Economics and Financial

Accounting Module
By :
Mrs.Shubhangi Dixit

1
DAY 3

2
Economic System

• An Economic system means by which governments organize

and distribute available resources, services, and goods across a
geographic region or country
• Economic systems regulate factors of production, including
capital, labor, physical resources, and entrepreneurs. An
economic system encompasses many institutions, agencies,
entities, patterns, as well as decision-making procedures.
Hence it is a type of social system.

• An economic system defines how all the entities in an

economy interact.
3
4
What are the 5 Economic Questions

• Every economic system looks at three or four basic questions:

Society (we) must figure out

• WHAT to produce (make)

• HOW MUCH to produce (quantity)
• HOW to Produce it (manufacture)
• FOR WHOM to Produce (who gets what)
• WHO gets to make these decisions?
5
Economic systems can be basically classed into three categories.

6
Market economy:

•  Here prices are determined by levels of supply and demand,

instead of central and or local government. Market forces
determine what is produced, how much is produced, how it is
distributed, plus the prices of goods and services.
• All decisions regarding investment and salaries are also driven
by market forces in a market economy.
• In a market economy, the government plays a minor role and
only lays down the rules so that businesses can thrive. An
outdated word for this type of economy is Capitalism.

7
Market Economy

Advantages of a Free Market Economy

Consumers pay the highest price they want to, and businesses only produce
profitable goods and services. There is a lot of incentive for entrepreneurship.
This competition for resources leads to the most efficient use of the factors of
production since businesses are very competitive.
Businesses invest heavily in research and development. There is an incentive
for constant innovation as companies compete to provide better products for
consumers.
Disadvantages of a Free Market Economy
Due to the fiercely competitive nature of a free market, businesses will not care
for the disadvantaged like the elderly or disabled. This lack of focus on societal
benefit leads to higher income inequality.
Since the market is driven solely by self-interest, economic needs have a
priority over social and human needs like providing healthcare for the poor.
Consumers can also be exploited by monopolies. 8
Planned economy:

•  All decisions regarding production, distribution, salaries,

investment and prices are made by a central authority – usually
the government. The closest examples to this type of economy
today are North Korea and Cuba (to a lesser extent).
• In a planned economy, also known as a centralized economy,
controlled economy or command economy, central government
has planners who make all the decisions.
• According to economists, the most fundamental difference
between a market and planned economy is the existence of
private property, i.e. it exists in the free market and does not in
the command economy.
9
Planned Economy

Advantages of Command Economic Systems

• If executed correctly, the government can mobilize resources on a
massive scale. This mobility can provide jobs for almost all of the
citizens.
• The government can focus on the good of society rather than an
individual. This focus could lead to a more efficient use of
resources.
Disadvantages of Command Economic Systems
• It is hard for central planners to provide for everyone’s needs. This
challenge forces the government to ration because it cannot
calculate demand since it sets prices.
• There is a lack of innovation since there is no need to take any risk.
Workers are also forced to pursue jobs the government deems fit. 10
Mixed Economy: 

• Market economies sometimes get into trouble, at which point

the government feels compelled to intervene. Sometimes,
when lawmakers believe some players are being exploited
unfairly, or the level playing field for business is under threat,
the government may become involved.
• Similarly, the leaders of a command economy may decide that
more investment is required, and the only way to accomplish
this is by allowing more freedom.
• The moment the government of a command economy loosens
its grip, or that of a market economy begins to intervene, they
integrate some aspects of the other. When this occurs, the
result is a kind of hybrid system – a mixed economy.
11
Mixed Economy

Advantages of Mixed Economies

There is less government intervention than a command economy. This results in private
businesses that can run more efficiently and cut costs down than a government entity
might.
The government can intervene to correct market failures. For example, most governments
will come in and break up large companies if they abuse monopoly power. Another
example could be the taxation of harmful products like cigarettes to reduce a 
negative externality of consumption.
Governments can create safety net programs like healthcare or social security.
In a mixed economy, governments can use taxation policies to redistribute income and
reduce inequality.
Disadvantages of Mixed Economies
There are criticisms from both sides arguing that sometimes there is too much
government intervention, and sometimes there isn’t enough.
A common problem is that the state run industries are often subsidized by the government
and run into large debts because they are uncompetitive.
12
Economic Growth

• Economic growth is an increase in the production of goods and

services over a specific period. To be most accurate, the
measurement must remove the effects of inflation.
• Economic growth creates more profit for businesses. As a
result, stock prices rise. That gives companies capital to invest
and hire more employees. As more jobs are created, incomes
rise. Consumers have more money to buy additional products
and services. Purchases drive higher economic growth. For this
reason, all countries want positive economic growth. This
makes economic growth the most watched economic indicator.

13
GDP stands for "Gross Domestic Product"

• GDP is the final value of the goods and services produced

within the geographic boundaries of a country during a
specified period of time, normally a year. GDP growth rate is
an important indicator of the economic performance of a
country.
• Why it matters:
• When GDP declines for two consecutive quarters or more, by
definition the economy is in a recession. Meanwhile, when
GDP grows too quickly and fears of inflation arise, the Federal
Reserve often attempts to stimulate the economy by raising
interest rates.
14
How GDP Affects You

• GDP impacts personal finance, investments, and job growth.

Investors look at a nations' growth rate to decide if they should
adjust their asset allocation. They also compare country growth
rates to find their best international opportunities. They
purchase shares of companies that are in rapidly growing
countries.
• If growth slows or becomes negative, then you should update
your resume. Slow economic growth leads to layoffs and 
unemployment. That can take several months. It takes time for
executives to compile the layoff list and prepare exit packages
15
Problems With GDP
• One of the biggest criticisms of GDP is that it doesn't count the
environmental costs. For example, the price of plastic is cheap because it
doesn't include the cost of pollution. GDP doesn't measure how these
costs impact the well-being of society. A country will improve its 
standard of living when it factors in environmental costs.
• Another criticism is that GDP doesn't include unpaid services. It leaves out
child care and unpaid volunteer work. As a result, the economy undervalues
these contributions to the quality of life.
• GDP also does not count the shadow or black economy. GDP underestimates
economic output in countries where a lot of people receive their income
from illegal activities. These products aren't taxed and don't show up in
government records. The government estimates, but cannot accurately
measure, this output. Global Financial Integrity estimated the black market
contributed up to $2.2 trillion to the $128 trillion global economy in 2017. 16
Ways to Spur Economic Growth
• If a country is not blessed with the factors of production, it must find other ways to
spur growth. Governments want to increase growth because it increases tax revenue.
Growth allows businesses to hire workers, increasing their income. When people feel
prosperous, they reward political leaders by re-electing them.
• The government stimulates growth with expansive fiscal policy. It either spends more,
cuts taxes, or both. Since politicians want to get re-elected, they use expansive fiscal
policy to stimulate the economy.
• But expansive fiscal policy is addictive. If the government keeps spending more and
taxing less, it leads to deficit spending. It works for a while, but eventually leads to
higher debt levels. In time, as the debt-to-GDP ratio approaches 100 percent, it slows
economic growth. Foreign investors stop investing funds in a country with a high debt
ratio. They worry they won't get repaid or that the money will be worth less.
• Governments should then be careful with expansive fiscal policy. They should only
use it when the economy is in contraction or recession. When the economy is growing,
its leaders should cut back spending and raise taxes. This conservative fiscal policy
ensures that the economic growth will remain sustainable.
• A nation's central bank can also spur growth with monetary policy. It can increase the 
money supply by lower interest rates. Banks make loans for auto, school, and homes
less expensive. They also reduce credit card interest rates. All of these boost 
consumer spending and economic growth. 17
GDP can be measured by three methods, namely,
1. Output Method: This measures the monetary or market value of all the goods
and services produced within the borders of the country. In order to avoid a
distorted measure of GDP due to price level changes, GDP at constant prices o
real GDP is computed. GDP (as per output method) = Real GDP (GDP at
constant prices) – Taxes + Subsidies.

2. Expenditure Method: This measures the total expenditure incurred by all

entities on goods and services within the domestic boundaries of a country. GDP
(as per expenditure method) = C + I + G + (X-IM) C: Consumption expenditure,
I: Investment expenditure, G: Government spending and (X-IM): Exports minus
imports, that is, net exports.

3. Income Method: It measures the total income earned by the factors of

production, that is, labour and capital within the domestic boundaries of a
country. GDP (as per income method) = GDP at factor cost + Taxes – Subsidies.

In India, contributions to GDP are mainly divided into 3 broad sectors –

agriculture and allied services, industry and service sector. In India, GDP is
measured as market prices and the base year for computation is 2011-12. GDP at 18
market prices = GDP at factor cost + Indirect Taxes – Subsidies
GDP Growth Rate

• Growth Rate: The GDP growth rate is the percentage increase

in GDP from quarter to quarter. It tells you exactly whether the
economy is growing quicker or slower than the quarter before.
Most countries use real GDP to remove the effect of inflation.
• If the economy produces less than the quarter before, it 
contracts and the growth rate is negative. This signals a 
recession. If it stays negative long enough, the recession turns
into a depression.

19
RBI
Role of RBI

• Reserve Bank of India (RBI) is the supreme monetary authority of India. Reserve Bank of
India (RBI) is India's Central bank. It plays multi-facet role by executing
multiple functions such as overseeing monetary policy, issuing currency, managing foreign
exchange, working as a bank of government and as banker of scheduled commercial banks,
among others.
• This organization is responsible for printing of currency notes and managing the supply of
money in the Indian economy. 
• RBI works as a custodian of foreign reserve, banker's bank, banker to the government of India
and controller of credit.
• Bank Rates- Banks earn interest on such funds. Current CRR, SLR, Repo and Reverse
Repo Rates: The current rates are (November 2020)) - CRR is 3 % , SLR is 18.50%,
Repo Rate is 4% and Reverse Repo Rate is 3.35%.
•
• CR R stands for Cash Reserve Ratio and SLR is Statutory Liquidity Ratio. CRR and SLR are
the basic tools in the economy which manages inflation and flow of money in the country. RBI
control bank capacity of lending through CRR and SLR.
• Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep
with RBI in the form of reserves or balances. The higher the CRR with the RBI, the lower will
be the liquidity in the system, and vice versa. RBI is empowered to vary CRR between 15
percent and 3 percent.
22