions:

1. Accounting Equation Approach
2. Traditional Approach
Accounting Equation Approach:

The rules may be summarised as follows:
1. Increase in assets are debits;
Decrease in assets are credits.
2. Increase in capitals are credit;

Decrease in capitals are debit
3. Increase in liabilities are credit;

Decrease in liabilities are debit
4. Increase in incomes and gain are credit;

Decrease in incomes and gain are debits.
5. Increase in expenses and losses are debited;

Decrease in expenses and losses are credits.
In traditional approach, all the Accounts are classified into the

following three types.
a. Personal Accounts
b. Real Account
c. Nominal Accounts
Subsidiary Books
Subsidiary Books
For businesses having large number of transactions it is practically
impossible to write all transactions in one Journal. To address this
issue Subsidiary book is maintained.
Kinds of Subsidiary Book:

1. Purchase Book- Records only credit purchases of goods.
2. Sales Book- Records only credit sales of goods.
3. Purchase Return Book- Records the goods returned by the
trader (out of previous purchases) to supplier.
4. Sales Return Book- Records the goods returned by the
customer (out of previous sales).
5. Cash Book- Records only cash transactions, ie. cash receipt and
cash payment.
6. Bills Receivable Book- Records the receipt of bills (Bills
Receivable).
7. Bills Payable Book- Records the receipt of bills (Bills Payable).
8. Journal Proper- Records all the transactions which cannot be

written in any of the above mentioned subsidiary books.
Bad Debts-: When the goods are sold to customer on Credit and if
the amount becomes irrecoverable due to his insolvency or for
some other reason, the amount not recovered is called bad debts.
For recording it, the bad debt account is debited because the
unrealized amount is a loss to the business and the customers
account is Credited.
Bad debts recovered-: Sometimes, the bad debts previously

written off are subsequently recovered. In such a case, cash
account is debited and bad debts recovered account is Credited
because the amount so received is gain to the business.
Discount: A Reduction in Amount

Trade Discount: This discount is given by seller to buyer if the
buyer purchases in bulk. It is not shown in the books. Only
discount amount will be reduced.
Example: M/s KT Enterprises sold 500 pens to its customer, Mr. A.
The retail price is Rs.10/pen. M/s KT Enterprise gave 20%
discount to its customer. Thus the total retail price of Rs. 5,000
(500*10) will be reduced to Rs. 4,000 (500*8). Here, the trade
discount is Rs. 1,000.
Discount: A Reduction in Amount

Cash Discount:A cash discount is a deduction allowed by some
sellers of goods or by some providers of services in order to
motivate customers to pay within a specified time. The cash
discount is also referred to as an early payment discount.
This Discount will be shown in the books as it is loss to the seller.
Treatment of Cash Discount allowed: Always Debit Cash

Discount
Treatment of Cash Discount received: Always Credit

Cash Discount
Let’s understand it through an example and Journal Entry:

On 15-6-18 M/s MP Enterprises sold 50 pens to its customer, Mr. X
on credit. The retail price is Rs.10/pen. M/s MP Enterprise gave
20% discount to Mr. X on early payment as he paid the money on
18-6-18. Here, the cash discount is Rs. 100.
Trial Balance
TRIAL BALANCE AND RECTIFICATION OF ERRORS

After Recording and Classifying the transactions, the next step is to
check arithmetical accuracy of the transactions recorded. Trial
Balance is a statement which shows debit balances and credit
balances of all accounts present in the ledger. Since, every debit
should have a corresponding credit as per the rules of double
entry system, the total of the debit balances and the credit
balances should tally.
Note:
1. Trial balance can be prepared on any date.
2. Trial Balance is made from Ledger & Subsidiary Books.
3. The purpose to prepare trial balance is to check the arithmetical
accuracy of the accounts.
Objectives Of Trial Balance:

1. To check the arithmetical accuracy of the Ledger Account.
2. To locate the Errors.
3. To facilitate the preparations of Final Accounts (P&L A/c &
Balance Sheet).
4. It is the basis on which Final Accounts are prepared.
Note:
1) A Debit balance is either an asset or loss or expense.
2) A Credit balance is either a liability or income or gain.
Limitations of Trial Balance:-

1. As all the Errors made are not disclosed by the Trial Balance,
it would not be regarded as a conclusive proof of
correctness of the books of accounts maintained.
The fundamental Principle of the double entry system is that
every debit has a corresponding credit of equal amount and
vice versa. The total of all debit balances in different
accounts must be equal to the total of all credit balances in
different accounts, that is, the total of the two columns
should tally.
Illustration: The following balances are extracted from the ledger
of Amit on 31 March 2019. Prepare a trial balance as on that date.
Salaries 36,320 Repairs 1670

Purchases 1,44,670 Capital 1-4-19 62,500
Sales 1,73,500 Sundry Expenses 460
Sundry Debtors 1,430 Drawings 3,500
Plant & Machinery 34,300 Returns Inward 1,000
Travelling Expenses 2,630 Cash at Bank 1,090
Commission Paid 1,880 Discount Allowed 1,150
Carriage Inward 240 Returns Outward 400
Stock on 1-4-19 11,100 Rent and Rates 3,220
Sundry Creditors 14,260 Investments 6,000
Trial Balance-Kind of Error & Rectification of

Error
Kinds of Error: 1) Errors of Principle and 2) Clerical Errors
Errors of Principle: Transactions are recorded as per Generally
Accepted Accounting Principles (GAAP). If any of these Principles
is violated or ignored, Errors resulting from such violations are
known as Errors of Principle.
Eg.- Purchase of assets recorded in the Purchases Book.
Note: A Trial Balance will not disclose Errors of Principle.
Clerical Errors: These Errors arise because of mistake committed in

the ordinary course of accounting work. These can be further
classified into:
a) Errors of Omission b) Error of Commission
Errors of Omission: This Error arises when a transaction is

completely or partially omitted to be recorded in the books of
accounts. Errors of Omission may be classified as below:
1. Error of Complete Omission 2. Error of Partial Omission
1. Error of Complete Omission: Example, goods purchased but not

completely recorded. This
Error does not affect trial balance.
2. Error of Partial Omission: This Error arises when one aspect of

the transaction, either debit or credit is recorded. Example - a
Credit sale of goods to Shiva recorded in sales book but not posted
in Siva's account. This Error affects the Trial Balance.
Error Of Commission: This Error arises due to wrong Recording,

wrong Posting, wrong Casting, wrong balancing, wrong carrying
forward. Error of commission may be classified as follows: (i) Error
of Recording (ii) Error of Posting
Error Of Recording: This Error arises when a transaction is wrongly

recorded in the Books of Original Entry. Eg.- goods of Rs. 5000
purchase on credit from Ravi, is recorded as Rs. 5500.
Note: This Error does not affect the trial balance.
(ii) Error of Posting: This Error arises when information in the

books of original entry are wrongly entered.
a) Right amount in the right side of wrong account.
b) Right amount in the wrong side of correct account.
c) Wrong amount in the right side of correct account.
d) Wrong amount in the wrong side of correct account.
e) Wrong amount in the correct side of wrong account.
f) Wrong amount in the wrong side of wrong account.
Note: This Error may or may not affect the Trial Balance
Error of Casting (totalling): This Error appears when a mistake is

committed while totalling an account. Eg.- A total of Rs. 12,000
may be wrongly totalled as Rs. 10,000 is called Under Casting. If it
is wrongly totalled as rupees 13,000 it is called Over Casting.
Error of Carrying Forward - When a mistake is committed in

carrying forward a total of 1 page to the next page. Total of
purchase book in page 282 of the ledger Rs. 10686, while carrying
forward the balance to the next page it was recorded as rupees
10866.
Compensating Error:-The Errors arising from excess debit or under

debit of accounts being neutralized by the excess credit or under
credits to the same extent of some other account is compensating
Error such that the Errors in one direction are compensated by
Errors in another direction.
Example - If the purchase book and sales book are both overcast
by rupees 10000, the Error mutually compensate each other.
Note: 1. This Error will not affect the agreement of Trial Balance.
2. Arithemetical accuracy of the Trial Balance is not at all affected

in spite of such Errors.
Suspense Account: When it is difficult to locate the mistake before

preparing the final accounts, the difference is transferred to newly
opened imaginary and temporary account called Suspense
Account. Suspense Account is prepared to avoid the delay in the
preparation of final accounts. If the total Debit balance of the Trial
Balance exceeds the total Credit balance the difference is
transferred to the credit side of suspense account. On the other
hand, if total credit balances of the trial balance exceed the total
debit balances the difference is transferred to the debit side of the
suspense account.
Suspense account is continued in the book until the Errors are

located and rectified. Such balance will be shown in the balance
sheet. Debit balance will be shown on the assets side and the
credit balance will be shown on the liabilities side. When all the
Errors affecting the trial balance are located and rectified, the
suspense account automatically gets closed.
Note: Types of Errors and Rectification of Errors is very important.
One must memorize well the Errors that are disclosed by trial
balance and the Error that are not disclosed by trial balance.
Illustration:
Rectify the following errors:
1. Purchases from Ravi for Rs. 500 has been posted to the debit
side of his account.
2. Sale to Nihal for Rs.120 has been posted to his credit as Rs.102.
3. Purchase from Simran for Rs.750 has been omitted to be posted
to the personal A/c.
Illustration: The following errors were found in the books of

Sujata. Give the necessary entries to correct them:
1. Salary of Rs. 8,000 paid to Tripti has been debited to her
personal account.
2. Rs.50,000 paid for a laptop was charged to purchases account.
3. Rs.8,000 paid for furniture purchased has been charged to office
expenses account.
4. Repairs made were charged to machinery account for Rs.4,500.
5. An amount of Rs.2,000 withdrawn by the proprietor for his
personal use has been debited to trade expenses account.
6. Rs.2,000 received from Raghu. has been wrongly entered as
from Raghav.
Cash Book
Cash Book is a special journal which is used for recording all Cash Receipts
and Cash Payments. The Cash Book is a book of Original Entry or Prime
Entry since transactions are recorded for the first time from the Source
Documents.
The Cash Book is considered as a Ledger also.
The total of the receipt column (debit side) will always be greater than the
total of the payment column (credit side). The difference will be written on
the credit side as "by balance c/d
Cash Book are of three types:

1) Single Column Cash Book
2) Double Column Cash Book
3) Triple Column Cash Book
Illustration: Enter the following transactions in Single Column Cash Book of

M/s. Mini Pig Co.
1-5-18 Started business with cash Rs. 1,000
3-5-18 Purchased goods for cash Rs. 500
5-5-18 Sold goods for cash Rs. 1,700
7-5-18 Cash received from Juli Rs. 200
8-5-18 Paid Balan Rs. 150
9-5-18 Bought furniture Rs. 200
10-5-18 Purchased goods from Ravi on credit Rs. 2,000
Note: Cash Book is also a Ledger of Cash a/c. The above posting can be
done after writing Journal Entry also.
Illustration: Prepare a double column cash book from the following

transactions of Mr. Atul
5-7-18 Cash in hand Rs. 4,000
6-7-18 Cash Purchases Rs. 2,000
10-7-18 Wages Paid Rs. 40
12-7-18 Cash received from Sidhu Rs. 1,980 and allowed him discount Rs.
20
13-7-18 Cash paid to Soni Rs. 2,470 and received discount Rs. 30
14-7-18 Cash Sales Rs. 6,000
Illustration: Prepare Triple Column Cash Book of Mr. Arush from the
following transactions:
1-6-18 Cash in Hand Rs. 30,000
Bank Balance Rs. 1,000
2-6-18 Ravi, our customer, has paid directly into our bank a/c Rs. 5,000
3-6-18 Paid rent by cheque Rs. 500
4-6-18 Cheque issued to Juneja Rs. 2,400
5-6-18 Recd. from Aman Rs. 2,225 Disc. allowed Rs. 75
6-6-18 Paid into bank Rs. 4,000
7-6-18 Cash withdrawn from bank Rs. 2,000
Note: When cash is deposited into bank, cash balance will decrease but
bank balance will increase. The transaction “Cash deposited into Bank” will
have two side effect on Cash Book. In the debit side of Cash Book, we will
debit Bank Column, whereas in credit side we will credit Cash Column.
Bank Reconciliation Statement
Bank Passbook: Bank Passbook is merely a copy of the customer's account

in the books of a bank. It shows all the deposit, withdrawal and the
balance available in the customer's account. In the Particulars column
Withdrawal and Deposits are recorded.
BANK RECONCILIATION STATEMENT

The balance of the bank column in the double or triple column cash book
represents the customers cash balance at Bank. It should be the same as
shown by his bank passbook on any particular day. For every entry made in
the cash book if there is a corresponding entry in the pass book
(maintained by the banker) or vice a versa, the bank balance will be the
same in both the books.
The Cash book and the Pass book are maintained by two different parties
and hence it is not certain that entry in one book will always have a
corresponding entry in the other. Normally entries in the cash book should
tally (agree) with those in the passbook and the balances shown by both
the books should be the same. In case of disagreement in the balance of
the cash book and the pass book, the need for preparing bank
reconciliation statement arises.
Need of Bank Reconciliation Statement

1. The errors that might have taken place in the cash book in connection
with bank transaction
can be easily found.
2. Regular preparation of bank reconciliation statement prevents frauds.
3. It indirectly imposes moral check on the accounting staff.
4. By the preparation of bank reconciliation statement, uncredited
cheques can be detected and steps can be taken for their collection.
Cause of Disagreement between the Balances shown by the Cash Book

and the Balances shown by the Passbook:
1. Cheques paid into bank but not yet collected.
2. Cheques Issued but not yet presented for payment.
3. Amount credited by the bank in the passbook without the
immediate knowledge of the customer.
4. Amount debited by the bank in the passbook without the
immediate knowledge of the customer.
5. Bank Overdraft:
Bank Overdraft
Bank Overdraft is an amount drawn over and above the actual balance
kept in the bank account. This facility is available only to the current
account holders. Interest will be charged for the amount overdrawn, ie.,
overdraft.
The cash book will show a credit balance that is, unfavourable balance. The
passbook will show a Debit balance.
Case 1: When balance as per cash book favourable is given: Example:

From following details, prepare B R S for M/s ABC as on 31-3-19 to find out
balance as per pass book.
1. Cheques deposited but not yet collected by the bank Rs. 1,500
2. Cheque issued to Mr. Raju has not yet been presented for payment Rs.
2,500
3. Bank charges debited in the pass book Rs. 200
4. Interest allowed by the bank Rs.100
5. Insurance premium directly paid by the bank as per standing
instructions Rs. 500
6. Balance as per cash book Rs. 200
Case 2) Balance as per pass book (favourable) is given

Prepare Bank Reconciliation Statement and ascertain the balance as per
Cash Book in the following case. Mr. Amit’s Pass Book showed a balance of
Rs. 25,000 on 20-6-2019. His cash book shows a different balance. On
examination, it is found that:
1. No record has been made in the cash book for a dishonour of a cheque
of Rs. 250.
2. Cheques paid into Bank amounting to Rs. 3,500 on 15 June 2019 and the
same had not been entered in the passbook.
3. Bank charges of Rs. 300 have not been entered in the cash book.
4. Cheques amounting to Rs. 9000 issued to Mr. Harish has not been
presented for payment still.
5. Mr. Kishan who owed Rs. 3000 has directly paid the sum into the bank
account.
Case 3) When overdraft as per cash book is given:

Prepare a Bank Reconciliation Statement as at 15-6-2019 for M/s Jyoti
Sales Private Limited from the information given below:
1. Bank overdraft as per cash book Rs. 1,10,450
2. Cheques issued on 8-6-2019 but not yet presented for payment Rs.
15,000.
3. Cheques deposited but not yet credited by bank Rs. 22,750.
4. Bills receivable directly collected by bank Rs. 47,200.
5. Interest on overdraft debited by bank 12,115.
6. Amount wrongly debited by bank 2,400.
Case 4) When Overdraft as per Pass Book is given:

Prepare Bank Reconciliation Statement from the following information and
find balance as per Cash Book.
1) Bank Overdraft as on 31-3-2019 as per pass book Rs. 6,500.
2) Cheques amounting to Rs. 15,000 were paid into Bank out of which,
only cheques amounting to Rs. 4,500 was credited by the bank.
3) Cheques issued during March amounted in all to Rs. 11,000, out of
these, cheques amounting to Rs. 3,000 were unpaid till March 31 2019.
4) The account stands debited with Rs. 150 for interest and Rs. 30 for bank
charges.
5) The bank has paid the annual subscription of Rs. 100 to club according
to instructions.
Depreciation
Depreciation
Generally, the term ‘depreciation’ is used to denote decrease in
value, but in accounting, this term is used to denote decrease in
the book value of a fixed asset.
Need for Providing Depreciation

1. To ascertain correct profit / loss:
For proper matching of cost with revenues, it is necessary to
charge depreciation against revenue in each accounting year, to
calculate the correct net profit or net loss.
2. To present a true and fair view of the financial position:
If the amount of depreciation is not provided on fixed assets in the
books of account, the value of fixed assets will be shown at a
higher value than its real value in the balance sheet.
3. To ascertain the real cost of production:
For ascertaining the real cost of production, it is necessary to
provide depreciation.
4. To comply with legal requirements
Causes of Depreciation:
1. Wear and tear: Use of the tangible fixed asset.
2. When a machine is kept continuously idle, it becomes
potentially less useful.
3. The value of machine deteriorates rapidly because of lack of
proper maintenance.
4. Depletion: It refers to the physical deterioration by the

exhaustion of natural resources eg., mines, quarries, oil wells etc.
5. Obsolescence: The old asset will become obsolete (useless) due
to new inventions, improved techniques and technological
advancement.
6. Time Factor: Lease, copy-right, patents are acquired for a fixed
period of time. On the expiry of the fixed period of time, the assets
cease to exist.
Terms used for Depreciation:

1. Amortization: This refers to loss in the value of intangible assets
such as goodwill, patents and preliminary expenses.
2. Depletion: Decrease in the value of mineral wealth such as coal,
oil, iron ore, etc. is termed as depletion.
3. Obsolescence: When an asset becomes useless due to new
inventions, improved techniques and technological advances, it is
termed as obsolescence.
Methods of Calculating Depreciation:

1. Straight line method or fixed instalment method.
2. Written down value method or diminishing balance method
3. Annuity method.
4. Depreciation Fund method.
5. Insurance Policy method.
6. Revaluation method
Straight Line Method or Fixed Instalment Method or Original Cost

Method
The same amount of depreciation is charged every year
throughout the life of the asset.
Merits:
1. Simplicity: It is very simple and easy to understand.
2. Easy to calculate: It is easy to calculate the amount and rate of
depreciation.
3. Assets can be completely written off: Under this method, the
book value of the asset becomes zero or equal to its scrap value at
the expiry of its useful life.
Demerits:
The amount of depreciation is same in all the years, although the
usefulness of the machine to the business is more in the initial
years than in the later years.
Illustration :
Raheem & Co. purchased a fixed asset on 1.4.2000 for
Rs.2,50,000. Depreciation is to be provided @10% annually
according to the Straight line method. The books are closed on
31st March every year.
Pass the necessary journal entries, prepare Fixed asset Account
and Depreciation Account for the first three years.
Written Down Value Method or Diminishing Balance Method or

Reducing Balance Method
Under this method, depreciation is charged at a fixed percentage
each year. The amount of depreciation goes on decreasing every
year.
Attention Please: Under Written Down Value Method, scrap value
is not deducted and depreciation is calculated on the original cost.
Merits:
1. Uniform effect on the Profit and Loss account of different
years: The total charge (i.e., depreciation plus repairs and
renewals) remains almost uniform year after year, since in earlier
years the amount of depreciation is more and the amount of
repairs and renewals is less, whereas in later years the amount of
depreciation is less and the amount of repairs and renewals is
more.
2. Recognised by the Income Tax authorities: This method is
recognised by the Income Tax authorities
3. Logical Method: It is a logical method as the depreciation is
calculated on the diminished balance every year.
Demerits:
It is very difficult to determine the rate by which the value of asset
could be written down to zero.
Illustration :
A Company purchased Machinery for Rs.50,000 on 1st April 2002.
It is depreciated at 10% per annum on Written Down Value
method. The accounting year ends on 31st March of every year.
Pass necessary Journal entries, prepare Machinery account and
Depreciation account for three years.
Annuity Method:
 The annuity method considers that the business besides
loosing the original cost of the asset in terms of
depreciation, also looses interest on the amount used for
buying the asset.
 This is based on the assumption that the amount invested in
the asset would have earned in case the same amount
would have been invested in some other form of
investment.
 This method is used to calculate depreciation amount on
lease.
Depreciation Fund Method or Sinking Fund Method :

Under this method, funds are made available for the replacement
of asset at the end of its useful life.
 The depreciation remains the same year after year and is
charged to Profit and Loss account every year through the
creation of depreciation fund.
 The amount of annual depreciation is invested in good
securities bearing interest at a specified rate.
 ·When the asset is to be replaced, the securities are sold and
the amount so realised by selling securities is used to
replace the old asset
Insurance Policy Method:

 According to this method, an Insurance policy is taken for
the amount of the asset to be replaced.
 The amount of the policy is such that it is sufficient to
replace the asset when it is worn out.
 A sum equal to the amount of depreciation is paid as

premium every year. The amount is received on maturity.
 The amount so received is used for the purchase of new
asset, replacing the old one.
Revaluation Method:
Under this method, the assets like loose tools are revalued at the
end of the accounting period and the same is compared with the
value of the asset at the beginning of the year. The difference is
considered as depreciation.
Recording Depreciation
1. Entry for the amount of depreciation to be provided at the end
of the year:
2) For transferring the amount of depreciation at the end of the
year.
Calculation of Profit or Loss on sale of asset

 This is done by comparing the selling price with the book
value of the asset.
 Book value = Cost Price less Total Depreciation provided till
the date of sale
 If the book value is less than the selling price, then it is Profit
on Sale.
 If the book value is more than the selling price, it is Loss on
Sale.
Illustration :
Robert & Co. purchased a Machinery on 1st April 2002 for
Rs.75,000. After having used it for three years it was sold for
Rs.35,000. Depreciation is to be provided every year at the rate of
10% per annum on Diminishing balance method.
Accounts are closed on 31st March every year. Find out the profit
or loss on sale of machinery.
Illustration :
Deepak Manufacturing Company purchased on 1st April 2002,
Machinery for Rs.2,90,000 and spent Rs.10,000 on its installation.
After having used it for three years it was sold for Rs.2,00,000.
Depreciation is to be provided every year at the rate of 15% per
annum on the Fixed Instalment method.
Pass the necessary journal entries, prepare machinery account and
depreciation account for three years ends on 31st March every
year.
Capital & Revenue Transactions
CAPITAL TRANSACTION & REVENUE TRANSACTION

Business Transactions can be Capital Transactions or Revenue
Transactions. Capital transaction forms part of Balance Sheet
whereas Revenue transaction forms part of Profit and Loss A/c.
That is the reason why we need to classify transactions between
Capital Transaction & Revenue Transaction.
CAPITAL TRANSACTION & REVENUE TRANSACTION

From Trial Balance we make Profit and Loss A/c and Balance Sheet.
Revenue transactions go in Profit and Loss A/c and Capital
Transactions go in Balance Sheet.
Capital Transactions-: The business transactions, which provide

benefit to the business concern for more than one year or one
operating cycle of the business, are known as Capital Transactions.
Capital Transactions are again sub-divided into Capital
Expenditure &Capital Receipt.
Capital Expenditure: Capital Expenditure consists of those

accounting expenditure, the benefit of which is carried over to
several accounting periods. In other words the benefit of it is not
consumed within one accounting period.
Characteristics of Capital Expenditure

1) Not required for sale.
2) It is non-recurring in nature.
3) Incurred to increase the operational efficiency of the
business concern.
4) Purchase of a fixed asset.
Examples of Capital Expenditure:

1) Expenses incurred in the acquisition of, building, machinery,
furniture, goodwill, copyright, patent right, etc.
2) Expenses incurred for increasing the seating accommodation in
a cinema hall.
3) Expenses incurred for installation of fixed asset like wages paid
for installing a plant.
4) Expenses incurred for remodeling and reconditioning an existing
asset like remodeling a building.
Capital Receipt: Capital Receipt is one which is invested in the

business for a long period. It includes long term loan obtained
from others and any amount realised on sale of fixed assets. It is
generally nonrecurring in nature.
Characteristics of Capital Receipt:

1) Amount is not received in the normal course of business.
Examples:
1) Capital introduced by the owner
2) Borrowed Loans 3) Sale of Fixed Asset.
Revenue Transactions:
The business transactions, which provide benefits to a business
concern for an accounting period (one year) only, are known as
Revenue Transactions.
Revenue Transactions can be:

1) Revenue Expenditure; or
2) Revenue Receipt
Revenue Expenditure:
Revenue Expenditure consists of those expenditure, that occur in
the normal course of business. They are incurred in order to
maintain the existing earning capacity of the business and helps in
the upkeep of fixed assets. Generally it is recurring in nature.
Characteristics:
1. It helps in maintaining the earning capacity of the business
concern.
2. It is recurring in nature.
Examples: 1) Cost of goods purchased for resale.

2) Office and Administrative expenses.
3) Selling and Distribution expenses.
4) Depreciation of fixed assets, interest on borrowings etc.
5) Repair, renewals etc.
Revenue Receipt: It is the receipt of income which occurs during

the normal course of business. It is recurring in nature.
Characteristics:
1) It is received in the normal course of business.
2) It is recurring in nature.
Examples:
1) Sale of goods or services.
2) Commission and Discount received.
3) Dividend and Interest received on Investment etc.
Deferred Revenue Expenditure: Heavy Revenue Expenditure,

which may be extended over a number of years, and not for the
current year alone, is called Deferred Revenue Expenditure.
For example, a new firm may advertise very heavily in the
beginning to capture a position in the market. The benefit of this
advertisement campaign will last for quite a few years. It will be
better to write off the expenditure in 3 or 4 years and not only in
the first year.
Characteristics of Deferred Revenue Expenditure :

1) Benefit is enjoyed for more than one year
Examples:
1) Expenses incurred on research and development.
2) Abnormal loss arising out of fire or lightning (in case the
Asset has not been insured)
3) Huge amount spent on advertisement.
Capital profit: Capital profit is the profit which arises not from the
normal course of the business.
Example: Profit on Sale of Fixed Asset.
Revenue Profit: Revenue Profit is the profit which arises from the
normal course of the business that is,
Net Profit = Revenue Receipt – Revenue Expenditure
Capital losses: The losses which arise not from the normal course
of business.
Example: Loss on sale of fixed assets is an example of capital loss.
Revenue losses: The losses that arise from the normal course of
the business. In other words, Net Loss = Revenue Expenditure -
Revenue Receipts.
Bill Of Exchange
BILL OF EXCHANGE: Note: Bill of exchange is an instrument in writing

containing an unconditional order, signed by the maker, directing a certain
person to pay a certain sum of money only to, or to the order of a certain
person or to the bearer of the instrument'.
Thus Bill of Exchange :-

1. is a written document.
2. contains an unconditional order.

3. is an order to pay a certain sum of money.
4. is signed by the drawer.
5. bears a stamp or it is drafted on a stamp paper.

6. is accepted by the acceptor.
7. the amount is paid to drawer or endorsee.
Parties to Bill Of Exchange
1. Drawer:- Prepares the bill

2. Drawee:- Accepts to make the payment
3. Payee:- Who receives the payment (third party over the drawer himself).
Drawing of a bill:-Seller prepares the bill
Due Date:- A bill is payable after a specified period (due date).
Days of grace:- 3 extra days will be given after due date. If the date of
maturity falls on a holiday, the bill will be due for payment on the preceding
date. In case of emergency holiday, the previous day.
Endorsement:- Writing of one's signature on the face or back of a bill for the
purpose of transferring the title of the bill to another person. The person who
endorses is called endorser. The person to whom a bill is endorsed is called
the Endorsee. The Endorsee is entitled to collect the payment.
Discounting:- When the holder of a bill needs money before the due date of a
bill, he can convert it into cash by discounting the bill with his banker. This
process is called discounting the bill. The banker deducts a small amount of
the bill which is called discount and pay the balance in cash immediately to
the holder of the bill.
Retiring of a bill: An acceptor may make the payment of a bill before its due
date and discharges its liability. This is called Retirement of Bill.
Renewal: When the acceptor of a bill knows in advance that he will not be
able to meet the bill on its due date, he may approach the drawer with a
request for extension of time. The drawer of the bill may cancel the original
bill and draw a new bill for the amount due and will charge a little interest for
the extended period. This is called renewal.
Dishonour: Non-payment of the bill, when it is presented for payment.
Noting &Protesting :
• If a bill is dishonoured, the Drawer may approach the court, and file a Suit
against the Drawee.
• In order to collect documentary evidence that the bill has really been
dishonoured, the Drawer will approach a lawyer and explain the fact of
dishonour of Bill.
• The lawyer will take the bill to the drawee and ask for the payment.
•If the drawee does not make the payment, the lawyer will write the
statement of drawer and get the statement signed by him.
• The Lawyer will then put his signature.
• The statement noted by the lawyer will be the documentary evidence for
the dishonour of the Bill.
• Writing this statement by the lawyer is known asNoting of the Bill.
• The lawyer performing this work of Noting the Bill is called as Notary Public.
• After recording a note of dishonour, the notary public issues a certificate
which is called Protest. A Protest is a certificate issued by the notary public
attesting that the Bill has been dishonoured.
After Noting, the lawyer issues a certificate that the bill has been
dishonoured. This certificate is called Protest. Protest is enforceable in the
court of law.
Final Accounts:
Profit & Loss Accounts & Balance Sheet
Final Accounts
The Businessman wants to know whether the business has resulted in Profit
or Loss and what the Financial Position of the business is at a given period. In
short, he wants to know the Profitability and the Financial Soundness of the
business. A trader can ascertain these by preparing the Final Accounts, that is,
Trading and Profit and Loss Account and Balance Sheet.
Parts of Final Accounts:
Trading Account: Trading means buying and selling. The Trading Account
shows the result of buying and selling of goods. Gross Profit or Gross Loss is
calculated by Trading Account.
Profit and Loss Account: This is prepared to find out the Net Result of the
Business, ie., Net Profit or Net Loss
Balance Sheet: This is prepared to know the financial position of the

business.
However Manufacturing concern, prepare Manufacturing Account prior to
the preparation of Trading Account, to find out cost of production.
A trader will first prepare Trading Account and then Profit & Loss Account to
ascertain the result of his business operation at the end of the year.
Example: Prepare Trading Account for the year ended 31-3-19.

Opening Stock Rs. 1,70,000
Purchase Return Rs. 10,000

Sales Rs. 2,50,000
Wages Rs. 50,000
Sales Return Rs. 20,000

Purchases Rs. 1,00,000
Carriage Inwards Rs. 20,000
Closing Stock Rs. 1,60,000
Illustration: From following balances of M/S. Sani Enterprises prepare Profit

and Loss Account for the year ended 31-3-2019.
Office rent Rs. 30,000

Salaries Rs. 80,000
Printing Expenses Rs. 20,000
Gross Profit Rs. 2,50,000
Stationeries Rs. 3,000
Tax, Insurance Rs. 4,000

Discount allowed Rs. 6,000
Advertisement Rs. 36,000
Discount Received Rs. 4,000
Travelling Expenses Rs. 26,000
Note: Trading & PL Account is prepared for a period whereas Trial Balance &
Balance Sheet is prepared at a particular point (date).
Note:
1) If trial balance shows trading expenses as well as office expenses the
trading expenses should be shown in the trading account and office expenses
should be shown in profit and loss account. On the other hand, if the trial
balance shows only trading expenses, it should be shown in the profit and loss
account.
2) If in the trial balance, wages are clubbed with salaries and shown as "wages
and salaries", this item is shown in trading account. On the other hand, if it
appears as 'salaries and wages', this item is recorded in the profit and loss
account.
3) Income Tax paid by a proprietor is considered as personal expenses. It

should be deducted from the capital.
Balance Sheet:
It is a statement showing the Financial Position of a business. Balance Sheet
shows net balance of Assets and Liabilities. Balance Sheet is prepared by
taking up all Personal Accounts and Real Accounts (Assets and Liabilities)
together with the Net Result obtained from Profit and Loss Account.
On the left hand side of the statement, Liabilities and Capital are
shown. On the right hand side, all the Assets are shown.
Balance Sheet is not an Account but it is a Statement.
Q.) From the following Trial Balance of MM Enterprises, prepare Trading,

Profit & Loss Account for the year ended 31-3-19 and Balance Sheet as on
date.
Trial Balance of MM Enterprieses as on 31-3-19
Need for preparing a Balance Sheet is as follows:

1) To know the nature and value of asset of the business
2) To ascertain the total Liabilities of the business.
3) To know the position of Owners Equity.
Format: Horizontal form and Vertical form

Classification of Assets:
Assets: Assets represent everything which a business owns and has money
value.
a) Tangible Assets: Assets which have some physical existence are known as
tangible assets. They can be scene, and felt. Example: plant and machinery.
Tangible assets are classified into:
1) Fixed Assets: Assets which are permanent in nature, having long period of
life and cannot be converted into cash in a short period are termed as fixed
assets.
2) Current Assets: Assets which can be converted into cash in the ordinary
course of business and are held for a short period is known as Current assets.
This is also termed as floating assets. Example, cash in hand, cash and Bank,
sundry debtors etc.
b) Intangible Assets: No physical existence and cannot be seen or touched.

They help to generate revenue in future, example goodwill, patent,
trademark, etc.
c) Fictitious Assets (Fake): These assets are nothing but the Expenses or
Losses which cannot be adjusted during an Accounting Year. They are really
not assets but are worthless items. Example: preliminary expenses.
Classification of Liabilities:
Liabilities: The amount which a business owes to others is liabilities.

a) Long term Liabilities: Liabilities which are repayable after a long period of
time are known as Long Term Liabilities.
b) Current Liabilities: Current liabilities are those which are repayable within
a year. For example, creditors for goods purchased, short term loans etc.
c) Contingent Liabilities: It is an anticipated liability which may or may not

arise in future. For example, liability arising for bills discounted. Contingent
liabilities will not appear in the balance sheet but shown as footnote.
Note: 1) The Assets and liabilities can be shown in the order of permanence.
2)Assets will be said to be liquid if it can be converted into cash easily.
Balance Sheet Equation: In Balance Sheet, the total value of the Assets is
always equal to the total value of Liabilities. This is because the Liability of the
Owner is always made up of the difference between Assets and liabilities.
Thus,
Assets= Liabilities + Capital or,
Capital = Assets- Liabilities

Economics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Economics

Uploaded by

Copyright:

Available Formats

Economics

Economics is divided into two parts:

Microeconomics: When economic problems or economic issues are studied

Vital components of Microeconomics:

Macroeconomics: Macroeconomics refers to the study of economic problems

Difference between Microeconomics and Macroeconomics:

3) Microeconomics is basically concerned with determination of output and

Central Problems of Economy: Economic activities include production,

2) How to produce? and

How to produce? (Problem of Choice):

Solution of Central Problems in Different Economies:

Centrally planned economy: In a centrally planned economy, decisions

Mixed Economy: It has merits of Market Economy and Centrally Planned

Example- In India producers are free to produce clothes to maximizing their

Production possibility curve (PPC):

Goods Production Possibilities

Reason for Shifting of Production Possibility Curve:

b) Resources are increased/Technology is improved for the production of

Some basic problems of Macroeconomics: Problem of unemployment,

Note: Intermediate goods are not included in the estimation of national

Demand for a commodity is the desire to buy a commodity backed

Demand Curve and its Slope: Demand curve is simply a graphic

Slope of demand curve: It shows the ratio between change in

Exceptions to the law of demand:

Movement along a demand curve:

Downward movement along the demand curve (Extension of

Shifts in demand curve:

Backward shift in Demand Curve - Decrease in Demand:

Relationship between income and demand:

Concept of Price Elasticity of Demand:

1) Proportionate or Percentage Method: Elasticity of demand

2) Geometric Method: Geometric method measures price

Perfectly Elastic Demand [𝑬𝒅 = ∞]: A perfectly elastic demand

Unitary Elastic Demand [𝑬𝒅 = 1]: Elasticity of demand is equal to 1

Factors Affecting Price Elasticity of Demand:

1) Nature of Commodity: Goods of necessities like textbooks,

Cross Elasticity of Demand: A change in the demand for good in

Supply and Quantity Supplied: Quantity supplied refers to a

Price of Goods (P) Quantity of Goods

Note: The full chart given above is supply schedule, because it

Slope of supply curve: Slope of supply curve refers to the ratio

Where ∆P = Change in Price,

Factors on which supply of a commodity depend: The supply of a

Law of supply: Law of supply states that, other things remaining

Assumptions of law of supply:

Exceptions to the law of supply:

Movements along a supply curve: If we move down the supply

Contraction of Supply: Contraction of supply occurs when quantity

Shift in supply curve: Shift can be forward shift and backward

Backward Shift in Supply Curve – Decrease in Supply: In the

Causes of increase in supply:

Price Elasticity of Supply: Price elasticity of supply measure the

2) Geometric Method: Geometrically, elasticity of supply depends

Situation 2) Es›1: A positively sloped supply curve starting from Y-

Perfectly Inelastic Supply Curve (Zero Elasticity of Supply): A

Production Function and Returns to a Factor

Factors of Production are classified as:

Note: (1) Short Run is a period of time when production can be

Example on AP, MP and TP:

No. of Total Product(TP) Average Product Margianl Product (MP)

Total Product, Marginal Product and Average Product of the

Marginal Product: Marginal Product refers to change in Total

Explanation: A) Marginal Product is change in Total Product when