Session 1B.

CONCEPTS

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 CONCEPTS
Consumption: Direct and final use of goods- destruction of
utility.
Savings are that part of the income which is not used for
current consumption i.e., Postponement of current
consumption
S = Y-C
Investment: Savings when mobilised and converted into
real physical assets
Production: Creation or addition of utility
Productive activity: Any activity undertaken with the
objective of earning an economic reward

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 CONCEPTS
Factors of production
Land
• All natural resources lying on, above or below
the earth’s surface
• Geographically immobile but occupationally
mobile
• Passive factor of production

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 CONCEPTS
Factors of production
Labour
• Physical or mental exertion by a human
being in the process of production
• Heterogeneous
• Inseparable from the labourer
• Active factor of production

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 CONCEPTS
Factors of production
Capital
• Produced means of production
• Factories, machines, tools, buildings etc
• Derived demand
• Subject to depreciation
Money Capital: Money funds at the disposal of a
firm or individual
Real capital: Physical assets. E.g., machines,
buildings, etc
Human capital: Skills, knowledge and health of
labour as a factor of production
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 CONCEPTS
Factors of production
• Enterprise & Organization: Newer concepts
• Identifying potential sources of production,
collecting them in required quantities,
assigning them specific tasks as per skills
is the role of Organisation.
• Using these factors for economic activities,
without any certainty of returns is the
function of the entrepreneur.

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 CONCEPTS
Concept of scarcity- Scarcity of resources
and multiplicity of wants- Choice
Opportunity Cost: Benefits foregone from
the alternatives that are not selected-
arises from scarcity and versatility of
resources

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 Business Cycles
• Widespread contraction and expansion in
most sectors of the economy.

Rec
ess

ion
Peak

ion

ns
pa
Trough Ex

Time
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 Phases of Business Cycles

Phases of Business Cycles

• Expansion
• Peak of boom or prosperity
• Recession or downturn
• Trough, the bottom of the depression
• Recovery and expansion

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• Business cycles are marked by
widespread expansion and contraction in
most sectors of the economy
• Major phases of a business cycle are
recession and expansion (or prosperity).
• Peak and trough are the turning points of
the phases.
• If recession is severe in terms of scale and
longer in duration, it is termed depression
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 Characteristics of Recession

• Fall in consumers purchase

• Fall in demand for labour and other inputs.
• Fall in output and increase in inventories.
• Fall in investments and demand for credit
• Fall in profits
• General pessimism
Increase in the above factors describe the phase of
expansion
Each phase carries the seeds of its own destruction

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 Characteristics of Recession

The Great Recession :

• Fall in Durable consumer goods demand
• Freeze on new recruitments
• Job cuts and pay cuts
• Unsold houses (Foreclosures)
• Bankruptcies
• Stock market slide and falling investor
confidence
• General mood of pessimism
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 Recovery

• US sub prime lending

• Jobless recovery??

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 Indicators of Economic
Recovery
• Unemployment
• Non-farm payrolls
• ASA Staffing Index: Measures activity in the
temporary staffing industry; often when employers
seek to add workers, they add temporary workers
first so as to avoid the commitments and expenses
of adding full-time workers until they are sure that
business has improved. A rising ASA Staffing
Index can signal that a recovery is underway.

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• Consumer spending
• Consumer Sentiment
Surveys ask people how they feel about the
economy in near-term and their own individual
or family prospects.
• Consumer sentiment indicators like the
Consumer Confidence Index (CCI) and the
Michigan Consumer Sentiment Index do seem
to correlate with reality more often than not.

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• Bank Lending
• PMI: The Institute for Supply Management (ISM)
calculates the Purchasing Managers Index (PMI)
• Composite index of five "sub-indicators", based on
surveys of more than 400 purchasing managers
from around the USA
•

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• Production level (.25)
• New orders (from customers) (.30)
• Supplier deliveries - (are they coming
faster or slower?) (.15)
• Inventories (.10)
• Employment level (.20)

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• Whether businesses are seeing new
orders, higher production levels, timely
deliveries from suppliers and increasing
inventories and employment

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• Questions have only three options;
"better", "same", or "worse“ (As the
manager sees it)
• PMI figure ranges from 0 to 100
• PMI reading of 50 would indicate an equal
number of respondents reporting "better
conditions" and "worse conditions".

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• Since most people buy things that come
from some other place, overall economic
activity is correlated with the movement of
goods across the continent. Notable
indexes here include the Cass Freight
Index and the American Trucking
Association's Truck Tonnage Index.
• In India also truck sales are taken as an
important indicator
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 Contra Cyclical Policy
Contra-cyclical or Counter-cyclical Measures
(Measures to control business cycles)
A) Monetary Policy for Tackling Recession–Designed by
the central bank of the country. (RBI in India) Monetary
measures control liquidity and availability of credit .
Need to increase liquidity through:
• Repo and reverse Repo rates
• CRR decrease
• SLR decrease
• OMO: Selling securities Moral suasion and other
qualitative credit controls

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 B) Fiscal Policy for Tackling
Recession
Measures by the government- Emphasised by
J. M. Keynes during Great Depression
• Reduce tax rates
• Increase subsidies
• Increase public expenditure
• Debt polices.

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Fiscal measures directly affect
• Prices
• Consumers’ disposable income
• Money supply
• Supply of goods and commodities
- which in turn affect the movements of
business cycles

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3.Other measures –
Buffer stock operations
Declaration of minimum procurement price
etc are used to stabilize prices in
agriculture

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 Inflation
• Demand pull/ Cost- push

• WPI: 435 commodities tracked- - revision

later
• CPI is a better index as it captures cost of
living, but it comes with a time lag
• 4 types of CPI- Industrial workers, urban
Non manual workers, AL, rural labor
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 Monetary Policy
• Repo rate : Rate of interest charged by
central bank when banks borrow money
from it
• Tool through which RBI infuses funds into
the system by lending to banks against
pledging of securities

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 Monetary Policy
• Reverse repo: Rate which RBI offers to
banks when they deposit funds with it.
• RBI drains out liquidity from the financial
system through reverse repo by releasing
bonds to the banks. This is a daily
operation by the Bank to manage liquidity.
Over a longer period, RBI can also
manage liquidity through OMO.

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 Monetary Policy
• When liquidity is tight and banks need
short term funds from RBI to manage
mismatches, then repo rate emerges as
the effective policy rate.
• But if liquidity returns to the system
reverse repo rate would become the
operative rate as RBI would be draining
out funds from the system,

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 Monetary Policy
• . In US there is a single Fed Fund Rate. This is
the key interest rate and short term funds are
available to eligible borrowers at this rate.

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• The maximum limit of SLR is 40% and
minimum limit of SLR is 25%.. This
restriction is imposed by RBI on banks to
make funds available to customers on
demand as soon as possible.

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CRR, or cash reserve ratio, is the portion of
deposits that the banks have to maintain
with the RBI. Higher the ratio, the lower is
the amount that banks will be able to use
for lending and investment

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Difference between SLR and CRR:
• To meet SLR, banks can use cash, gold or
approved securities - CRR has to be only
cash.
• CRR is maintained in cash form with RBI,
where as SLR is maintained in liquid form
with banks themselves.

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• The RBI can increase the SLR to contain
inflation, suck liquidity in the market, to
tighten the measure to safeguard the
customers’ money. In a growing economy
banks would like to invest in stock market,
not in G Secs or Gold as the latter would
yield less returns.

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 Reverse logic in recession
• A cut in SLR means that the home, car
and commercial loan rates will go down.

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 FISCAL MEASURES
• Recession:
• Increase government spending (stimulus
packages)
• Reduce taxes

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 India 2011
• RBI’s dilemma- Inflation vs growth
• Currency is wobbly as imports exceed
exports, threatening to take current
account deficit to 2001 levels
• Fiscal deficit may not come under control
as state elections are approaching; with 2
months to go, privatisation target of 40,000
c remains unmet
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 Indian Economy,2011 -
Performance & Prospects
Foreign investment in India:
Record $29 bn in 2009
Now leaving India
Sensex is down 5.7%since Nov ; during this
period, US S&P rose by 7.2%, other
emerging markets up 1.4%. India remains
the most expensive BRIC country

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Factors that will affect corporate earnings:
Soaring cost of funds
Increase in commodity prices
Increase in oil prices
Increasing protectionism

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 According to NCAER
• How India Earns, Spends & saves by Rajesh
Shukla:
• Rising middle class numbers
• Rural jobs growing (Expenditure on NREGA :
• 07-08: Rs.15,857
• 09-10: Rs. 37, 938
• 10-11: Rs. 40,100
• NREGA wage rates have gone up from Rs.80 to
Rs. 100
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• Rural economy is no more synonymous
with agriculture
• Every new car creates 5 new jobs-
cleaner, driver, parking attendant,
mechanic & auto insurance surveyor

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• According to Morgan Stanley report, the
Indian economy will start growing faster
than China in 2013.
• Reason : demographic dividend- India
will see a declining trend in the share of
non-working population and add 136 mn to
working population over the next 10 years;
China, only 23 mn.

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• India’s savings rate will go up, while share
of consumption in China’s GDP will go up
• Assumptions:
• Sustained increase in India’s infra
spending,
• Educational levels
• Fiscal consolidation.

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Raghuram Rajan: Fault Lines: How Hidden
Fractures Still Threaten the World Economy

• We must create real jobs,- not make-work jobs-

to increase productivity of rural worker to the
levels of manufacturing/ service workers
His prescription for population dividend:
• Infrastructure
• Education
• Health
• Financial Inclusion- credit only one aspect

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ET’s warning:
• Need inclusive growth and internal
security.
• To tackle the second, you need inclusive
growth

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 On china (From Economist
19/08/10)
2010 (2nd quarter) output:
US: $ 3.522 trillion
China: $1.337 trillion
Japan: $ 1,288 trillion

China is now world’s 2nd largest economy,

having surpassed Japan in the 2nd quarter
of 2010
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 China- Some Facts
• World’s largest population
• World’s largest exporter
• World’s largest car market
• World’s largest consumer of energy
• World’s largest carbon emitter

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• China’s problems:
• Inequality
• All areas not fully developed
• Rural neglect
• Absence of democracy
• Trade wars with Us
• Strikes in plants
• Housing bubble?
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 Role Play
 Company XYZ is an exporter whose major
profits come from the US market. Of late, it has
been facing falling demand and dropping profits.
A meeting is called to discuss the problem:
 The HR head wants to reduce manpower to
revive profits.
 The operations head wants to have a stable
workforce which is well-trained and highly
skilled so that resources do not migrate to
competitors and morale is not lowered.

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 The Product Development head wants
increased R&D spending so that new
product lines can help beat the falling
demand.
 The Finance Head wants to avoid any new
investments because the company has
limited capital and will be hit hard if new
products do not do well.

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 The Marketing Head has two alternatives :
Either explore new foreign markets or to
launch an exciting campaign to rejuvenate
domestic demand.

What should the Managerial Economist Do?

What lessons did you learn?

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