Session Overview

Welcome to this session on ‘Demand and Supply’.

The terms demand and supply refer to the behaviour of individuals. They are the twin forces that make market economies work. Prices play

a special role in the analysis of demand and supply.

However, before delving into 'demand and supply', you will explore the concept of scarcity and how the field of economics revolves around

it.

In this session

Here, you will learn about the following:

1. Scarcity

2. Law of demand

3. Determinants of demand

4. Law of supply

5. Determinants of supply

6. Price elasticity of supply and demand

7. Market equilibrium

Note that graded questions are given in a separate segment labelled 'Graded Assessments' at the end of this session. These graded questions

will adhere to the following guidelines.

Scarcity
We live in the world of scarcity. Scarcity means that we have limited resources and we cannot produce an

unlimited number of goods and services that we may desire to have.

You possess several scarce resources such as time, money, energy, etc. Every day, you make decisions about

what to do with these scarce resources. The study of economics is all about such decisions.

Economics is therefore a study of how scarce resources are managed and how scarce resources are allocated

through the actions of households and firms.

Demand is inversely proportional to price. This is referred to as the law of demand.

The demand curve shows the quantity of a product demanded by consumers at various prices.

You may have noticed that the demand curve is indeed a curve and not linear. This is because people

who buy products at cheaper prices are more sensitive to price changes. Hence a small reduction in

price at the lower levels would bring in more consumers than the same small reduction in price at

higher levels.

However, we would often use a straight line to show the demand curve for easier analysis.

Additional Reading

 The Law of Demand, Economics Discussion

Determinants of Demand
Price is obviously one of the most important determinants of demand. However, there are also other factors that affect the

demand curve.

Let's learn more about price and the other determinants of demand in this video.

You learnt about the major determinants of demand. The demand curve shifts due to a change in any of these factors.

Determinants Change in Determinant Shift in Demand Curve

Increase None (upward movement along the demand curve)

Price
Decrease None (downward movement along the demand curve)

Increase in the price of substitutes Rightward shift

Price of substitutes
Decrease in the price of substitutes Leftward shift

Price of complements Increase in the price of complements Leftward shift

 Determinants Change in determinant Shift in Supply Curve

Decrease in price of related goods Rightward shift

Increase Rightward shift

Number of suppliers
Decrease Leftward shift

Improvement in technology Rightward shift

Technology
Deterioration in technology Leftward shift

Expectation of lower prices Rightward shift

Expectations
Expectation of higher prices Leftward shift

Price Elasticity of Supply and Demand

You know by now that a small change in price would usually lead to a change in the quantity supplied and

demanded.

The magnitude of change in the quantity due to change in price is known as price elasticity. Let's learn more

about this in the following video.

You learnt about the two important concepts:

1. Price elasticity of demand: Price elasticity of demand is calculated as the percentage change in the

quantity demanded divided by the percentage change in price.

2. Price elasticity of supply: Price elasticity of supply is calculated as the percentage change in the

quantity supplied divided by the percentage change in price.

You also learnt about the different degrees of elasticity. The following figures are shown on a demand curve,

but are applicable to the supply curve as well.

Degrees of Elasticity Graph

Perfectly elastic

Quantity falls to 0 with any change in price

Market Equilibrium
Market equilibrium refers to the price of a product at which the quantity supplied is equal to the quantity demanded.

Let's learn more about this in the following video.

You learnt about market equilibrium, which is a central concept in economics. The market forces

always push the price towards the equilibrium point. This is because:

1. At lower prices, there is not enough supply to meet demand. This allows suppliers to charge a higher

price for the product.

2. At higher prices, there is not enough demand. This forces suppliers to reduce prices to increase the

demand.

3. At equilibrium price, the supply is exactly the same as demand. Thus, suppliers have no incentive to

increase or reduce prices.

You learnt that the equilibrium shifts when the demand or the supply curve shift. The following table

shows how the market equilibrium price and quantity change with each combination of change in the

demand and supply curves.

The Russia‒Saudi Arabia price war is a good example, which shows that the equilibrium price paid by

consumers can be impacted by the amount of supply in the market and also by the supplier’s

motivations for supplying that amount in the market.

Session Summary

This session covered the central themes of demand and supply.

1. You learnt about the law of demand

1. The demand for a product increases if its price is reduced, and vice versa

2. The demand curve shows the quantity of a product demanded by consumers vs the price of the product

3. Several factors affect the demand curve. These are called determinants of demand.

2. You learnt about the law of supply

0. The supply for a product increases if its price is increased, and vice versa

1. The supply curve shows the quantity of a product supplied by firms vs. the price of the product

2. Several factors affect the supply curve. These are called determinants of supply

3. You learnt about the price elasticity of supply and demand

0. Price elasticity of demand: Calculated as the percentage change in the quantity demanded divided by the percentage

change in price.

1. Price elasticity of supply: Calculated as the percentage change in the quantity supplied divided by the percentage

change in price.

2. You also learnt about the different degrees of elasticity

4. Finally, you learnt about market equilibrium

0. Market equilibrium is the price point where quantity demanded is equal to the quantity supplied
 2. Preferences

Next, you learnt about the following two economic models: the budget line and indifference curve.

Budget Line:

In economics, a budget constraint or a budget line reflects all the combinations of goods and services

that a customer can buy within his or her income given current prices. A budget line shows the trade-

off between consuming two goods.

If you observe the budget line of two products, you will notice that the slope of the line represents the

rate at which the consumer is willing to substitute the good represented by the X-axis for the good

represented by the Y-axis. Hence, the slope of the budget line is also known as the marginal rate of

substitution (MRS).

Indifference Curve:

An indifference curve is a model that represents a consumer’s preferences. The different points on a

single indifference curve give the consumer the same utility.

Indifference curves can have many different shapes, and each shape has its own significance:

1. L-shaped Indifference Curve: When the goods are perfect complements

2. Convex Indifference Curve: Most common and applicable to most real-life cases

3. Straight Line Indifference Curve: When the goods are perfect substitutes

Indifference curves are helpful in understanding gains from trade and implications of government

subsidy on consumers, among other applications.

Consumer's Equilibrium

Now that you have a thorough understanding of budget constraints and indifference curves, in this segment, you will learn

how they come together to help consumers make purchase decisions.

Lastly, you saw how the demand curve is derived from these decisions. As a good becomes cheaper compared with that of a

competitor, people will want to buy it more and, hence, the demand for that good will go up as compared with the demand

for the goods of other competitors (substitution effect). And as the income of an individual increases, they have more money

to spend on goods, and, therefore, the demand for goods will increase (income effect).

Production Possibilities Curve

For businesses engaged in selling products, one of the most important operational needs is to ensure that all of their scarce

resources are being utilised for the production of the output and that such utilisation is maximised.

Now, let’s move ahead and watch the upcoming video to learn more about this from our faculty.

In the video, you learnt about the production possibilities curve (PPC) and the law of diminishing returns.

The PPC explains the variations in quantities that can be achieved for two goods whose production relies on the same finite

resources, and how a firm can operate efficiently at a particular point on this curve.

In the pizza example, you saw how with each worker hired, the company made fewer extra pizzas than the workers before

them. Worker One produced 100 pizzas, workers One and Two together produced 190 and workers One, Two and Three

produced 270 pizzas. This illustrates the concept of diminishing marginal product. Each additional production unit we put

into our store produces less than the one before it. The first worker was the most productive, the second worker was a little

less productive than the first and the third was a little less productive than the second.

The law of diminishing marginal utility states that with everything else being equal, an increase in consumption decreases

the marginal utility derived from each additional unit.

The PPC is a useful tool that helps to understand the concepts of opportunity cost, scarcity and specialisation. It can be used

to understand other real-life concepts such as economic growth and efficiency.

For example, suppose you want to compare the production possibilities of two firms. By comparing their PPCs, you can
In the video, you also learnt from our pizza parlour example that the average total cost can help us decide the

minimum as well as the maximum quantity that needs to be produced in order to prevent losses. In our example,

producing less than 100 units and more than 1,500 units could have led to a loss as the average total cost is greater

than the price of the product. So keeping a track of average total cost is crucial for setting the price of the product.

Economies of Scale
Large companies are often able to offer products at lower prices. One of the key underlying reasons is that the cost per unit

depends on the number of products that they produce.

When a firm produces a particular product more than others, the average cost per unit tends to decrease. This is called

economies of scale. So, in the upcoming video, you will learn more about this from our expert.

So, in the video, you learnt about Long-Run Average Costs (LRAC) that with an increase in output, the average total cost of

production decreases (economies of scale). It is important for firms to utilise growth to bring down their costs.

External economies of scale are associated with a cost advantage to a company owing to external factors, whereas internal

economies of scale are specific to a firm.

In the video, you also learnt about the reasons behind diseconomies of scale, which primarily include unmanageably large

infrastructure maintenance costs and/or fragmentation or break-up in the company leading to inefficient utilisation of

resources.

Additional Learning

Read this article to understand how developing economies of scale helped Toyota to gain dominance in the US Auto market.
3. You learnt about the consumer's equilibrium. This occurs at the point where budget constraint line touches the

highest indifference curve possible. Such a point represents that combination of goods which a consumer can afford and

gives the highest possible satisfaction.

4. You saw that the consumer equilibrium shifts due to income and substitution effects.

2. You learnt about producer's decisions.

0. You learnt about the different types of costs incurred by producers. These are:

0. Fixed cost

1. Variable cost

2. Opportunity cost

3. Sunk cost

1. You learnt about the production possibilities curve. You learnt that at any point on the production

possibilities curve, the output produced by a company is a function of the inputs: Q = f (K,L), where Q

is the output, K is the capital and L is the labour.

2. You learnt about economies of scale. Economies of scale occurs when a firm produces more of a

particular product, the average cost per unit tends to decreases.

3. You learnt how microeconomics of digital goods differs from those of the traditional goods.

You are now set to learn about the more advanced concepts in microeconomics.

In the next module, we shall cover the various types of markets and their properties. You will learn how actual markets differ

from theoretical ideals and what are the important considerations that need to be made in order to operate in different market

scenarios.

Session Overview
In the previous two sessions you learnt all about fundamental economic theory related to demand, supply, consumer and

producer theory. This was done in the context of free market systems, however, the notion that markets operate in an

environment of unrestricted competition is not realistic.

In this session we will consider the influence of external market forces, and the impact this has on firms.
 2. The US aircraft industry falls under a duopoly.

3. The US electricity industry falls under a monopoly.

Next, Chris took you through a real-world example of Facebook that is made up of three primary business lines. This illustrated

how a single company can fall under various market types.

Perfect Competition Model

Until now, in your study of economics, you have assumed that a firm operates within a perfectly competitive environment.

In reality, perfect competition is an abstract concept. However, the model provides a robust framework to begin the study of

various market types.

In the following video, let’s understand the perfect competition model in detail.

Through this video, you learnt about the characteristics of the perfect competition model, which are as follows:

1. There is a large number of producers and sellers in the market.

2. Products sold are perfect substitutes.

3. Both sellers and buyers are price takers.

4. There is no entry or exit barriers.

5. There is relatively high information among the market participants.

In the real world, it is hard to find examples of industries that fit all the criteria of perfect competition. However, some

industries come quite close, such as:

1. Agricultural markets

2. Manual labour

You also understood that a firm’s focus to achieve a larger market share or revenue is reinforced by competitive pressure, as

competitors also face the same choice. In a perfectly competitive market structure, efficiency in terms of productivity is an

important aspect of maintaining a firm’s position in the market.

Monopolistic Competition Model
Consider the iPhone by Apple. Do you think Apple has a monopoly in the smartphone market? Not really. There are many

other players such as Samsung, Oppo, Huawei and Xiaomi in the market with significant sales.

So, is it a perfectly competitive market? No. There are some major players who dominate the industry with their products.

However, there is something distinct about Apple’s iPhone that makes it stand out and create a niche for itself. Such a

market structure, where companies have a narrow monopoly on their kind of product but not on the entire industry,

is called monopolistic competition.

Let’s understand this market structure and how to model it from Chris in the next video.

In this video, you learnt about monopolistic competition, which characterises an industry in which many firms offer

products or services that are similar but not perfect substitutes. You also looked at its short- and long-term outcome

characteristics. In the short term, the firm makes profits from the product, but in the long term, specific demand

falls, and the profit is driven to zero.

Additional Learning

You can refer to this article on Monopolistic Competition to get a better insight into the market structure.

The Oligopoly Model

Probably, the most widely recognised type of market structure is an oligopoly. Consider the computer operating systems

(OS) market. It is hard to even think of any computer OS other than Microsoft Windows, macOS and Linux. More than 99%

of all the computers in the world use one of these three operating systems. Thus, the computer OS market is a classic

example of an oligopoly.
 2. On the other hand, they can increase prices for the end-consumers as they control the availability of produce in the markets. In this case, they

are abusing their market power of being a single supplier.

But in each of these cases, the consequence of the event would be that the intermediaries would prosper at the sake of the

farmers and the end-consumers.

Such scenarios, where an economy operates inefficiently due to the abuse of market power by a firm, are known as scenarios

of 'market failure due to market power'. Let’s understand market failures in detail from Chris as he speaks about market

failure due to market power in the upcoming video.

In this video, you understood the most common type of market failure, i.e., market power. You also learnt that

market power cannot be established on public goods and that they need to be kept free. In the next video, let’s take a

look at the actions that the government takes in case of market failure.

In this video, you learnt how the government supplies services, and if, for any product, the government anticipates a market

failure, it is likely to become, at least, the sole customer for the product.

You also learnt that the government looks for collaboration that can provide it with quality products and services.

Market Failure due to Imperfect

Information
Until now, we have assumed that consumers and producers have perfect information when making decisions. However, we

all know that this is far from reality.

ultimately, human life. Pollution can be termed as an externality. It is called an externality because it is affecting third parties

that may or may not be directly involved with industries that cause pollution.

In the following video, let’s understand externalities in detail from Chris.

In this video, you understood how externalities could affect the effective functioning of the market. You also looked at the

possible ways in which the government can intervene to minimise these negative risks for society.

You can understand externalities in the following way.

The costs of running a business can be thought of as consisting of:

1. Private costs, which are all the costs directly borne by the producer; and

2. Social costs, which are the costs borne by society.

Total costs, in this scenario, would take into account the full spectrum of costs and hence is equal to private costs + social

costs.

Similarly, total benefit = private benefit + social benefit.

The difference between a positive externality and a negative externality is as follows:

1. A positive externality occurs when social benefit > private benefit.

2. A negative externality occurs when there's a social cost > private cost.

In the next video, let’s hear from Chris as he explains some ways to prevent or reduce negative externalities and to account

for or include positive externalities.

In this video, you learnt about the following ways to prevent negative externalities:

1. Governments can penalise actions that cause negative impacts.

2. Goods and services with negative externalities can be taxed.

3. Contracts can include clauses for penalising potential negative externalities.

 5. Various other regulations can be enforced by the government to ensure social welfare.

Whenever governments create policies for regulating a market, they are most likely to support one set of stakeholders over

the other. For example, typically, price ceilings are intended to support the consumers, while price floors are intended

to support the producers.

And, many times, these stakeholders form groups to lobby with the government or politicians to advance their goals. In the

next video, let’s hear Chris’ views on whether such lobbying is good or bad.

In this video, you learnt about the concept of lobbying, which demonstrates how stakeholders may express concerns about an

issue that they deeply care about. Lobbying affects government policies, and government intervention impacts the businesses

in the market.

Ultimately, it is important to note that markets do not operate in a vacuum. They are shaped by various factors and parties.

Businesses need to consider the overall impact of all stakeholders on their market before making any economic decision.

You can refer to this article on Government Intervention in Markets to understand how the demand of a market is

affected by these interventions.

Session Summary
In this session you learnt about perfect competition and monopolies.

1. Introduction to Markets

A market consists of consumers and producers of a specific good or service.

You learnt about the characteristics that determine the structure of a market. These include:

 The number of producers and sellers transacting in the market,

 The type of product in terms of how similar or differentiated it is within a market,

  There is no substitute for the product sold.

 Firms are price setters.

 There are high entry or exit barriers.

4. Monopolistic Competition

The characteristics of the monopolistic model are as follows:

 There are many buyers and sellers in the market.

 Products are differentiated; however, close substitutes do exist.

 Firms have some control over price.

 There are low entry or exit barriers.

5. Oligopolies

The characteristics of an oligopoly market structure are as follows:

 There are few large firms that dominate the market.

 A product can be identical, as in the example of telecommunication providers, or differentiated, as in the example of pizza chains.

 Entry into the industry is restricted because of the existence of big players in the market.

Then, you learnt about the three major causes of market failures: market power, imperfect information and externalities.

Market failures are caused due to:

1. Abuse of market power: when powerful members in the market abuse their market power to prosper at the sake of other members in the

market

2. Imperfect Information: when members in the market are unable to or do not provide all the necessary information required to carry out healthy

transactions.

3. Externalities: Outcomes that can positively or negatively affect stakeholders who may not directly take part in a transaction.
  How income flows in an economy

 What productivity means for an economy

 How the size of an economy is measured in terms of GDP

 What causes a recession in an economy

 Two macroeconomic models

Introduction to Macroeconomics
Now that you have studied microeconomics, which focuses on the individual players in an economy, you must be curious to

know how the economy looks once you zoom out of it. How does an aggregated view of the economy help governments and

central banks in decision-making?

In the following video, Chris will present to you a macro view of the economy and explain how macroeconomics differs

from microeconomics. So, let’s begin!

Play Video
2683610

In this video, you learnt that macroeconomics studies the behaviour and performance of the economy as a whole. It is

not concerned with the individual elements in an economy, like microeconomics, but with the “macro” view of the economy.

You also understood why macroeconomics needs to be studied independently as a subject.

Throughout this module, you will learn what makes macroeconomics so important and how macroeconomic decisions

impact countries and their economies. In the next segment, you will learn about the circular flow of income from a

macroeconomic perspective.

Circular Flow of Income

Now, you have looked at the circular flow of income from a microeconomic perspective. In this segment, you will look at it

from a macroeconomic perspective and also understand the two-sector, three-sector and four-sector models of the economy.
G = Government expenditure

X = Total exports

M = Total imports

In the formula, the (X – M) value indicates net exports. A country that exports more than it imports is a net exporter, and a

country that imports more than it exports is called a net importer.

GDP is an important consideration for businesses that are planning to invest in other countries, as it is an important indicator

of a country’s economic health. A high GDP indicates a thriving economy, in which businesses would prefer to invest.

Likewise, a low GDP figure indicates a weak economy, and businesses would need to weigh their risks before investing in

economies with a weak GDP.

You also learnt the two approaches used to measure the GDP of a country:

 Expenditure approach: This involves adding up the money spent on the components discussed in the formula for calculating

the GDP.

 Income approach: This approach, conversely, takes into consideration the income earned by the residents of a country.

Now, GDP is of two types:

 Nominal GDP: This is the value of GDP at current market prices and is not adjusted for inflation.

 Real GDP: As the name suggests, this is the value of all goods and services produced in a country during a year, adjusted for

inflation to reflect changes in real output.

You also learnt about the alternative ways to measure an economy:

 Gross National Product or GNP, which basically takes into account the GDP and also income from abroad.

 Net National Product or NNP, which is calculated by deducting the depreciation in the value of the factors of production.

In the next segment, you will learn how some economies perform better than others through the concept of Productivity. But

before that, attempt the questions given below to reinforce your learning from this segment.
You also learnt that at a recession can be brought about by a significant decrease in demand, which would lead to a demand

shock, or by a severe decrease in the supply, which is referred to as a supply shock.

 A demand-led recession occurs when there is a lack of demand in an economy owing to various factors like an increase in

leakage from the economy by way of high imports or high savings, higher taxes, etc.

 A supply-led recession or supply shock occurs when there is a sudden decrease in the supply of an essential commodity, which

affects production in an economy.

Now, attempt the questions given below to reinforce your learning from this segment.

Macroeconomic Models
In this segment, let’s look at two economic models that are imperative to the understanding of the broader economy and will

help you understand macroeconomics better. These are the Aggregate Demand – Aggregate Supply (AD/AS) model and

the Investment-Savings and Liquidity Preference – Money Supply (IS-LM) model.

First, let’s look at the AD/AS model. So, aggregate demand refers to the total demand for goods and services in a market.

Likewise, aggregate supply refers to the total supply of goods and services that businesses or producers can supply to a

market.

Essentially, the AD/AS model helps you understand the relationship between aggregate demand and aggregate supply. It

shows how spending in an economy (AD) relates to the production in an economy (AS) to help determine the

macroeconomic equilibrium, which indicates the real GDP and price levels.

Some features of the AD-AS model:

 It is similar to a simple market demand and supply model, but it takes a broader view of the economy, which helps governments

or economists interpret the economy better and thus take better decisions.
  As money supply in an economy increases, there is less need to compete over it, and this leads to lower interest rates. This

situation occurs when people start spending and thereby circulating more money in the economy. So, the LM curve slopes

downwards.

That brings us to the end of this session. In the next session, you will learn about various macroeconomic theories and

factors. Now, try to attempt the following questions.

Session Summary
In this session on the Fundamentals of Macroeconomics, you got a complete overview of the critical concepts in

macroeconomics. Here is a brief summary of all what was covered in this session:

1. You learnt how macroeconomics differs from microeconomics. So, macroeconomics looks at the economy from a broader

perspective and helps governments and central banks in making decisions that serve in the best interest of the economy and

the citizens of the country.

2. You learnt about the Circular Flow of Income from a macroeconomic perspective through an analysis of the two-sector,

three-sector and four-sector model of the economy.

 Two-sector model: Households and Businesses

 Three sector model: Households, Businesses and Government

 Four-sector model: Households, Businesses, Government and Foreign Trade

Through this model, you understood how income flows in an economy and what role each of these sectors plays in the

economy. Then, you also learnt how the circular flow of income in an economy can increase or decrease through injections

and leakages.

3. You understood how national income can be measured through the Gross Domestic Product (GDP), which can be

calculated as
In this session

You will learn about:

1. Classical economic theory and Keynesian economic theory, and understand how these have influenced the economics in the modern world

2. The multiplier effect, which shows you how multiplication of investment in an economy happens and why it is beneficial for economies

3. The consumption function, which helps you understand how consumption is modelled in an economy

4. Theories of interest, which help you understand what influences savings and investment decisions

5. Unemployment and inflation, which are core macroeconomic factors, and understand how they are related

Classical vs Keynesian Theory

The debate between Classical and Keynesian theorists has been ongoing for decades. Any understanding of macroeconomics

would be incomplete without understanding the roots of economic theory.

In this segment, let’s look at some of the facets of these important theories and understand how they have shaped our view of

the functioning of an economy over the years.

This video gave you a broad overview of the Classical and Keynesian theories of economics. You understood how these

theories differ in their approaches to analysing how economies operate and grow. Two major approaches that you learnt

about are:

 Say's Law of Markets: It states that 'supply creates its own demand', arguing that even if there is over-production in an

economy, demand will automatically be created for it.

 John Maynard Keynes' theory: It states supply cannot create its own demand and that 'demand creates its own supply'.

Keynes argued that aggregate demand drives production in an economy.

Based on your learnings from this segment, attempt the following assessment.

The Consumption Function

You learnt that the multiplier effect refers to the proportional change in output for a given amount of input in the

economy. Simply put, for every dollar injected in the economy, how much does the economy grow.

The multiplier effect helps governments understand which investments have a larger impact on the economy and yield better

results. A high multiplier indicates higher returns and a low multiplier indicates low returns.

Now, based on your learning from this segment, attempt the following questions.

Theories of Interest
As you learnt in the IS-LM model, interest refers to the amount of money you get paid for saving your money or the

amount that you need to pay for borrowing money. Based on this understanding of the interest rates, let's look at the

following video and learn about theories of interest.

In this video, you learnt that the interest rate and demand for money have an inverse relationship:

 As interest rates increase, demand for money decreases, as borrowing money becomes more expensive

 As interest rates decrease, demand for money increases, as borrowing money becomes cheaper

You also learnt how interest rates affect the GDP, and also how interest rates are determined for different investments

durations through the example of the yield curve.

Unemployment and Inflation - I

In this segment, let's look at the two most important factors in macroeconomics: Unemployment and Inflation. These factors

have a strong impact on the economic performance of a country.

In this video, let's hear from Debopam as he explains to you why unemployment occurs and what are its types.

In this video, you understood how unemployment negatively impacts the circular flow of income in an economy as well as

the GDP.
In the previous segment, you learnt about the types of unemployment and inflation.

In this segment, let's hear Chris as he elaborates on the concept of inflation, including its causes, and explains the

relationship between inflation and unemployment.

In this video, you understood how inflation can impact the return on investment of businesses. You also learnt about:

1. Cost-push theory of inflation: Here, producers push the rising input costs to the customers, which leads to a rise in prices of

goods and services.

2. Demand-pull theory of inflation: This happens in a low-supply situation, where demand is high but supply is low, so producers

increase or inflate their prices.

You also understood the relationship between inflation and unemployment by looking at the Phillips Curve, which shows the

trade-off between inflation and unemployment.

Based on your learnings from this segment, attempt the following question.

Session Summary
In this session, you understood some of the theories in macroeconomics and also learnt about the various macroeconomic

factors. Now, let's quickly summarise all that you learnt in this session.

1. You got an overview of economic theory over the years, starting from the Classical approach that began in the 1800s,

to Say's Law of Markets proposed by Jean-Baptiste Say, to Keynesian theory propagated by John Maynard Keynes, who

argued that demand drives production in an economy. You also understood how the views of Classical theorist and

Keynesian theorists differed based on their interpretation of how an economy functions.

2. You learnt about the Consumption function, which is important as household consumption is the biggest component of

GDP for most countries. You learnt how consumption can be modelled to gauge the total consumption in an economy using

the model:

C = A + M * D, where
Session Overview
Welcome to this session on Macroeconomic Policies and Tools. So far in this module, you learnt about what happens in an

economy, what are the various macroeconomic factors and how they interact. In this session, you will learn what role

governments and central banks play in regulating an economy.

In this session

You will learn about:

1. Monetary policy, and how central banks use monetary policy to regulate economic activity in a country through various measures

2. Fiscal policy, and how governments use fiscal policy to regulate economic activity in an economy through various measures

3. Exchange rate, and what drives fluctuations in exchange rates

4. Uses of economic data and where to find it

Monetary Policy
In this segment, let's try to understand how central banks, who are the primary actors in monetary policy, influence the

economy through various measures.

Let's hear Chris as he walks you through various concepts related to monetary policy.

In this video, you understood how central banks make monetary policy decisions to regulate the economy.

As you learnt, the purpose of monetary policy is to influence the investment and savings and spending decisions of

consumers and businesses in the economy.

You also learnt that central banks achieve their objective by:

1. Regulating money supply

2. Regulating interest rates

Whenever you travel abroad, one factor that you always need to keep in mind is the currency exchange rate. So, in this

segment, let's learn about exchange rates and what influences them.

In this video, you learnt that foreign exchange refers to "all currencies other than the domestic currency".

You learnt that exchange rate is of two types:

1. Nominal exchange rate: How much of one currency can one unit of another currency buy

2. Real exchange rate: The rate at which one country can trade its goods for goods from another country

You also learnt about the theory of purchasing power parity (PPP), which states that no matter where in the world you are,

the same bundle of products should cost you the same.

Another important concept that you learnt about is currency pegging, wherein countries take measures to ensure that

currency does not move much against another currency. For example, Saudi Arabia has pegged its currency Riyal against the

US dollar at 3.75 Riyal per US dollar.

The objective of currency pegging is to assure investors that their investments are safe.

Based on what you learnt in this segment, attempt the following questions.

Economic Data
Imagine you are a business analyst and need to find data pertaining to an economy. How do you go about this? In this

segment, you will learn about various information sources available for economic data, and also about what type of data is

useful in which context.

In this video, you learnt how you can find economic data through various government websites and agencies. For example,

in India, you can access a vast variety of economic data at data.gov.in, which is a government website.

You also learnt about the criteria for evaluating information or data:

1. Frequency of data

2. Reliability of data
4. Finally, you learnt that as business managers or analysts, where you can find the economic data that you might need for

business decision-making. You also understood that the criteria for evaluating this data are: frequency and reliability of

data.

Session Overview
Welcome to the final module of this session. Here, let's learn about one of the most important sectors in an economy:

Foreign Trade. In this session, you will learn about the role foreign trade plays in an economy.

In this session

You will find answers to the following questions:

1. What is foreign trade and what is competitive advantage in foreign trade

2. What is trade policy and how governments design these policies to their advantage

3. What is FDI and the role of foreign investments in an economy

4. What is Balance of Payments (BoP) and how it is an indicator of economic health

Introduction to Foreign Trade

Exports and imports are both a part of a country's foreign trade sector. In this segment, let's look at what foreign trade means

and how countries benefit from it.

You learnt that the most important aspect of foreign trade is that it allows countries to use their comparative advantage

for economic benefit. This helps them grow economically and gain financial advantage.

You understood the basis of foreign trade:

1. It allows countries to export goods at comparatively higher prices than they can get in the domestic market

2. It allows countries to import goods at a lower price than they can get in the domestic market.

Then you learnt about some of the factors that can drive comparative advantage:
 1. Tariff barriers, wherein a tax is imposed on the imported good, usually with the purpose of restricting imports and ensuring that

domestic versions of the imported goods are cheaper.

2. Non-tariff barriers: These are barriers that are not in the form of tariffs. Some types of non-tariff barriers are import quotas,

bans, sanctions, etc.

You also learnt that countries also opt for free trade agreements (FTAs), which are agreements that allow countries to

export and import freely without any restrictions or barriers.

Now, based on what you learnt in this segment, attempt the questions given below.

Foreign Investments
When a foreign company like Walmart invests in Flipkart, what is it an example of? Well, it's a foreign direct investment or

FDI. In this video, let's understand the concept of FDI and other foreign investments.

You learnt that foreign investments can be of two types: Foreign direct investments and foreign indirect investments.

You learnt that companies can offer FDI to other countries by:

 Setting up operations in another country

 Acquiring assets or businesses in another country

Foreign indirect investments can be made through:

 Investing in the shares or bonds in another country or stock market

 Purchasing government debt in another country

Now when companies make foreign investments, the motivation behind them is economic benefit. So, expectations from

foreign investments include financial benefit for the involved parties, a high rate of return for the investor, and economic

growth for the country receiving the capital from abroad.

You also understood that high FDI inflow into a country indicates good economic health and prospects for a country.

Balance of Payments
Case Study - The 1991 Crisis
Now that you have learnt how the economy works and how the government uses economic policies to overcome the

different hurdles, let's hear from Debopam as he analyses the 1991 Economic Crisis, which changed the face of the Indian

economy.

You learnt how India was a closed economy until the late 1980s. India's exports were very low and imports were very high.

Owing to this, the Indian economy faced a Balance of Payments crisis. The government was unable to grow its revenues and

was spending too much money on subsidies for farmers. This lead to an increase in the country's fiscal deficit.

Domestic production was at an all-time low; unemployment levels were at an all-time high; inflation was rising; the

economy was not growing. The government had to find a way to rebuild the economy.

The IMF bailed out the Indian economy by loaning it money, with the condition that India had to open its doors to the

outside world. This led to what is now commonly known as 'LPG Reforms', led by the then Finance Minister Dr Manmohan

Singh and Prime Minister P.V. Narasimha Rao.

LPG Reforms included Liberalization, Privatization and Globalization.

 Liberalization helped the economy free itself from the infamous license raj that was prevalent in those times.

 Privatizations helped increase the productivity and competitiveness of many producers in the economy by turning public sector

units into private organizations and withdrawing control and ownership over most public sector units.

 Globalization helped India open its doors to for trade with outside economies. These reforms helped in bringing the economy out

of the crisis it was facing and then helped the economy grow more.

These reforms made India an open economy and improved the ease of doing business with other countries. After these

reforms, India saw steady economic growth, with the unemployment and inflation levels under control.
You also learnt that indirect investments can be made through:

 Investing in the shares or bonds in another country or stock market

 Purchasing government debt in another country

The main objective behind FDI is to earn a good return on investments.

4. In the final segment of this module, you learnt about the Balance of Payments (BoP), which is the recorded summary

of all the financial transactions that a country’s entities perform with the rest of the world over a defined period of

time.

You learnt that the two components of the BoP are current account and capital account.

Then you learnt what balance of trade (BoT) means. It is the difference between the value of a country’s exports and

imports for a given period of time.

You also understood what disequilibrium in BoP means and learnt about the various measures that can be taken to correct it.

Question 1/4
Mandatory

Foreign Trade

Zaldia has an abundance of rice production. It has been exporting rice to its neighbouring countries for many years now. But
last year, Scandia too entered the rice market and has been selling its rice in the global markets at very cheap prices, including
to Zaldia’s neighbours. How will this impact Zaldia’s rice producers?

The producers will need to increase their prices.

The producers will not need to take any action.

The producers will need to lower their prices.

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