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Economics 101

Rahul Reddy
Career Launcher
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Fundamentals

Economic resources are limited

and

There are multiple uses of the same resources

=> There are always tradeoffs to be made

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Economics is the science of the optimum or best utilization of

economic resources
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Microeconomics Basics
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Economic Good

An economic good is a physical object or

service that has value to people and can be sold
for a non-negative price in the marketplace.

Example of economic good: bread, oil, education

Example of non-economic good: air, pollution,

peace
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Demand

Demand is the want or desire to possess an

economic good, backed by the necessary
financial capability to buy that good, at a given
price.
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Supply

Supply is the total quantity of an economic good

that is available for purchase at a given price
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Consumer

An individual who acquires an economic good

for direct use or ownership and not for resale or
use in production of some other economic good
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Customer

An individual who purchases an economic good on

behalf of the consumer.
A customer may be different from the consumer, eg:
1. Government purchasing oil from the OPEC for
consumption by the population
2. Parents purchasing baby food for consumption by the
infant
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Complementary good

An economic good which is usually used

along with another good

Examples
1. Tea: milk, sugar
2. Pen: ink, paper
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Some definitions

 Economic Good

 Demand

 Supply

 Consumer

 Customer

 Complementary Good

 Substitute Good
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Some definitions

 Substitute good

An economic good which is usually used in

place of another good

Examples
1. Tea: coffee, cold drinks
2. Pen: pencil, crayon, brush
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Diminishing Marginal Utility

Marginal utility of
water

The utility, and therefore demand, of every incremental unit of water

diminishes
 Price will have to be reduced to sell every incremental unit of water
 If price reduces, demand increases
Law of demand

The higher the price of an economic good, the lower is its

quantity demanded, ceterus paribus.

Demand Curve of a normal economic good is downward sloping

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Other factors affecting demand

 Income

 Tastes and Preferences

 Price of complement goods

 Price of substitute goods

 Price expectations of the customer

 Number of customers (at a macro level)

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Exceptions to law of demand

 Giffen / Inferior Good

 Veblen Good (snob effect, bandwagon effect)

Inferior cereals, Diamonds, Antiques, Super Luxury Cars

+Price elasticity of demand ‘ep’

 Unit change in demand when there is unit change in price.

 Mathematically, pe is the slope of the demand curvè
e p =Δ D
ΔP
 e < 0 for normal goods
p

 e > 0 for Giffen and Veblen goods

p

 e = 0: perfectly inelastic goods

p

 e < 1: inelastic goods

p

 e = ∞: perfectly elastic goods

p

 e would be smaller for items of necessity than for items of luxury

p
+Income elasticity of demand ‘eI’

 Unit change in demand when there is unit change

in income.
 eI > 0 for normal goods
 eI < 1 for goods of necessity: Engel’s law
 eI < 0 for inferior goods
 eI is highly positive for luxury goods
 eI would be larger for smaller incomes than for
larger incomes
+Cross elasticity of demand ‘ec’

 Unitchange in demand when there is unit change

in price of other goods

 eI < 0 for complementary goods

 eI = 0 for unrelated goods

 eI > 0 for substitute goods

 eI = -∞ for perfect complements

 eI = ∞ for perfect substitutes
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Law of supply

The higher the price of an economic good, the higher is its quantity supplied,
ceterus paribus.

Supply Curve of a normal economic good is upward sloping

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Other factors affecting supply

 Price and availability of resources

 Price of complement goods

 Price of substitute goods

 Technological changes

 Price expectations of the seller

 Taxes and subsidies

 Number of sellers (at a macro level)

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Equilibrium

Surplus

Equilibrium price and Equilibrium

quantity
Shortage
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Change in equilibrium when…

 Change in quantity demanded

 Shift in demand

 Change in quantity supplied

 Shift in supply
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Macroeconomics Basics
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Gross Domestic Product, GDP
Total market value of all final goods and
services manufactured within the country in a
financial year
=
Household Consumption + Investment + Government Expenditure + Net
Exports
(Consumption approach)

=
Wages + Interest + Rent + Profit + Indirect Tax + Depreciation
(Income approach)
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Gross National Product, GNP

Total market value of all final goods and

services manufactured within the country
in a financial year plus net factor
income from abroad
=
GDP + Income earned by Indians from foreign investments –
Income earned by foreigners from domestic investments
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Consumer Price Index, CPI
CPI is a measure of the level of inflation.

CPI measures how much the price of a basket

of consumer goods has changed over a
given time period.

In India CPI is computed weekly and is

measured YoY and WoW
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Wholesale Price Index, CPI
WPI is a measure of the level of inflation from
an industrial point of view.

WPI measures how much the price of a basket

of wholesale goods has changed over a
given time period.

Generally WPI leads the CPI by 45 - 60 days

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Current Account Convertibility
Freedom to exchange the Rupee into other currencies for
1. The international transactions consisting of payments
due in connection with foreign trade, other current
businesses including services and normal
2. Short-term banking and credit facilities
3. Payments due - as interest on loans and as net income
from other investments
4. Moderate remittances for family living expenses
5. Business travel, participation in overseas conferences,
studies abroad, training or medical treatment
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Capital Account
Convertibility
Home currency can be freely converted into foreign currencies for
acquisition of capital assets abroad.

The rupee is currently not freely convertible on the capital

account.
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Purchasing Power Parity, PPP

 A method of measuring the relative purchasing power of different

countries’ currencies over the same types of goods and services.

 Allows us to make more accurate comparisons of standards of living

across countries.

 Not all items can be matched exactly across countries and time, the
estimates are not always "robust”

 India is # 3 in GDP (PPP) terms and # 6 in GDP (nominal) terms

worldwide
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Foreign Direct Investment, FDI
Foreign Direct Investment (FDI) is permitted as under the following forms of

Investments:

 Through financial collaborations.

 Through joint ventures and technical collaborations.

 Through capital markets via Euro issues.

 Through private placements or preferential allotments.

Areas prohibited under FDI

 Atomic Energy.

 Railway Transport.

 Coal and lignite.

 Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds etc

+ Foreign Institutional Investors, FII
FII means an entity established or incorporated outside India which proposes to

make investment in India.

Following entities / funds are eligible to get registered as FII:

 Pension Funds

 Mutual Funds

 Insurance Companies

 Investment Trusts

 Banks

 University Funds

 Endowments

 Foundations

 Charitable Trusts / Charitable Societies

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CRR / SLR
CRR

 Cash Reserve requirements imposed on banks.

 Minimum level of funds to be kept with RBI every fortnight to tackle sudden
customer withdrawals / liquidity problems

SLR

 At the close of business every day, a minimum proportion of the Net

Demand and Time Liabilities as liquid assets

 The ratio of liquid assets to demand and time liabilities is known as

Statutory Liquidity Ratio (SLR).
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Types of markets

 Perfect Competition

 Oligopoly

 Monopoly

 Monopsony
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Types of markets

 Perfect Competition

 Oligopoly

 Monopoly

 Monopsony
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Types of markets

 Perfect Competition
A hypothetical market where no single producer or
consumer has the market power to influence prices

 Large number of sellers and buyers

 Sellers and buyers are price takers
 Goods are perfect substitutes, i.e. there is no product
differentiation
 All buyers and sellers have perfect, complete and
homogenous market information
 All sellers have equal access to resources and
technologies; which are perfectly mobile
 There are no entry or exit barriers
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Types of markets

 Perfect Competition
A hypothetical market where no single producer
or consumer has the market power to influence
prices

 Normal Profits earned by the firms

 Pareto optimum situation
 Example of near perfect competitions:
vegetable market
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Types of markets

 Perfect Competition

 Oligopoly

 Monopoly

 Monopsony
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Types of markets

 Oligopoly

A market with a small number of sellers

 High interaction among the sellers

 Sellers are price makers
 Example of oligopoly: telecom players,
petroleum
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Types of markets

 Perfect Competition

 Oligopoly

 Monopoly

 Monopsony
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Types of markets

 Monopoly
A market with a single seller

 Seller is the price maker

 Firm can make Abnormal profit
 No close substitutes
 Large entry barriers
 Legal / government license, subsidies
 Technological reasons
 Fierce competitiveness of existing firm
 Examples: Indian Railways, Nuclear power plants
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Types of markets

 Perfect Competition

 Oligopoly

 Monopoly

 Monopsony
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Types of markets

 Monopsony

A market with a single buyer

 Buyer is the price maker

 Examples: Military tanks
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Types of unemployment

 Frictional

 Seasonal

 Cyclical

 Structured/Technological

 Disguised
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Fiscal Policy
The government’s policy of achieving economic
objectives (employment, per capita income…)
through government earning and spending.

Government sources of funds: Taxes and duties,

government businesses,
fines, borrowing from public,
investments

Government uses of funds: Infrastructure, mining, public

welfare, defence, power
generation, research and
development
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Monetary Policy
The government’s policy of achieving
economic objectives (employment, per capita
income, balance of trade, economic parity…)

through controlling money supply

Decrease in supply: Deflation or decrease in prices

Increase in supply: Inflation or increase in prices

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Inflation

 Sustained increase of general price level over a period of

time.

 Supply Side factors

 Demand side factors

 Interest Rate and Inflation

 Real Interest Rate

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Currency Exchange

 Demand for $
 Imports
 Foreign Travel
 Outward Remittances

 Supply of $
 Exports
 Incoming Travellers
 Inward Remittances

 Capital Account
 Inward Investments
 Outward Investments

 Trade Deficit and Current Account Deficit

 How is Inflation connected to Currency rates?

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Subsidies

 A form of Financial Assistance

 To prevent decline of an Industry
 To reduce price of certain products
 To increase production, hiring etc etc

 A subsidy distorts markets

 A price must be paid
 A form or cash transfer from 1 group to another

 Subsidy is a political decision

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Types of Subsidies

 Universal Vs Targeted

 Merit Vs Non Merit

 Explicit Vs Disguised

 Subsidy Given to
 Consumers
 Producers
 Producers of Input
 Direct Production by Govt/PSU’s
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Farm Subsidies – Developed world

 US & Europe etc heavily subsidize farmers

 Making Direct payments to farmers
 Paying them extra money per unit produced

 The effect
 Cheaper Imports from 3rd world are prevented
 US produce is dumped to other countries

 It is a cash transfer
 From general public (tax payer) to Farmers
 Would be cheaper to import food and compensate farmers
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Farm Subsidies – Developed world

 Reasons cited
 Food security due to supply and price fluctuation
 Protection of farming as an industry

 The negatives
 Distorts price signals – wrong production choices
 Unfair trade practice – 3rd world farmers
 Benefits the wrong people
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Issues with Subsidies

 Public Investment Vs Subsidy debate

 Market distortions due to subsidy

 Governmental Inefficiency in subsidy targeting and delivery

 Wrong targeting of subsidy

 Lack of will to recover cost of public services

 Effect on organizations delivering subsidized services

 Flat rate Vs Pay per use

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Subsidies in India

 Food (PDS)

 Fertilizer

 Petroleum products
 Diesel, Kerosene, LPG etc

 Electricity

 Education

 Public healthcare
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How Big is the problem?

 FY 12 Revised Estimates (BE 1.34 Lakh Cr)

 Explicit Central Subsidies 2.08 Lakh Crore

 Food 72,800

 Fuel 68,500

 Fertilizer 67,200

 FY 13 Budgets for 1.8 Lakh Crore

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Public Distribution System

 Food Grains procured by Union Govt (FCI)

 Procurement, Storage and Transport

 Distribution by State Government

 Identifying Beneficiaries, Mange FP Shops
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Issues with PDS

 Huge losses in procurement, storage and transportation

 High cost of subsidy due to losses and operational costs

 MSP and Procurement quantities hiked for political reasons

 Huge difference between Central Allocation and off takes of

states. Barely 20-25% of the allocated quantities are taken by
the state governments
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Issues with PDS

 Leakage/Diversion of food grains

 Bogus BPL cards, Race to be poorest of the poor

 Poor coverage of rural, tribal areas, denial of supplies to

poorest of the poor

 %age of food grains under PDS reaching poorest 40% is

25%.
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The Shocking economics

 The FCI cost of procurement, storage and Transport of Wheat

and Rice is Rs 952 and Rs 1254 per quintal (100kg) as against
an actual subsidy of Rs 357 and Rs 482 for Wheat and Rice
respectively

 Cost of transferring Rs 1 to the poor is Rs 6.68

 Administrative Costs are 85% of the subsidy

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Cash Tranfers

 Direct Transfer of Cash to beneficiary

 Can be made conditional CCT

 Advantages

 Least Cost, Most efficient method

 Relatively low leakages

 Beneficiary decides optimal usage of cash

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Cash Transfers

 Disadvantages

 End use of cash cannot be monitored

 Creates a dependency, disincentive to employment

 Use as electoral bribe

 Financial infra and Knowledge lacking

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Conditional Cash Transfers

 Use of CTs as incentives

 Schooling
 Basic Healthcare

 Examples

 Brazil and most of SA

 Indonesia and Philippines

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Principles

 Subsidize only essential commodities, Services

 Give the subsidy as directly as possibly

 Direct Cash Transfer, Conditional Cash Transfer

 Have a Clearly defined target

 Never make it free

 Don’t distort incentives

 Misallocation of resources & Wastage
 Distortion of production & Consumption choices
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The way forward…

 Infrastructure Vs Subsidies

 Merit Vs Non Merit Subsidies

 Targeting of subsidies
 Diesel, LPG etc

 Quantity restrictions
 Metered Water, Electricity etc

 Retain ‘Free Market completion’

 Education and Healthcare vouchers
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Two Schemes to watch

 Rythu Bandhu (Telengana State)

 Rs 4000 per acre per Cropping Season
 No cap on total farm holding
 Direct to Bank Account
 Reduces dependance on Loans for Farm Inputs

 Ayushman Bharat
 Health Insurance scheme
 Defined Benefit cover of Rs 5 lakh per family
 Cashless Pvt and Govt Hospitals
 Designed to cover 10 Cr families (40% of Population)
 Premium shared between Centre and State
 100 Days: 6.85 Lakh people have benefited