Kishor Bhanushali

Real refers the fact that the data have

been adjusted for changes in the level of
prices
Nominal GNP are expressed in current
rupees
Real GNP is the GNP at current rupees
deflated for changes in prices of items
included in GNP
Price index called GNP deflator is
constructed to a price index to reveal the
cost of purchasing the items included in
GNP during the period relative to the cost
of purchasing the same items during the
base period
1. Choice of the base year
2. Selection of commodities
3. Price list for each commodity
4. Represent price of each commodity for
the base year as 100 and the price of the
same commodity in the current year as a
percentage of price for the base year
5. Assigning weights
6. Computation of index
 Laspeyre’s Index=
= (The cost of purchasing the base year basket in
current year /
The cost of purchasing the base year basket in base
year ) *100
= Laspeyre’s index is weighted sum of price relatives
for the ‘n’ goods the weights being share of the ‘n’
good in the total consumption expenditure in the
base year
Item Quantit Price in Price in Relativ weight index
y in base current e s
base year year prices
year
Pulses 10 kg 7.50 9.00 120 0.20 24.00

Rise 20 kg 5.00 7.00 140 0.27 37.80

Cotton 10 mtr 15.00 20.00 133 0.40 53.20

cloths

Electric 100 0.50 0.75 150 0.13 19.50

ity units
Laspeyre’s Consumer Price Index 134.5
Value of money is the quantity of goods
and services in general that will be
exchanged for a unit of money
Value of money is purchasing power i.e.
quantity of goods and services that a unit
of money can purchase
Value of money has inverse relationship
with the general level of prices
Cash Transaction approach
Cash balance approach
Income approach : Keynesian approach
 Other things remaining constant, changes in
general price levels are to be explained with
reference to the changes in the quality of money
in circulation so that an increase in the quantity of
money leads to rise in the price level, while
contraction in the quantity of money will lead to a
fall in general price level
The changes in general price level, other things
remaining the same, are directly proportional to
changes in the money supply
- Velocity of circulation of money
- Credit instruments
- Barter transactions
- Volume of transaction
Equation of Exchange
Prof Irving Fisher
P= MV+M’V’/T
P = Price level
T = Transactions to be performed by money
M=Metallic money
M’=Credit money
V= Velocity of metallic money
V’ = Velocity of credit money
In short run period T, V, V’,remains constant
Therefore P varies inversely with M
Equation of Exchange

1. Process not spelt out

2. Money not merely a medium of
exchange
3. Not independent variables
4. M & V differs
5. Not useful
Cash Balance Approach – Cambridge Equation –
Neoclassical
Value of money depends on demand for cash
balances and the supply thereof at any given
time
An individual keeps only a fraction of his
income in the title as legal tender(liquid
cash)to carry on his business smoothly and
to guard against emergences
M =kpR
M =quantity of money
R = Real national income
p =average price level
pR= monetary national income
k= desire of the public to have liquid
Classical Theory of Interest

Rate of interest is determined by the

fund demanded for investment and
supply of savings
Rate of interest is determined where
demand for investible resources and
supply of savings are equated
 Classical Theory of Interest
S

E’
Interest Rate

R2

E
R1

S
I2
I1

Savings and Investments

Classical theory assumes income to be
given and savings to be a unique
function of income. But saving is also
function of income
Classical theory assumes investment as
a function of interest rate only. But
investment also depends on income,
marginal efficiency of capital and also
cost of capital
 Three motives - Transaction, Precautionary and
Speculative
Mt = f (Y)
Mt = kY
Interest
Rate

Mt