INDRAPRASHTHA LAW COLLEGE

(Affiliated to CCS University)

(Session 2023-24)
(Course: BA. LLB Semester:1st) ECONOMICS

Compiled by
(Dr. Sonia Khari)
Assistant Professor
Indraprastha Law College
Greater Noida

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 Unit-1

1. General Principals
a.) Economics as a Science and its relevance to law:

Law and Economics

Law and economics,” also known as the economic analysis of law, differs from other forms of
legal analysis in two main ways. First, the theoretical analysis focuses on EFFICIENCY. In simple
terms, a legal situation is said to be efficient if a right is given to the party who would be willing
to pay the most for it. There are two distinct theories of legal efficiency, and law and economics
scholars support arguments based on both. The positive theory of legal efficiency states that the
common law (judge-made law, the main body of law in England and its former colonies,
including the United States) is efficient, while the normative theory is that the law should
be efficient. It is important that the two theories remain separate. Most economists accept both.

Law and economics stresses that markets are more efficient than courts. When possible, the legal
system, according to the positive theory, will force a transaction into the market. When this is
impossible, the legal system attempts to “mimic a market” and guess at what the parties would
have desired if markets had been feasible.

The second characteristic of law and economics is its emphasis on incentives and people’s
responses to these incentives. For example, the purpose of damage payments in accident (tort)
law is not to compensate injured parties, but rather to provide an incentive for potential injurers
to take efficient (cost-justified) precautions to avoid causing the accident. Law and economics
shares with other branches of economics the assumption that individuals are rational and respond
to incentives. When penalties for an action increase, people will undertake less of that action.
Law and economics is more likely than other branches of legal analysis to use empirical or
statistical methods to measure these responses to incentives.

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The private legal system must perform three functions, all related to property and PROPERTY

RIGHTS. First, the system must define property rights; this is the task of property law itself.
Second, the system must allow for transfer of property; this is the role of contract law. Finally,
the system must protect property rights; this is the function of tort law and criminal law. These
are the major issues studied in law and economics. Law and economics scholars also apply the
tools of economics, such as GAME THEORY, to purely legal questions, such as various parties’
litigation strategies. While these are aspects of law and economics, they are of more interest to
legal scholars than to students of the economy.

Economics is a subject matter that is based upon human behavior which plays a very prominent
role in many aspects of the law. Economics is always interested to know law and as per my
opinion, every lawyer should know about economics concept as law deal with many of the
concepts that are related to economics. And sometimes equitable knowledge should be there for
a lawyer to depict the actual reasons behind the fluctuating economy parallel to the crimes in the
society. The emergence of economics in-law makes the easy task for an observer to analyze the
law and economy as a whole. It is somehow gain popularity because of various eminent
economics and jurists.

Meaning of economic analysis of law

In simple words, economic analysis of law refers to the applying of economic theories to the
matters of law which is specifically the microeconomic theories rather than the macro Economic
theories. The application of economics into the law system originated from The scholars of
Chicago school of Economics where they used to explain the effect of laws and rules of law with
the help of economic concepts. Moving further, economic analysis of law can be taken as an
application of economic tools to the law for the better understanding of the economy as well as
monitoring the economic factors in law and society

Historical background of economic analysis of law

In 1960, an eminent scholar named Ronald Coase who later got Nobel Prize firstly introduced
the concept of economic analysis of law in an article named ” The Problem of Coase” mention
the concept of economic analysis of law. Along with this, Friedrich Hayek also wrote about the
same concept. Afterward, Richard who is an eminent economics scholar published a journal

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named “Economic Analysis of Law “where he discussed the same matter. Then in modern latest
developments proved the necessity of economics in the field of law.

Importance of economics in law

1. Economic laws are the statement of cause and effect
By this statement, we meant that atomic as well as law is concerned with the cause and effect
relationship that means it focuses on the relationship between one thing which is affecting
another thing, for example, the relationship between the substitute and the complementary goods.

1. Economics helps in better interaction with human behavior

The primary objective of the law is to video from the infringement from his basic rights which
means the law is rotated towards human behavior and has to build a proper and better interaction
with the humans to provide the settlements for their disputes arising out of the economic factors
in the economy. Therefore, we can easily say that economics helps in better interaction with
human behavior.

2. Regulation of various bodies needs a better understanding of Economics

Every aspect of the economy like cash flow, demand, supply, utility, etc. Therefore, proper
enactments related to these concepts need a basic understanding of economics. Moreover, the
regulation of various bodies governing these concepts needs proper law constituting them. For
example – RBI, LIC, SEBI, etc.

1. Economics helps in understanding the negative externalities in various law subjects

2. Economics helps in understanding tax laws
Economics helps in understanding tax laws directly or indirectly economics helps in
understanding various concepts of tax laws. For example, the economics of taxation pocket on
the problems concerned with the levying of taxes. As we know Economics deal with the issues
of the economy alike law is concerned with the issues related to the society.

3. Economic help in understanding the company law

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Company Law or we can say business law, in other words, is concerned with the corporate sector
which includes various terms and definitions which early man can’t understand without
understanding the concept of Economics. Therefore we can say that company law can be
understood to the people having a piece of basic knowledge regarding economics.

4. Economics helps in understanding consumer protection law

Economic directly or indirectly helping the understanding of consumer protection that is covered
under the Consumer Protection Act which is enacted for the protection of consumers and
encroachment of their rights as a consumer of the goods and services. Therefore, the basic
understanding of Economic helps in understanding Consumer Protection laws.

5. Economics helps in understanding property laws

Economics talks about the availability of resources in our country, size, and characteristics of the
population of our country, their expectations and preferences, the institutional framework for the
people to execute in the territorial boundaries of a country. Economic provides detailed
information all the above said categories which enable lawmakers to enact property laws after
determination of these factors for the citizens of the country to be applied to them.

 Laws related to the limited resources can only be understood by having a basic
knowledge of Economics.
As we know India is a diverse country having very limited resources for example water,
petroleum and many others. For that purpose, to conserve these resources proper rules and
regulations are to be introduced in various legislation or promulgations to sustainable
development. For example, Water (prevention and control of pollution) act of 1974 have been
enacted

 Concept of uncertainty and expectations taught by economics in law

As we know economics to deal with unlimited wants and limited resources thus comprises
greater expectations. And for the accomplishment of these expectations wants, normally people
used to do unfair means to attain it. For that purpose, proper legislation is to be made in the law
itself which reflects the significance of economics in lawmaking.

6. Economics act as a critical examination of lawmaking

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There is no doubt that economics deals with each and every sector of the economy. Therefore,
for the enactment of necessary legislation, we have to consider the parameters of economics.
Economics exam board critical examination for the present situation of the economy which helps
in enactment of various promulgations related to the economy.

Criticism faced by economic analysis of law

Criticism faced by economic analysis of law is discussed in the following points :

1. As per critics, economic analysis of law missed out various important variables.

2. According to the people are not rational maximizes of individual preferences which eminent
economists assume them to be.

3. Economic analysis of law is interdeterminant in nature.

4. Sometimes economic analysis of law generates undesirable and unjust outcomes.

5. According to critics, economic analysis of law resulted in the generation of

commodification which is a serious problem.

B.) Economics as a basis of social justice

Defining Economic Justice and Social Justice

One definition of justice is “giving to each what he or she is due.” The problem is knowing what
is “due”.
Functionally, “justice” is a set of universal principles which guide people in judging what is right
and what is wrong, no matter what culture and society they live in. Justice is one of the four
“cardinal virtues” of classical moral philosophy, along with courage, temperance (self-control)
and prudence (efficiency). (Faith, hope and charity are considered to be the three “religious”
virtues.) Virtues or “good habits” help individuals to develop fully their human potentials, thus
enabling them to serve their own self-interests as well as work in harmony with others for their
common good.
The ultimate purpose of all the virtues is to elevate the dignity and sovereignty of the human
person.

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The concept of social and economic justice is a living concept of revolutionary importance; it
gives sustenance to the rule of law and meaning and significance to the idea of welfare state.
Article 38(1) of the constitution of India provides that “State shall strive to promote the welfare
of the people by securing and protecting as effectively as it may social order in which justice-
social, economic and political, shall inform all the institutions of the national life”

The preamble of the constitution of India also provides, “We the people of India, having
solemnly resolved to constitute India into a Sovereign Socialist Secular Democratic Republic and
to secure to all its citizens: Justice, social, economic and Political…”

Article 28(2) of the constitution states, “the state shall, in particular, strive to minimize the
inequalities in income, and endeavour to eliminate inequalities in status, facilities and
opportunities, not only amongst individuals but also amongst groups of people residing in
different areas or engaged in different vocations.”

Social Justice is linked with the securing economic justice. Social Justice is justice according to
social interest. Social Justice is designed to undo the injustice of unequal birth and opportunity,
to make it possible that wealth should be distributed as equally as possible and to provide that
material things of life should be guaranteed to each man.

Social justice is dealing equitably and fairly not between individuals but between classes of
society; the rich and the poor. Social justice is founded on the basic idea of socio-economic
equality and it aims at assisting the removal of socio-economic disparities and inequalities of
birth and status and endeavours to resolve the completing claims especially between employers
and workers by finding a just, fair and equitable solution to their human relations problem so that
peace, harmony and co-operation of the highest order prevails amongst them which may further
the growth and progress of nations.

The State, under action program as per article 39 adopted the following enactments to provide
social and economic justice:

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 The Monopolies and Restrictive Trade Practices Act (MRTP Act), 1969.
 The Industrial (Development Regulation) Act, 1951.
 Land Ceiling Acts by State Governments.
 The Equal Remuneration Act, 1976.
 The Child Labour (Prohibition and Regulation) Act, 1986.
 The Employment of Children (Amendment) Act, 1985.
 The Employees Provident Fund Scheme, 1952.
 The Payment of Gratuity Act, 1972.
 The Employment Family Pension Scheme, 1971.
 The Employees’ Pension Scheme, 1995.
 The Old Age Pension Schemes.

Besides enacting these acts, the state launched many poverty eradication schemes to bring the
people above poverty line under Community Development Programmes. There should be more
equitable distribution of wealth to achieve social justice in any society. There are economists
who firmly believe that any matter concerning economic policy or economics. Social justice,
thus, is indispensable for the formulation of economic policies. The social justice can be
considered as a function of each individual’s welfare.

Defining Social Justice

Social justice encompasses economic justice. Social justice is the virtue which guides us in
creating those organized human interactions we call institutions. In turn, social institutions, when
justly organized, provide us with access to what is good for the person, both individually and in
our associations with others. Social justice also imposes on each of us a personal responsibility to
collaborate with others, at whatever level of the “Common Good” in which we participate, to
design and continually perfect our institutions as tools for personal and social development.
Defining Economic Justice
Economic justice, which touches the individual person as well as the social order, encompasses
the moral principles which guide us in designing our economic institutions. These institutions
determine how each person earns a living, enters into contracts, exchanges goods and services

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with others and otherwise produces an independent material foundation for his or her economic
sustenance. The ultimate purpose of economic justice is to free each person to engage creatively
in the unlimited work beyond economics, that of the mind and the spirit.
The Three Principles of Economic Justice
Like every system, economic justice involves input, out-take, and feedback for restoring
harmony or balance between input and out-take. Within the system of economic justice as
defined by Louis Kelso and Mortimer Adler, there are three essential and interdependent
principles: Participative Justice (the input principle), Distributive Justice (the out-take
principle), and Social Justice (the feedback and corrective principle). Like the legs of a three-
legged stool, if any of these principles is weakened or missing, the system of economic justice
will collapse.

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Participative Justice

“Participative Justice” describes how each of us makes an “input” to the economic process in
order to earn a living. It requires equal access to the means (through social institutions such as
our money and credit system) of acquiring private property in productive assets, as well as equal
opportunity to engage in productive work.
The principle of participation does not guarantee equal results. It requires, however, that every
person possess the equal human right to participate in/contribute to the production of marketable
goods and services — through one’s labor (as a worker) and/or through one’s productive capital
(as an owner). Thus, this principle rejects monopolies, special privileges, and other exclusionary
social barriers to the full participation and economic self-reliance of every person.

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Distributive Justice

“Distributive Justice” defines the “output” or “out-take” rights of an economic system matched
to each person’s labor and capital inputs. Through the distributional features of private property
within a free and open marketplace, distributive justice becomes automatically linked to
participative justice, and incomes become linked to productive contributions. The principle of
distributive justice involves the sanctity of property and contracts. It turns to the free and open
marketplace, not government, as the most objective and democratic means for determining the
just price, the just wage, and the just profit.
Many confuse the distributive principles of justice with those of charity. Charity involves the
concept “to each according to his needs,” whereas “distributive justice” is based on the idea “to
each according to his contribution.” Confusing these principles leads to endless conflict and
scarcity, forcing government to intervene excessively to maintain social order.
Distributive justice follows participative justice and breaks down when all persons are not given
equal opportunity to acquire and enjoy the fruits of income-producing property.

SocialJustice

“Social Justice” is the “feedback and corrective” principle that detects distortions of the input
and/or out-take principles and guides the corrections needed to restore a just and balanced
economic order for all. This principle is violated by unjust barriers to participation, by
monopolies or by some using their property to harm or exploit others.
Economic harmony results when Participative and Distributive Justice are operating fully for
every person within a system or institution. The Oxford English Dictionary defines “economic
harmonies” as “Laws of social adjustment under which the self-interest of one man or group of
men, if given free play, will produce results offering the maximum advantage to other men and
the community as a whole.” Social Justice offers guidelines for controlling monopolies, building
checks-and-balances within social institutions, and re-synchronizing distribution (out-take) with
participation (input). The first two principles of economic justice flow from the eternal human
search for justice in general, which automatically requires a balance between input and out-

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take, i.e., “to each according to what he is due.” Social Justice, on the other hand, reflects the
human striving for other universal values such as Truth, Love and Beauty. It compels people to
look beyond what is, to what ought to be, and continually repair and improve their systems for
the good of every person.
It should be noted that Louis Kelso and Mortimer Adler referred to the third principle as “the
principle of limitation” as a restraint on human tendencies toward greed and monopoly that lead
to exclusion and exploitation of others. Given the potential synergies inherent in economic
justice in today’s high technology world, CESJ feels that the concept of “social justice” is more
appropriate and more-encompassing than the term “limitation” in describing the third component
of economic justice. Furthermore, the harmony that results from the operation of social justice is
more consistent with the truism that a society that seeks peace must first work for justice.

C.) Free eneterprise, Planned Economy And Mixed Economy

MEANING OF AN ECONOMY

An economy is a man-made organization for the satisfaction of human wants. According to A.J.
Brown, “An economy is a system by which people get living”. The way man attempts to get a
living differs in major respects from time to time and from place to place. In primitive times ‘get
a living’ was simple but with growth of civilization it has become much more complex. Here it is
important to note that the way person earns his/her living must be legal and fair. Unfair and
illegal means such as robbery, smuggling may earn income for oneself but should not be taken
into consideration as gainful economic activity or a system of ‘get a living’. It will therefore be
appropriate to call that economy is a framework where all economic activities are carried out.

Some of the salient features of an economy are as follows:

1. Economic institutions are man made. Thus an economy is what we make it.

2. Economic institutions can be created, destroyed, replaced or changed. For example the
capitalism was replaced by communism in 1917 in USSR and the communism was destroyed in
1989 through a series of economic reforms by former USSR. In India after independence in 1947

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through economic and social reforms we abolished Zamindari system and introduced many land
reform.

3. Levels of economic activities keep on changing.

4. Producers and consumers are the same persons. Thus they have a dual role. As producers they
work and produce certain goods and services and consume the same as consumers.

5. Production, consumption and investment are the vital processes of an economy.

6. In modern complex economies we use money as a medium, of exchange.

7. Now-a-days the government intervention in the economy is considered undesirable and the
preference for free functioning of prices and market forces is increasing in all types of economic
system.

TYPES OF ECONOMIES

As you know that economy is a man-made organization, which is created, destroyed or

changed as per the requirement of the society. We can differentiate in various types of economic
systems on the basis of following criteria.

On the Basis of Ownership and Control over Means of Production or Resources

Resources or means of production remain either in private ownership with full individual
freedom to use them for the profit motive or they can be in collective ownership Based on the
criterion of degree of individual freedom and profit motive, economies are labelled as:

(A) Capitalist or free enterprise economy

(B) Socialist or centrally planned economy

(C) Mixed economy

(A) Capitalist Economy

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The capitalist or free enterprise economy is the oldest form of economy. Earlier economists
supported the policy of ‘laissez fair’ meaning leave free. They advocated minimum government
intervention in the economic activities. The following are the main features of a capitalist
economy;

(i) Private property

In a capitalism system all the individuals have the right to own property. An
individual can acquire property and use it for the benefit of his own family.
There is no restriction on the ownership of land, machines, mines, factories
and to earn profit and accumulate wealth. After the death of a person the
property or wealth is transferred to the legal heirs. Thus the institution of
private property is sustained over time by the right of inheritance.
(ii) Freedom of enterprise
In a capitalist economy the government does not coordinate production
decisions of the citizens. Individuals are free to choose any occupation.
Freedom of enterprise implies that business firms are free to acquire resources
and use them in the production of any good or service. The firms are also free
to sell their product in the markets of their choice. A worker is free to choose
his/her employer. In small business units owner himself takes the risk of
production and earns profit or loss for himself. But in modern corporations the
shareholders take risks whereas paid directors manage business. Thus the
individual supervision of one’s own capital is now no longer required to earn
profit. Government or any other agency does not impose restrictions/obstacles
in the way of workers to enter or leave a particular industry. A worker chooses
that occupation where his income is maximum.
(iii) Consumer’s Sovereignty
In a capitalist economy consumers are like a king. They have the full freedom
to spend their income on goods and services that give them maximum
satisfaction. In capitalist system production is guided by consumer’s choices.
This freedom of consumers is called consumer’s sovereignty
(iv) Profit Motive

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 Self-interest is the guiding principle in capitalism. Entrepreneurs know that
they will own the profit or loss after the payment to all other factors of
production. Therefore they are always motivated to maximize their residual
profit by minimizing cost and maximizing revenue. This makes the capitalist
economy an efficient and self-regulated economy.
(v) Competition
There are no restrictions on the entry and exit of firms in a capitalism system.
The large number of producers are available to supply a particular good or
service and therefore no firm can earn more than normal profit. Competition is
the fundamental feature of capitalist economy and essential to safeguard
against consumer’s exploitation. Although due to large-size and product
distinction monopolistic tendencies have grown these days still the
competition can be seen among a large number of firms.
(vi) Importance of markets and prices
The important features of capitalism like private property, freedom of choice,
profit motive and competition make a room for free and efficient functioning
of price mechanism. Capitalism is essentially a market economy where every
commodity has a price. The forces of demand and supply in an industry
determine this price. Firms which are able to adjust at a given price earn
normal profit and those who fail to do so often quit the industry. A producer
will produce those goods, which give him more profit. (vii) Absence of
government interference In a free enterprise or capitalist economy the price
system plays an important role of coordinating agent. Government
intervention and support is not required. The role of government is to help in
free and efficient functioning of the markets. Capitalism in today’s world Pure
capitalism is not seen in the world now-a-days. The economies of USA, UK,
France, Netherland, Spain, Portugal, Australia ect. are known as capitalistic
countries with active role of their respective government in economic
development.

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(B) Socialist Economy

In the socialist or centrally planned economies all the productive resources are owned
and controlled by the government in the overall interest of the society. A central planning
authority takes the decisions. The socialist economy has the following main features.

(i) Collective Ownership

means of Production In a Socialist economy means of production are owned
by the government on behalf of the people. The institution of private property
is abolished and no individual is allowed to own any production unit and
accumulate wealth and transfer it to their heirs. However, people may own
some durable consumer goods for their personal use.

(ii) Social Welfare Objective

The decisions are taken by the government at macro level with the objective of maximization of
social welfare in mind rather than maximization of individual profit. The forces of demand and
supply do not play any important role. Careful decisions are taken with the welfare objectives in
mind.

(iii) Central Planning

Economic planning is an essential feature of a socialist economy. The Central Planning

Authority keeping the national priorities and availability of resources in mind allocates
resources. Government takes all economic decisions regarding production, consumption and
investment keeping in mind the present and future needs. The planning authorities fix targets for
various sectors and ensure efficient utilization of resources.

(iv) Reduction in Inequalities

The institutions of private property and inheritance are at the root of inequalities of income and
wealth in a capitalist economy. By abolishing these twin institutions a socialist economic system

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is able to reduce the inequalities of incomes. It is important to note that perfect equality in
income and wealth is neither desirable nor practicable.

(v) No class conflict

In capitalist economy the interests of the workers and management are different. Both of them
want to maximize their own individual profit or earnings. This results in class conflict in
capitalist economy. In socialism there is no competition among classes. Every person is a worker
so there is no class conflict. All are co-workers.

(C) Mixed Economy

A mixed economy combines the best features of capitalism and socialism. Thus mixed economy
has some elements of both free enterprise or capitalist economy as well as a government
controlled socialist economy. The public and private sectors co-exist in mixed economies.

(i) Co-existence of public and private sectors

. The private sector consists of production units that are owned privately and work on the basis of
profit motive. The public sector consists of production units owned by the government and
works on the basis of social welfare. The areas of economic activities of each sector are
generally demarcated. Government uses its various policies e.g. licensing policy, taxation policy,
price policy, monetary policy and fiscal policy to control and regulate the private sector.

(ii) Individual Freedom

Individuals take up economic activities to maximize their personal income. They are free to
choose any occupation and consume as per their choice. But producers are not given the freedom
to exploit consumers and labourers. Government puts some restrictions keeping in mind the
welfare of the people. For instance, government may put restrictions on the production and
consumption of harmful goods. But within rules, regulations and restrictions imposed by the
government, for the welfare of the society the private sector enjoys complete freedom.

(iii) Economic Planning

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The government prepares long-term plans and decides the roles to be played by the private and
public sectors in the development of the economy. The public sector is under direct control of the
government as such production targets and plans are formulated for them directly. The private
sector is provided encouragement, incentives, support and subsidies to work as per national
priorities.

(iv) Price Mechanism

Prices play a significant role in the allocation of resources. For some sectors the policy of
administered prices is adopted. Government also provides price subsidies to help the target
group. The aim of the government is to maximize the welfare of the masses. For those who can
not afford to purchase the goods at market prices, government makes the goods available either
free of cost or at below market (subsidized) prices. Thus in a mixed economy people at large
enjoy individual freedom and government support to protect the interests of weaker sections of
the society. Indian economy is considered a mixed economy as it has well defined areas for
functioning of public and private sectors and economic planning.

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 Unit- 2 (Demand & Supply)

INTRODUCTION

Satisfaction of human needs is the basic end and goal of all production activities in an economy.
Human wants are unlimited and recurring in nature, whereas means available to satisfy them are
limited. Therefore, a rational consumer has to make an optimal use of available resources. The
demand and supply analysis provides a framework within which these decisions have to be
made. Hence, in this unit we shall discuss the various issues related to the theory of demand and
supply analysis.

THE NATURE OF DEMAND

At first, let us understand the meaning of the terms like desire, want, and demand. Desire is just a
wish on the part of the consumer to possess a commodity. If the desire to possess a commodity is
backed by the purchasing power and the consumer is also willing to buy that commodity, it
becomes want. The demand, on the other hand is the wish of the consumer to get a definite
quantity of a commodity at a given price in the market backed by a sufficient purchasing power.
There are three important points to remember about the quantity demanded:

First, the quantity demanded is the quantity desired to be purchased. It is the desired purchase.
The quantity actually bought is referred to as actual purchase.

Secondly, quantity demanded is always considered as a flow measured over a period of time, like
if the quantity demanded of oranges is 10, it must be per day or per week, etc.

Thirdly, the quantity demanded will have an economic meaning only at a given price. For
example, the demand for oranges equal to 10 units per week at a price of Rs. 100 per dozen is a
full and meaningful statement, as used in micro-economic theory.

DETERMINANTS OF DEMAND

The demand of a product is determined by a number of factors. Let us discuss them in detail.

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Determinants of Demand by a Consumer

The demand for commodity or the quantity demanded of a commodity on the part of the
consumer is dependent on a number of factors. These are mentioned as follows:

i) Price of the commodity in question

ii) Prices of other related commodities
iii) Income of the consumers, and
iv) Taste of the consumers.
ii) Demand function refers to the rule that shows how the quantity demanded depends upon
above factors. A demand function can be shown as:

Dx = f (Px, Py,Pz, M, T)

where, Dx is quantity demanded of X commodity,

Px is the price of X commodity,

Py is the price of substitute commodity,

Pz is price of a complement good,

M stands for income,

T is the taste of the consumer.

If all the factors influencing the demand for a commodity X vary simultaneously, the picture
would be highly complicated. Therefore, normally we allow only one of the factors to change,
assuming that all other factors remain unchanged (‘ceteris paribus’ other things remaining
equal).

Demand Relationship:

Relationship of quantity demanded of a commodity to its various determinants can be stated as

follows:

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1.) Price of the commodity:

Normally, higher the price of the commodity, the lower the demand of the commodity. This is
the law of demand.

2) Size of the consumer’s income:

When the increase in income leads to an increase in the quantity demanded, the commodity is
called a ‘normal good’. If an increase in income leads to a fall in the quantity demanded, we call
that commodity an ‘inferior good’.

3) Prices of other commodities:

A consumer’s demand for a commodity may also be influenced by the prices of some other
commodities. Some are complementary goods, which are consumed along with the commodity
in question while others may be used in place of this commodity. This category is called
substitutes.

 Demand bears inverse relationship with prices of complements and direct

relationship with prices of substitutes.

Tea and coffee are substitutes and a car and petrol are example of a pair of complementary
goods.

4.) Tastes of consumer:

If a consumer has developed a taste for a particular commodity, he/she will demand more of that
commodity. Similarly, if a consumer has changed his taste against a particular commodity, less
of it will be demanded at any particular price. This development of tastes may be related to
seasons of the year as well. In summer months, you may consume more cold drinks and ice
creams, whereas in winters, the preference may shift towards hot or warm drinks like tea and
coffee etc.

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Determinants of Market Demand

The factors determining the demand for a commodity in a market are the same as those which
determine the demand for the commodity on the part of a consumer. Besides that two additional
factors are also to be included. These two factors are:

1.)Size of the population:

All other factors remaining unchanged, the greater is the size of the population, more of a
commodity will be demanded.

2) Income distribution:

People in different income groups show marked differences in their preferences. So if larger
share out of national income goes to the rich, demand for the luxury goods may rise and a rise in
income share of the poor will increase demand for the wage goods.

THE LAW OF DEMAND

The inverse ralationship between the quantity of a commodity and its price, given all other
factors that influence the demand is called ‘law of demand’. It gives us a demand curve that
slopes downwards to the right. We can explain this idea with help of a demand schedule, a table
that records quantities demanded at different prices. This schedule, on being recorded on a two
dimensional axes system, gives us a demand curve.

The Demand Schedule

Table : The Demand Schedule of a Consumer for Apples

Price of Apple per Kg. (in Rs.) Quantity Demanded of Apples

(in Kg. per week)
100 15
200 12
300 8
400 3

22
Four combinations of price and quantity demanded are shown. We can easily infer that as price
of an apple rises quantity demanded by the consumer is falling.

The Demand Curve

The demand curve graphically shows the relationship between the quantity of a good that
consumers are willing to buy and the price of the good. Let us understand the demand curve . In
this figure, on the Y-axis, price of an apple in rupees in measured and on the X-axis the quantity
demanded of apples per week is measured. The first combination is shown by point a where at
Rs. 100 per kg 15 units of apples are demanded. Similarly points b, c, d represent combinations
of Rs. 200 price – 12 quantity demanded, Rs. 300 price – 8 quantity demanded and Rs. 400 price
– 3 quantity demanded, respectively. The joining together of points a, b, c, and d give Us
thedemand curve, DD.

Why does a Demand Curve Slope Downwards?

Law of demand states that there is an inverse relationship between the price of a commodity and
its quantity demanded.

1.)Substitution Effect

Substitution effect results from a change in the relative price of a commodity. Suppose a Pepsi
Can and a Coke Can both are priced at Rs. 90 and Rs. 20 each. If the price of Coke is raised to
Rs. 25, and the price of Pepsi is not changed, Pepsi will become relatively cheaper to Coke, i.e.
although the absolute price of Pepsi has not changed, the relative price of Pepsi has gone down.
The change in the relative price of commodity causes substitution effect. Similarly, if price of
mango falls, the rest of the fruits will appear costlier, in comparison with mango. So in both the
cases above, the quantity demanded of relatively costlier items will register a decline.

2. Income Effect

This is the effect of a change in total purchasing power of the money income of the
consumer. As price of mango falls the purchasing power of the given money income

23
 rises, or his real income rises. Thus, he can buy more of the mangoes with the same
money income. His demand for any other commodities may also rise. This is called the
‘income effect’. A commodity with positive income effect is called a ‘normal good’. It
shows a positive or direct relationship between the income and the quantity demanded.
When rise in income leads to a fall in the quantity demanded, we have a case of negative
income effect. Such goods are called the ‘inferior goods’.
3. Price Effect
Price Effect is the sum total of the substitution effect and income effect,
i.e. PE = SE + IE
Where PE = Price Effect.
SE = Substitution Effect
IE = Income Effect

It is important to note that substitution effect and income effect operate simultaneously
with the change in the price of the commodity. ‘Substitution effect’, and ‘income effect’
taken together give ‘price effect.’ We can identify three cases.
1) Substitution effect always operates in a manner such that as price falls, quantity
demanded of this commodity increases. If along with substitution effect, we take
income effect and if that happens to be positive (a case of normal commodity) the law
of demand will necessarily apply. 2) Given substitution effect, if income effect is
negative (a case of an ‘inferior commodity’) the law of demand can still apply
provided the substitution effect outweighs or is more powerful than the negative
income effect, and
2) Given substitution effect, if income effect is negative and it outweighs or is more
powerful than the substitution effect, the law of demand will not hold good.

GIFFEN GOODS
A case where negative income effect outweighs substitution effect is possible when
we have ‘Giffen good’ named after the Robert Giffen who first talked of such
paradox. Here a fall in the price of a commodity does not lead to a rise in its demand,
it may result in a fall in demand for this commodity.

24
 SUPPLY CURVE
The quantity of a commodity that is supplied in the market depends not only on the
price obtainable for the commodity but also on potentially many other factors, such as
the prices of substitute products, the production technology, and the availability
and cost of labour and other factors of production. In basic economic analysis,
analyzing supply involves looking at the relationship between various prices and the
quantity potentially offered by producers at each price, again holding constant all
other factors that could influence the price. Those price-quantity combinations may
be plotted on a curve, known as a supply curve, with price represented on the vertical
axis and quantity represented on the horizontal axis. A supply curve is usually
upward-sloping, reflecting the willingness of producers to sell more of the commodity
they produce in a market with higher prices. Any change in non-price factors would
cause a shift in the supply curve, whereas changes in the price of the commodity can
be traced along a fixed supply curve.

25
 Fig: SUPPLY CURVE

Quantity supplied (Qs) is the total amount of a good that sellers would choose to produce and
sell under given conditions.

The given conditions include:

• price of the good

• prices of factors of production (labor, capital)

• Prices of alternative products the firm could produce

• Technology

• Productive capacity

26
• Expectations of future prices

When we talk about Supply, we’re talking about the relationship between quantity supplied and
the price of the good, while holding everything else constant.

The Law of Supply states that “when the price of a good rises, and everything else remains the
same, the quantity of the good supplied will also rise.”

In short, ↑P → ↑Qs

A Supply Curve is a graphical representation of the relationship between price and quantity
supplied (ceteris paribus). It is a curve or line, each point of which is a price-Qs pair. That point
shows the amount of the good sellers would choose to sell at that price.

Changes in supply or shifts in supply occur when one of the determinants of supply other than
price changes.

Supply will increase:

Profit = Total Revenue – Total Cost

Revenue = Money received through the sale of output = Price (P) x Quantity (Q)

Determinants of Supply

The following are the determinants of the supply:

1. Cost of production – if it increases, supply decreases. The shifts in the supply curve:
o If the cost of production increases, the quantity supplied will reduce and the
supply curve will shift leftwards

o If the cost of production decreases, the quantity supplied will increase. The supply
curve will shift rightwards.

2. Taxes – If taxes increase, supply will reduce, and the supply curve will shift leftwards.

27
 o The impact of the increase in the cost of production and increase in taxes will be
the same After the global financial crisis of 2008, the government reduced taxes
to boost supply.

o This shifted the supply curve rightwards.

3. Goals of Firms – Profit is not always the only goal of the firm
o The goal may be sales maximization or social welfare

o In this case, the supply increases, and the supply curve shifts rightwards

o Supply may also increase due to good rainfall leading to increase in Agriculture
supply

Elasticity of Supply-

Responsiveness of the quantity supplied to the change in price”

If the change is steep => high elasticity
Elasticity (Es) = (% change in quantity supplied) / (% change in price)
If Es>1 => supply is elastic
If Es<1 => supply is inelastic Determinants of elasticity of supply
The overall determinant is choice – more the choice with the firm, higher the elasticity

e.g. Perishable quantities – the firm has no option/choice to store; have to sell at any price.
Similarly for agricultural commodities – inelastic supply.

What is Market Equilibrium?

 Quantity demanded = quantity supply

Equilibrium point = point of intersection of demand and supply curves

 Ideal situation – both buyers and sellers derive maximum utility and satisfaction from this
point

 Markets comprise of two groups – buyers and sellers

28
Buyers want lower prices to maximize their satisfaction
Sellers want higher profits

Who fixes the price in the market – buyers, sellers, government, or nobody?

It happens automatically through the ‘market mechanism’. Also called the Price
Mechanism or the ‘Invisible Hand’ (Adam Smith). Adam Smith is called the father of
Economics (Book – An inquiry into nature and the causes of the wealth of nations, 1776). The
wealth of nations is the first book on Economics, separating it from Philosophy. Though
Kautilya’s Arthshashtra dealt with Economics, it was primarily about statecraft.

Impact of Change in Demand & Supply

Change in Impact on
Example
Supply/Demand Price

More supply of agricultural produce in the

When supply increases Price decreases
mandis.

When demand increases price increases Price of fruits during Navratri

Market equilibrium, or balance between supply and demand

Supply and demand are equated in a free market through the price mechanism. If buyers wish to
purchase more of a good than is available at the prevailing price, they will tend to bid the price
up. If they wish to purchase less than is available at the prevailing price, suppliers will bid prices
down. The price mechanism thus determines what quantities of goods are to be produced. The
price mechanism also determines which goods are to be produced, how the goods are to be

29
produced, and who will get the goods—i.e., how the goods will be distributed. Goods so
produced and distributed may be consumer items, services, labour, or other salable commodities.
In each case, an increase in demand will lead to the price being bid up, which will induce
producers to supply more; a decrease in demand will lead to the price being bid down, which will
induce producers to supply less. The price system thus provides a simple scale by which
competing demands may be weighed by every consumer or producer.

The tendency to move toward the equilibrium price is known as the market mechanism, and the
resulting balance between supply and demand is called a market equilibrium.

As the price of a good rises, the quantity offered usually increases, and the willingness of
consumers to buy the good normally declines, but those changes are not necessarily proportional.
The measure of the responsiveness of supply and demand to changes in price is called the
price elasticity of supply or demand, calculated as the ratio of the percentage change in quantity
supplied or demanded to the percentage change in price. Thus, if the price of a commodity
decreases by 10 percent and sales of the commodity consequently increase by 20 percent, then
the price elasticity of demand for that commodity is said to be 2.

Q 1. What is Demand Curve?

Ans. The relationship between the price of the good and the amount or quantity the consumer
purchases in a specified period of time, given constant levels of the other determinants–tastes,
income, prices of related goods, expectations, and the number of buyers is known as Demand
Curve.

Q 2. What is Supply Curve?

Ans. The supply curve is a graphic representation of the correlation between the cost of a good or
service and the quantity supplied for a given period.

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C.)SAVING, CONSUMPTION AND INVESTMENT( MODULE 10 AS GIVEN IN
GROUP)

D.) Theories of Economic Growth

Different models of economic growth stress alternative causes of economic growth. The
principal theories of economic growth include:

1. Mercantilism – Wealth of a nation determined by the accumulation of gold and running

trade surplus
2. Classical theory – Adam Smith placed emphasis on the role of increasing returns to scale
(economies of scale/specialisation)
3. Neo-classical-theory – Growth based on supply-side factors such as labour productivity,
size of the workforce, factor inputs.
4. Endogenous growth theories – Rate of economic growth strongly influenced by human
capital and rate of technological innovation.
5. Keynesian demand-side – Keynes argued that aggregate demand could play a role in
influencing economic growth in the short and medium-term. Though most growth
theories ignore the role of aggregate demand, some economists argue recessions can
cause hysteresis effects and lower long-term economic growth.
6. Limits to growth – From an environmental perspective, some argue in the very long-term
economic growth will be constrained by resource degradation and global warming. This
means that economic growth may come to an end – reminiscent of Malthus theories.
Mercantilism

Popular at the start of the industrial revolution, Mercantilism isn’t really a theory of economic
growth but argued that a country could be made better off by seeking to accumulate gold and
increasing exports.

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Classical model

Developed by Adam Smith in Wealth of Nations (1776), Smith argued there are several factors
which enable increased economic growth

1. Role of markets in determining supply and demand

2. The productivity of labour. Smith argued income per capita was determined by “the state
of the skill, dexterity, and judgment with which labour is applied in any nation” (Wealth
of Nations I.6)
3. Role of trade in enabling greater specialisation.
4. Increasing returns to scale – e.g. specialisation we see in modern factories and the
economies of scale of increased production
Ricardo and Malthus developed the classical model. This model assumed technological change
was constant and increasing inputs could lead to diminishing returns. This led to the gloomy
predictions of Malthus – that the population would grow faster than the world’s capacity to feed
itself. Malthus under-predicted the capacity of technological improvements to increase food
yields.

Neo-Classical model of Solow/Swan

The neo-classical theory of economic growth suggests that increasing capital or labour leads to
diminishing returns. Therefore, increasing capital has only a temporary and limited impact on
increasing the economic growth. As capital increases, the economy maintains its steady-state rate
of economic growth.

To increase the rate of economic growth in the Solow/Swan model we need:

 An increase in proportion of GDP that is invested – however, this is limited as higher

proportion of investment leads to diminishing returns and convergence on the steady-
state of growth
 Technological progress which increases productivity of capital/labour
It suggests poor countries who invest more should see their economic growth converge with
richer countries.

32
Criticisms of this neo-classical (Exogenous model)
 It doesn’t explain why countries have different levels of investment as % of GDP
 Some developing countries don’t attract higher levels of investment because of structural
problems such as corruption, lack of infrastructure.
 It doesn’t explain how to improve rates of technological progress.
Harrod Domar model – Savings Ratio and Investment
The Harrod-Domar model is a type of neo-classical model. It states growth rate depends on a
function of the savings rate.

Some growth theories place a large emphasis on increasing domestic savings. Savings provide
the necessary funds to finance investment. It is this investment which creates further growth.
This has been an important factor behind the economic growth in Asia.

However, it depends on how efficient the investment is. If savings is too high it leads to lower
growth because people cannot afford to consume.

New Economic Growth Theories (Endogenous growth)

Endogenous growth models, developed by Paul Romer and Robert Lucas placed greater
emphasis on the concept of human capital. How workers with greater knowledge, education and
training can help to increase rates of technological advancement.
They place greater importance on the need for governments to actively encourage technological
innovation. They argue in the free market classical view, firms may have no incentive to invest
in new technologies because they will struggle to benefit in competitive markets. The model

 Places emphasis on increasing both capital and labour productivity.

 States that increasing labour productivity does not have diminishing returns, but, may
have increasing returns
 They argue that increasing capital does not necessarily lead to diminishing returns as
Solow predicts. They say it is more complicated; it depends on the type of capital
investment.
 Increased importance of spillover benefits from a knowledge-based economy.

33
  Emphasis is placed on free-markets, reducing regulation and subsidies. The argument is
that we need to keep economies open to the forces of change.
Joseph Schumpeter argued that an inherent feature of capitalism was the ‘creative destruction’ –
allowing inefficient firms to fail was essential for allowing resources to flow to more efficient
channels.

Unified growth theory

Developed by Oded Galor, unified growth theory tries to combine many different elements of
economic growth

 Economic stagnation that characterized most of human history until the eighteenth
century
 First industrial revolution and the beginning of economic growth
 The role of human capital formation in economic growth
 Explaining divergence in economic growth across countries.

Growth and development theories

development theories

Development theories attempt to explain the conditions that are necessary for development to
occur, and weigh up the relative importance of particular conditions.

What are the Different Theories of Growth?

. Classical Growth Theory

The Classical Growth Theory postulates that a country’s economic growth will decrease with an
increasing population and limited resources. Such a postulation is an implication of the belief of
classical growth theory economists who think that a temporary increase in real GDP per person

34
inevitably leads to a population explosion, which would limit a nation’s resources, consequently
lowering real GDP. As a result, the country’s economic growth will start to slow.

Structural Model

In the chart above, the y-axis represents total production, and the x-axis represents labor. Curve
OW outlines the total subsistence wages. If the level of population (labor) is ON, and the level of
output is OP, the per capita wage is represented by NR. Consequently, the surplus or profit is
RG.

Because of the surplus, the capital formation process comes into effect. Consequently, the
demand for labor increases, leading to a rise in total wages, as the curve moves to GH. If the total
population remains constant at ON, and wages exceed subsistence wages, i.e., NG > NR, then
total population or total manpower will increase as the curve moves toward OM. Because of the
increase in population, surplus can be generated.

35
Limitations of the Classical Growth Model

 Ignorance with respect to technology: The classical model of growth ignores the role
efficient technical progress could play for the smooth running of an economy.
Advancements in technology can minimize diminishing returns.
 Inaccurate determination of total wages: The classical model of growth assumes that
total wages do not exceed or fall below the subsistence level. However, this is not
entirely true. Changes in the industrial structure and substantial economic development
can result in total wages exceeding or falling below the subsistence level. Moreover, the
classical theory of growth does not consider the role played by trade unions in the process
of wage determination.

2. Neoclassical Growth Model

The Neoclassical Growth Theory is an economic model of growth that outlines how a steady
economic growth rate results when three economic forces come into play: labor, capital, and
technology. The simplest and most popular version of the Neoclassical Growth Model is
the Solow-Swan Growth Model.

The theory postulates that short-term economic equilibrium is a result of varying amounts of
labor and capital that play a vital role in the production process. The theory argues that
technological change significantly influences the overall functioning of an economy.
Neoclassical growth theory outlines the three factors necessary for a growing economy.
However, the theory puts emphasis on its claim that temporary, or short-term equilibrium, is
different from long-term equilibrium and does not require any of the three factors.

36
Production Function in the Neoclassical Growth Model

The Neoclassical Growth Model claims that capital accumulation in an economy, and how
people make use of it, is important for determining economic growth.

It further claims that the relationship between capital and labor in an economy determines its
total output. Finally, the theory states that technology augments labor productivity, increasing the
total output through increased efficiency of labor. Therefore, the production function of the
neoclassical growth model is used to measure the economic growth and equilibrium of an
economy. The general production function in the neoclassical growth model takes the following
form:

Y = AF (K, L)

Where:

 Y – Income, or the economy’s Gross Domestic Product (GDP)

 K – Capital
 L – Amount of unskilled labor in the economy
 A – Determinant level of technology

Also, because of the dynamic relationship between labor and technology, an economy’s
production function is often re-stated as Y = F (K, AL). This states that technology is
labor augmenting and that workers’ productivity depends on the level of technology.

Assumptions of the Neoclassical Growth Model

 Capital subject to diminishing returns: An important assumption of the neoclassical

growth model is that capital (K) is subject to diminishing returns provided the economy is
a closed economy.
 Impact on total output: Provided that labor is fixed or constant, the impact on the total
output of the last unit of the capital accumulated will always be less than the one before.

37
  Steady state of the economy: In the short term, the rate of growth slows down as
diminishing returns take effect, and the economy converts into a “steady-state” economy,
where the economy is steady, or in other words, in a relatively constant state.

Key Conclusions of the Neoclassical Model of Growth

 Output as a function of growth: The neoclassical growth model explicates that total
output is a function of economic growth in factor inputs, capital, labor, and technological
progress.
 Growth rate of output in a steady-state equilibrium: The growth rate of total output in
a steady-state equilibrium is equal to the growth rate of the population or labor force and
is never influenced by the rate of savings.
 Increased steady-state per capita income level: While the rate of savings does not
influence the steady-state economy growth rate of total output, it does result in an
increase in the steady-state level of per capita income and, therefore, total income as well,
as it raises the total capital per head.
 Long-term growth rate: The long-term growth rate of an economy is solely determined
by technological progress or regress.

3. Endogenous Growth Theory

The Endogenous Growth Theory states that economic growth is generated internally in the
economy, i.e., through endogenous forces, and not through exogenous ones. The theory contrasts
with the neoclassical growth model, which claims that external factors such as technological
progress, etc. are the main sources of economic growth.

38
Key Policy Implications of Endogenous Growth Theory

 Governmental policies can raise an economy’s growth rate if the policies are directed
toward enforcing more market competition and helping stimulate innovation in products
and processes.
 There are increasing returns to scale from capital investment in the “knowledge
industries” of education, health, and telecommunications.
 Private sector investment in R&D is a vital source of technological progress for the
economy.

39
 UNIT-3

INDIAN ECONOMICS
A) INTRODUCTION TO INDIAN ECONOMICS

India is a developing country and our economy is a mixed economy where the public sector co-
exists with the private sector. For an overview of Indian Economy, we should first go through
the strengths of Indian economy.

India is likely to be the third largest economy with a GDP size of $15 trillion by 2030.The
economy of India is currently the world’s fourth largest in terms of real GDP (purchasing power
parity) after the USA, China and Japan and the second fastest growing major economy in the
world after China.

Indian economy growth rate is estimated to be around seven to eight percent by year 2015-16.

Let’s look at some facts from history regarding India as an Economy. Dadabhai Naoroji is
known as the Father of Indian Politics and Economics, also known as the ‘Grand Old Man of
India’. Dadabhai Naoroji was the first to calculate the national income of India. In his book
“Poverty and Un-British Rule in India” he describes his theory, i.e. the economic exploitation of
India by the British. His theory is popularly called the Economic Drain Theory. Thats when
economy of India came into discussion as an entity, prior to that it was just a scramble of
princely states and colonisers. Thats all the history there for time being.

Introduction to Indian Economy:-

 Low per capita income.
 Inequalities in income distribution.
 Predominance of agriculture. (More than 2/3rd of India’s working population is engaged
in agriculture. But in USA only 2% of the working population is engaged in agriculture.)
 Rapidly growing population with 1.2% annual change.
 Chronic unemployment (A person is considered employed if he / she works for 273 days
of a year for eight hours every day.)Unemployment in India is mainly structural in nature.
 Low rate of capital formation due to less saving rate.
 Dualistic Nature of Economy (features of a modern economy, as well as
traditional).Mixed Economy
 Follows Labour Intensive Techniques and activities.

Agriculture in Indian economy:-

40
While Indian economy introduction is started, the major focus is always on the agriculture sector.
This is because Indian economy is based on agriculture.52% of the total population of India
depends on agriculture.

According to the 2011-2012 survey of Indian agriculture contributes 14.1% of the Gross
Domestic Product (GDP). It was 55.4% in 1950-1951.

India is the second largest sugar producer in the world (after Brazil).
In tea production, India ranks first. (27% of total production in the world).

Wheat production: Uttar Pradesh is the largest producer. Punjab and Haryana is then the second
and the third largest producer of wheat.

Rice production:The principal food grain in India is rice. West Bengal is the largest producer.
Uttar Pradesh is the second largest producer of Punjab and is the third largest producer of rice.

National Income:The national income is the sum total of the value of all the final
goods produced and services of the residents of the country in an accounting
year.

CSO: Central Statistical Organization is under the Department of Statistics. Govt. of India is
responsible for estimating the national income.CSO was founded by Prof. Mahalanobis. CSO is
assisted by the National Sample Survey Organization (NSSO) in estimating National Income.

Gross Domestic Product (GDP) is the money value of final goods and services produced in
the domestic
territory of a country during the accounting year.

41
In India Gross Domestic Product (GDP) is larger than national income because net factor income
from abroad
is negative, i.e. foreign payment is larger than the foreign receipt.
Net National Product (NNP) at market prices = Gross National Product at Market Prices –
Depreciation

Sectors of Indian Economy:-

1. Primary Sector: When the economic activity depends mainly on exploitation of natural
resources then
that activity comes under the primary sector. Agriculture and agriculture related activities
are the primary sectors of economy.
2. Secondary Sector: When the main activity involves manufacturing then it is the
secondary sector. All industrial production where physical goods are produced come
under the secondary sector.
3. Tertiary Sector: When the activity involves providing intangible goods like services
then this is part of
the tertiary sector. Financial services, management consultancy, telephony and IT are
examples of service sector.

Other Classifications of Economy:-

42
In Indian economy introduction, the sectors of economy based on other basis is also required to
get a clear picture of the strengths of Indian Economy.

1. Organized Sector: The sector which carries out all activity through a system and follows
the law of the
land is called organized sector. Moreover, labour rights are given due respect and
wages are as per the norms of the country and those of the industry. Labour working
organized sector get the
benefit of social security net as framed by the Government. Certain benefits like
provident fund, leave
entitlement, medical benefits and insurance are provided to workers in the organized
sector. These security
provisions are necessary to provide source of sustenance in case of disability or death of
the main
breadwinner of the family without which the dependents will face a bleak future.
2. Unorganized Sector: The sectors which evade most of the laws and don’t follow the
system come under
unorganized sector. Small shopkeepers, some small scale manufacturing units keep
all their attention on profit making and ignore their workers basic rights. Workers don’t
get adequate salary
and other benefits like leave, health benefits and insurance are beyond the imagination of
people working in
unorganized sectors.
3. Public Sector: Companies which are run and financed by the Government comprises the
public sector.
After independence India was a very poor country. India needed huge amount of money
to set up
manufacturing plants for basic items like iron and steel, aluminium, fertilizers and
cements. Additional
infrastructure like roads, railways, ports and airports also require huge investment. In
those days Indian
entrepreneur was not cash rich so government had to start creating big public sector
enterprises like SAIL
(Steel Authority of India Limited), ONGC(Oil & Natural Gas Commission).
4. Private Sector: Companies which are run and financed by private people comprise the
private sector.Companies like Hero Honda, Tata are from private sectors.

B) TRENDS IN POPULATION GROWTH

43
Trends and causes of population growth
Throughout human history the world’s population has been gradually
growing. Figure 2.1 shows the trend from the year 1700. Growth is slow until
the middle of the 20th century, when the gradient (slope) of the graph
increases, indicating a change to more rapid population growth. The graph
continues into the future to a predicted global population in 2050 in excess of
9 billion.

Figure 2.1 Population growth globally.

There are many factors that influence this trend. High rates of infant and
childhood deaths and short lifespans put a limit on population growth in the
past. However, improvements in nutrition, water, medical care and other
technological advances have contributed to a sharp decline in deaths while
births continue to increase, resulting in population growth.

Population change is governed by the balance between birth rates and death rates.

 If the birth rate stays the same and the death rate decreases, then population numbers will
grow.
 If the birth rate increases and the death rate stays the same, then population will also grow.

44
View larger image
Figure 2.2 Average annual rate of population change for the world and development groups,
1950–2100. (Note that more developed regions comprise Europe, Northern America, Australasia
and Japan; less developed regions include Africa, Asia (except Japan), and Latin America; 49
countries, including Ethiopia, are defined by the United Nations as ‘least developed’.)
(UNDESA, 2013)

The least developed countries continue to have a higher rate of population

increase for several reasons. Significant among these is the fact that the
benefits from advances in health and agriculture are not spread evenly across
the world. Medical technologies, for example vaccines and antibiotics, reduce
the death rate by protecting people against diseases like influenza, measles,
polio and rubella. However, vaccines are still not available for many diseases
like malaria that are common in less developed countries, particularly in sub-
Saharan Africa. Other public health measures, like water and sanitation,
waste management and nutritional education are very important in preventing
disease and in reducing the death rate. These measures are well developed in
industrialised countries but less so in developing countries. Similarly, in
agricultural science and technology, advances such as new kinds of seed,
fertilisers, pesticides and mechanisation in farming have transformed food
production. These have increased the quantity of food produced, which has
helped to improve nutrition and decrease death rates. However, advanced
food production and distribution are still developing in many countries.

45
 B) ESTIMATES OF NATIONAL INCOME IN INDIA

Introduction:

National income of India constitutes total amount of income earned by the whole nation of our

country and originated both within and outside its territory during a particular year. The National

Income Committee in its first report wrote, “A national income estimate measures the volume of

commodities and services turned out during a given period, without duplication.”

The estimates of national income depict a clear picture about the standard of living of the

community. The national income statistics diagnose the economic ills of the country and at the

same time suggest remedies. The rate of savings and investment in an economy also depend on

the national income of the country.

Moreover, the national income measures the flow of all commodities and services produced in an

economy. Thus, the national income is not a stock but a flow. It measures the total productive

power of the community during given period.

Further, the National Income Committee has rightly observed, “National income statistics enable

an overall view to be taken of the whole economy and of the relative positions and inter-relations

among its various parts”. Thus, the computation of national income and its analysis has been

considered an important exercise on economic literature.

Estimates of National Income During Pre-Independence Period:

During the British period, several estimates of national income were made by Dadabhai Naoroji
(1868), William Digby (1899), Findlay Shirras (1911, 1922 and 1934), Shah and Khambatta

(1921), V.K.R.V. Rao (1925-29) and R.C. Desai (1931-40): Among all these pre-independence

estimates of national income in India, the estimates of Naoroji, Findlay Shirras and Shaw and

Khambatta have computed the value of the output raised by the agricultural sector and then

46
added some portion of the income earned by the non-agricultural sector. But these estimates

were having no scientific basis of its own.

After that Dr. V.K.R.V. Rao applied a combination of census of output and census of income

methods.

The following table 2.1 reveals various estimates of national income and per capita income

of India as prepared by different dignitaries before independence:

All these estimates of national income were conducted out of individual effort and were

subjected to serious limitations due to some of its arbitrary assumptions.

All these estimates of national income were conducted out of individual effort and were
subjected to serious limitation due to some of its arbitrary assumptions. Although pre-
independence estimates of national income in India suffered from various difficulties and
limitations but it provided considerable light and insight about the economic conditions of the
country prevailing during those period.

47
Estimates of National Income During the Post-Independence Period: National Income
Committee’s Estimates:
After independence, the Government of India appointed the National Income Committee in

August, 1949 with Prof. PC. Mahalnobis as its Chairman and Prof. D.R. Gadgil and Dr.

V.K.R.V. Rao as its two members so as to compile a national income estimates rationally on a

scientific basis. The first report of this committee was prepared in 1951.

In its first report, the total national income of the year 1948-49 was estimated at Rs. 8,830 crore

and the per capita income of the year was calculated at Rs. 265 per annum. The committee

continued its estimation works for another three years and the final report was published in 1954.

National Income Committee and C.S.O. Estimates:

During the post-independence period, the estimate of national income was primarily conducted

by the National Income Committee. Later on, it was carried over by the Central Statistical

Organisation. For the estimation of national income in India the National Income Committee

applied a mixture of both ‘Product Method’ and the ‘Income Method’. This Committee divided

the entire economy into 13 sectors.

Income from the six sectors, viz., agriculture, animal husbandry, forestry, Fishery, mining and

factory establishments is estimated by the output method. But the income from the remaining

seven sectors consisting of small enterprises, commerce, transport and communications, banking

and insurance, professions, liberal arts, domestic services, house property, public authorities and

rest of the world is estimated by the income methods.

The National Income Unit of the Central Statistical Organisation (C.S.O.) is now-a-days

entrusted with the measurement of national income. Here this unit of C.S.O. estimated the major

part of national income from the various sectors like agriculture, forestry, animal husbandry,

fishing, mining and factory establishments with the help of product method.

48
The unit of C.S.O. is also applying the income method for the estimation of the remaining part of

national income raised from the other sectors.

Till now we have three different series in the national income estimates of India. These include

Conventional Series, Revised Series and New Series.

Again the C.S.O. has prepared another new series on national income with 1993-94 as base year

as against the existing series with 1980-81 as base year.

Methodology of National Income Estimation in India:

In India, the estimation of national income is being done by two methods, i.e., product method

and income method.

Net Product Method:

While estimating the -gross domestic product of the country, the contribution to GDP from

various sectors like agriculture, livestock, fishery, forestry and logging, mining and quarrying is

estimated with the adoption of product method. In this method, it is important to estimate the
gross value of product, bi-products and ancillary activities and then steps are taken to deduct the

value of inputs, raw materials and services from such gross value.

In respect of other sub-sectors like animal husbandry, fishery, forestry, mining and factory

establishments, the gross value of their output is obtained by multiplying the estimated output

with their market price. From such gross value of output, deductions are made for cost of
materials used and depreciation charges so as to obtain net value added in each sector.

In respect of secondary activities, the computations of gross domestic product are done by the

production approach only for the manufacturing industrial units (both registered and
unregistered). In respect of constructions activity, the estimates of the value of pucca

49
construction are made by the commodity How approach and that of the kachcha construction is

made by the expenditure method.

Net Income Method:

In India, the income from rest of the sectors, i.e., small enterprises, commerce, transport and

communications, banking and insurance professions, liberal arts, domestic activities, house

property, public authorities and rest of the world is estimated by the income method.

Here, the income approach is adopted to estimate the value added from these aforesaid remaining

sectors. Here, the process involves the measurement of aggregate factor incomes in the shape of

compensation of employees (wages and salaries) and operating surpluses in the form of rent,

interest, profits and dividends.

Finally, by adding up the contribution of all different sectors to national income of the country, it

is necessary to obtain net domestic product at factor cost. In order to derive the net national

income at current prices, it is necessary to add the net income from abroad and net indirect taxes

with the net domestic product at factor cost. This same estimate is then deflated at the prices of

the base year selected to derive a series of national income at constant prices.

C) POST INDEPENDENCE ECONOMIC POLICIES IN INDIA

After independence in 1947, the Indian economy was in a very poor state, it was at a stage of
complete stagnation. Nearly half the population at that time was below the poverty line. And two-
thirds of the population was entirely dependent on agriculture for their livelihood. So it can be said
the entire economy was dependent on agriculture. In fact, only 2% of the population was employed
by industries.

To sum up the problems at the time, they were

 Rampant poverty

 overdependence on agriculture

 practically no industrialization

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 very low national income

 high unemployment

 a stagnant economy and very slow economic progress

Browse more Topics under Government Policies For Business Growth

 Privatization in India

 FDI in India

 FII in India

 Meaning of Policy and Historical Overview of Policy Framework in India 

 Public Policy and its Features

 Nature and Process of Public Policy

 Economic Change Process of India

 Policy, Decisions, and Goals

India – A Mixed Economy

One of the biggest post-independence policy decision was to determine the type of economy India
would be. At the time of independence, there were two opposing economic policies reigning in the
world. One was the capitalist method that the USA follows.

Here the model was a strong private sector and freedom to privately own resources and property.
Russia follows the other method, the socialist method. Here the focus was on state ownership of all
resources and strict rules and oversight.

51
India then decided to follow the Mixed Economy method. It borrowed philosophies from both the
other systems to create a mixed economy system that suited it the best. Like while private
companies were encouraged, the state kept most big industries for themselves.

This meant it could provide its citizens with basic necessities (Power, transportation, etc) at lower
costs. The government also strongly discouraged imports, so we could grow our own domestic
manufacturing sector.

Planning Commission

One of the important post-independence public policy was the formation of

the planning commission. The main function of the planning commission was to asses our economy
and accordingly formulate Five Year plans.

The Five Year plans were policy directives and became a major source for laws and regulations
passed in years. The commission passed regulation policies as well as promotion policies for the
economy.

Social Policies

The government was not only concerned with the economic policies, but a lot of focus was only on
social post-independence public policy. There was a need for some major changes in the socio-
economic scenario of our country after independence.

There were external threats to our country’s security at the time. So the defense policy has to be
very strong. There was also internal conflicts and regionalism, casteism and some communal
discord. The government had to promote unity and national integrity via public policy to counter
separatist tendencies.

There have been times when public policies have been in contradiction with each other. A policy
that may be beneficial to the economy, may have a negative impact on the national integrity of the
country. So the actual impact of the post-independence public policy must be ascertained before
implementing it.

52
 UNIT-4

THE LOGIC OF INDIA’S DEVELOPMENT STRATEGY

India was under the British control for about 200 years, which ended with India’s independence
in 1947. For most part of the initial years after independence disruptions associated with
partition, drafting a constitution and establishment of a new government, etc. occupied the major
attention of the Indian leaders. The first major task of the first democratic government under
Prime Minister Jawaharlal Nehru was to formulate a development strategy to transform India’s
economy from a dismal state after the exploitative colonial rule to a self-contained economy, and
thereby, initiate a process of rapid and balanced economic development. To purport its
development strategy the Government of India set up the Planning Commission in 1950 under
the chairmanship of the Prime Minister, which is the central agency to design, execute and
monitor the Five Year Plans (FYP). The First FYP under Prime Minister Jawaharlal Nehru
provided considerable attention to formulate economic policy and set the direction for the future.
In line with the Preamble of the Constitution, the strategy was set for a “socialist pattern of
society”, that the government would play the leading role in the economy, and that economic
growth to be the foremost objective of the state. However, it was the Second FYP under Prime
Minister Jawaharlal Nehru and statistician P. C. Mahalanobis that broadly outlined India’s
development strategy that would dominate until the 1980s.

Post-Independence Development Strategy

The broad objectives that guided India’s development strategy were: (a) achievement of a high
rate of economic growth, which would lead to a sustained improvement in the standard of

living of the population, (b) reduction in inequalities and more especially an accelerated effort to
remove poverty at a pace faster than would be achieved solely through the normal growth
process, (c) development of a mixed economy with a strong public sector, especially in key areas
of the economy, (d) achievement of a high order of self-reliance, (e) promotion of balanced
regional development, with a narrowing of economic difference across regions, and finally, (f)
these social and economic objectives were to be pursued in the framework of a constitutional
democracy (Ahluwalia, 1998). The showpiece of India’s development strategy was
modernisation through industrialisation. Emphasis was given on state-led industrialisation, with
all industries and sectors like steal, mining, machine tools, chemicals, telecommunications,
power plants, etc. as well as trade and finance were reserved for the public sector. The second
FYP adopted the strategy of “machine-for-producing machine” and strongly emphasised on
technology and capital intensive heavy industries to achieve rapid industrial growth, which in
turn is the pre-condition for overall economic development. Along with the state-led

53
industrialisation strategy, the bureaucratic control, which was the result of the industrial licensing
policy, formed another aspect of India’s development strategy during this period. Another
important area of India’s development strategy was the policy towards international trade and
finance. The policymakers favoured a restrictive policy regime, with strong restrictions on
international trade and finance. This is mainly due to the negative perceptions towards
international openness, which were after

Major Economic Reforms of 1991 INDUSTRY

 Abolition of industrial licensing.

 Sharp reduction of industries reserved for the public sector.

 Abolition of separate permission needed by MRTP companies

.  Freer access to foreign technology.

 Items reserved for the small scale industries gradually reduced. EXTERNAL SECTOR 
Devaluation and transition to a Marketdetermined Exchange Rate

.  Phased reduction of import licensing (quantitative restrictions).

 Phased reduction of peak custom duties.

 Policies to encourage direct and portfolio foreign investment.

 Monitoring and controls over external borrowing especially short term.

 Build-up of foreign exchange reserves.

 Amendment of FERA to reduce restrictions on firms.

FINANCIAL SECTOR

 Phasing in of Basle prudential norms.

 Reduction of reserve requirements for banks (CRR and SLR).

 Gradual freeing up of interest rates.

 Legislative empowerment of SEBI.

 Establishment of the National Stock Exchange.

 Abolition of government control over capital issues.

 Eliminating prior approval of the Reserve Bank of India for large loans.

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 More liberal licensing of private banks.

 Freer expansion by foreign banks.

PUBLIC SECTOR

 Disinvestment programme begun.

 Greater autonomy/accountability for public enterprises

. FISCAL

 Reduction of the fiscal deficit.

 Launching of reforms of major tax reforms.

AGRICULTURE

 More remunerative procurement prices for cereals.

 Reduction in protection to the manufacturing sector.

B) PRIORITIES BETWEEN AGRICULTURE AND INDUSTRY

Role of Agriculture:
To begin with the concept of priority or preference of one sector and one technology over
another is a slippery one.

For instance, A. W. Lewis once remarked that “Agriculture has been the weakest link in the
development chain.” On the other hand, there is another argument that suggests that agricultural
productivity and output contribute towards an economy’s development. Against this backdrop,
the case for priority in agriculture rests on the following facts.
Since the days of David Ricardo, importance of agriculture in an economy’s development is
being recognised. Taking the “natural limits”—the problem of diminishing returns—in
agriculture into account, Ricardo concluded that such ‘limits’ in agricultural production would
set the upper limit to the growth of the non-agricultural sector and to capital formation for
economic development.

There are four ways through which agriculture contributes towards the process of economic
development as described by Simon Kuznets.

These are:

55
(i) Product contribution,

(ii) Market contribution,

(iii) Factor contribution, and

(iv) Foreign exchange contribution.

(i) Product Contribution:

The product contribution of agriculture refers to its contribution of wage-goods, that is,
foodstuffs over the subsistence level to feed the labour force of urban non-agricultural sector. A
growing population must be supported with increased food supply. Raising food supply through
different ways has thus great importance for economic growth of a country. The annual rate of
increase in demand for food in an economy is determined by

D=p+ηg

where p and g stand for the rates of growth of population and per capita income, and η stands for
income elasticity of demand for agricultural goods. Poor LDCs experience high population
growth rate and a high income elasticity of demand for food.

Under the circumstance, an increase in per capita income strongly increases the demand for
foodstuffs/agricultural goods in these countries more than the advanced countries of the West. In
Britain, agricultural revolution brought in the wake of Industrial Revolution (1760 onwards)
raised agricultural productivity, provided surplus labour to the non-farm sectors, and wage-goods
to support industrial expansion.

To this end, what is needed is the generation of ‘marketable surplus’—a surplus of agricultural
output over the subsistence needs. Marketable surplus from agriculture also tends to widen the
home market for the industrial products. Of course, the demand for industrial products largely
depends on farm income. Increased agricultural productivity, a growing marketable surplus, and
a rising income of the agriculturists are necessary to trigger an expansion in the demands for
industrial products by the agricultural sector.

(ii) Market Contribution:

The market contribution of agriculture to economic growth refers to the fact that the demand
from agriculture acts as the source of autonomous demand for industrial goods. As a result of

56
agricultural progress there occurs a market extension for industrial goods. Agriculture thus has
linkages with the industrial sector—there is a complementarity between the two sectors.

A precondition for rapid industrial growth is a rapidly expanding agricultural sector. Dr Bright
Singh asserts that increase in agricultural production and the rise in farm incomes together with
industrialisation and urbanisation lead to an increased demand for industrial products. Thus, a
sluggish growth in agriculture acts as a drag on industrial development.

Thus, it is evident that if agriculture itself grows, there occurs a product contribution and when
agriculture trades with other sectors, there occurs a market contribution.

(iii) Factor Contribution:

The factor contribution, comprising both labour contribution and capital contribution, occurs
when there is a transfer of productive factors/resources to other sectors from the given sector. A
overpopulated developing economy is characterised by the existence of surplus labour or
disguised unemployment. Arthur Lewis, Ragnar Nurkse once suggested that in over- populated
underdeveloped countries agricultural sector—by transferring its labour resources to the modern
industrial sector where they create a surplus—can contribute to growth and development.
Industrial development of many of the South East Asian countries had been bolstered by cheap
labour supply available in the farm sector.

Agriculture contributes substantially to the sources for capital formation. However, savings may
be voluntary or forced. Voluntary saving is made by rich landlords, peasant farmers while
savings may be collected by coercion as was done in the erstwhile Soviet Union and China in the
past. In addition, government, by taxing away agricultural sector, may collect resources for
investment.

Difference between agricultural product and industrial product

1. Perishability • Most of farm products are perishable in nature ;their perishability varies
from few hours to few months but most of the manufactured products are non-
perishable. • Perishability make it almost impossible for producer to fix the reserve price
for their farm grown products. Non perishable Perishable
1. . Seasonality of Production • Farm products are produced in particular season; they can’t
be produced throughout the year ;prices falls in harvesting season. • But the supply of
manufactured products can be adjusted or made uniform throughout the year,therefore
rices remain almost constant.
2. . . Bulkiness of Products • Farm products are bulky in nature it makes their storage and
transport difficult & expensive.It also restrict location of production to somewhere near
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 to consumption point. • Where as manufactured products are less bulky, their
volume/price ratio is low as compare to agricultural products.
3. . .Variations of quality in products • There is large variation in quality of agricultural
products,it makes their grading and standardization difficult and enhance their cost. •
There is no such problem in manufactured goods as they are products of uniform quality.
4. Irregular supply of agricultural products • The supply of agricultural products is
uncertain and irrigular because of dependence of agricultural production on natural
conditions.With varying supply, the demand remaining almost constant,so the prices
fluctuate. • Supply of manufacutred good is almost constant, so proce fluctuation is very
less
5. Scattered production • Farm products are produced throughout country and most of
producers are of small size. It makes estimation of supply difficult and creates problem
on marketing. • While manufacturing unit are of large size with a fixed supply with a
marketing plan.

6. Processing • Most of farm products have to be processed before their consumption by

ultimate comsumers.Processing increase price spread of agricultural
commodities.Processing firms enjoy advantage of monosony,oligospony or duopsony in
market. • While manufactured products donot need processing so advantage is directly
taken by producers

Choice of Technology: Problems and Solutions

(1) Scarcity of Capital:

Modern technology is an expensive technology. They require heavy doses of capital and skilled
manpower. In underdeveloped countries there is the scarcity of both capital and skilled
manpower.

So the adoption of new technology becomes difficult. According to Prof. Nurkse, “If capital is
scarce, development of know-how alone would not facilitate economic growth. It is only with the
help of capital that the benefits of know-how can be realized and the process of production
developed.”
(2) Problem of Utilization:
ADVERTISEMENTS:

Technological development has been a very slow process in developed countries. Accordingly,
their social, political and economic institutions have great difficulty in adopting the changing

58
technological scenario in the country. However, in underdeveloped countries traditions and
conventions still have a strong hold in the institutional set up of these countries.

The adoption of such a new technology is therefore not a smooth sailing process. People are so
much tied to their conventional wisdom that they do not easily adopt themselves to the changed
situations. Still, many would like to stick to the conventional methods of production. This creates
many other problems.

(3) Illiteracy:
Majority of the population in underdeveloped countries is uneducated. It is difficult to acquaint
them with new technology. Thus for the first task of the Govt, in underdeveloped countries is to
generate enthusiasm among the common masses regarding new ways of doing things. This
should be adopted specially in agricultural sector.

(4) Different Conditions:

Technology has been developed in developed countries to suit their needs and means. But, needs
and means of underdeveloped countries differ as in developed countries. Accordingly many
types of technology developed in advanced nations may not suit the underdeveloped world.
Therefore, different conditions prevailing in both countries create many obstacles for the
adoption of new technology.

(5) Problem of Obsolescence:

ADVERTISEMENTS:

It has been observed that technology has developed very fast in developed countries that the
existing techniques very soon become obsolete. When the new technology reaches the
underdeveloped world, it is declared as of vintage variety in the developed countries.

The result is that the underdeveloped are never able to reap full benefits of the so called new
technology. It is therefore desired that underdeveloped should develop their own technology
themselves and avoid to import new technology.

(6) Lack of Able Innovators:

Discovery and adoption of new technology presupposes the existence of able innovators. They
need lot of capital for the successful implementation of their programmes. But, there is not only
the dearth of capital but also of the able innovators and entrepreneurs in underdeveloped
countries.

59
(7) Capital Intensive:
In developed countries, technology is most capital intensive. Scarcity of labour results in high
wage rate in these countries. In contrast with the abundance of their man-power, underdeveloped
countries need labour intensive technology. Capital intensive technology would not be much
suitable for them.

Suggestions:
Keeping in view the various difficulties regarding the adoption of new techniques, following
suggestions are made:
(1) Use of Labor Intensive Techniques:
ADVERTISEMENTS:

In their initial stages of growth underdeveloped countries should prefer to adopt labour- intensive
techniques. Such techniques should be, as far as possible, indigenously developed. Technology
should aim primarily at the maximization of employment opportunities in less developed
countries.

(2) Co-ordination of Different Techniques:

Any particular technique cannot be solely successful in less developed countries. While
developing new techniques, proper consideration be made to the existing cultural, and social
environment in the country. Coordinating the various possible techniques, the one that
accelerates the process of growth should be adopted. Moreover new technology should be
compatible with the existing technology.

(3) Research:
In less developed countries suitable modifications may be made to adopt the technology of
developed countries. This need ‘research’ at various levels of the adoption of new know-how.
Thus, seeking the help of advanced countries. Govt., of under developed countries should open
research centres with trained personnel who would facilitate the task of adoption of new
technology. Special incentives may be given for outstanding research.

(4) Training Facilities:

The underdeveloped countries should provide maximum training facilities to its workers. This
would facilitate the adoption of new technology. Engineering institutions should be opened in the
country in large number.

60
(5) Minimum Costs:
Less developed countries should choose such techniques of production that
marginal productivity of the factors in their alternative uses is equalised. In such a
situation, costs of production would be minimum.

(6) Import of Technique:

Efforts should be made to import technology from abroad but only from those
countries which assure of continuous maintenance of the hi-tech machinery and
equipment.

(7) Maximum Surplus:

The underdeveloped countries should adopt such technology that generates
maximum possible surplus. This would stimulate the capital formation and rate of
growth.

(8) Appropriate Plants:

The under developed countries should invest in such plants that are within their
limited means. They should not be over-enthusiastic to invest in large plants
beyond their capacity.

The choice of appropriate technology in underdeveloped countries is a

difficult job. It is not possible to suggest a uniform pattern of technology for
all the underdeveloped countries. They differ widely from each other in
regard to factor endowments, level of income and capital formation,
demographic patterns, institutional arrangements and stage of economic
development.

Therefore, it is possible to lay down certain consideration, which must be

kept in mind, while making a choice of technology in a country. The

61
following factors are the most important which influence the choice of
technique.

(1) Objective of Development:

The objective of development is a vital determinant of the choice of
technique.

There may be various objectives of development, such as:

(i) Maximization of employment,

(ii) Maximization of investment

(iii) Maximization of output at lowest possible cost,

(iv) freedom from dependence upon other countries, etc. All these objectives
affect the choice of technique. For example, if the objective of development
is maximization of employment and freedom from dependence upon other
countries, labour intensive technology should be adopted. On the contrary, if
the government is in favour of external aid and wants to maximize output at
the lowest possible cost, capital intensive technique should be favoured.

(2) Factor Endowment:

The prevailing factor endowment in a country determines the type of
technology that will be suitable for that country. If the country has abundance
of labour and scarcity of capital then labour intensive techniques of
production must be adopted. On the other hand, in case of labour scarcity and
capital abundant economies, labour saving and capital intensive techniques
will be most suitable. Thus, the type of factor endowment in a country is an
important consideration in the choice of technology.

62
ADVERTISEMENTS:

(3) Technological Level already attained:

The prevailing level of technology forms the basis on which further
technological change can take place. New technology has to be supported by
the existing technology and only that type of technology should be preferred
which can be supported by the technological level already attained by the
country. Abrupt changes in technology are not in the interest of the economy.

(4) Resources Available:

Technological development in a country is largely determined by the
availability of resources for such development. The most important resource
necessary for technological development is capital, skill, organisation and
natural resources. The availability of all these inputs largely determines the
extent to which experimentation in new forms of organisation can be
undertaken. An over-ambitious programme of technological change will
merely result in waste of productive resources of the country. Hence, the
technology must be in accordance with the availability of necessary inputs.

ADVERTISEMENTS:

(5) Institutional Structure:

The institutional framework in a country also determines the type of
technology that should be adopted by it. Economic, political and social
institutions along with the aptitude of the people determine the technological
level in a country. The social system in a country may be rigid as not to
permit any technological change. Under these circumstances social and
institutional change must precede technological change.

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(6) Availability of Infra-structure:
Choosing the technique, one must also account for the existing infra-structure
comprising of transport, communication, power and related facilities in the
country. Such techniques are to be preferred which are compatible with the
existing infra-structure of the country. Expansion of infra-structural facilities
is not possible over short-periods. Therefore, in the initial stages of growth,
labour-intensive technique should be adopted. As infra-structural facilities are
expanded, one can switch over to more and more capital intensive techniques
of production.

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 UNIT-5

A) ROLE OF PUBLIC, PRIVATE AND JOINT SECTOR

Economic Systems: Meaning: An economic system, or economic order, is a system of
production, resource allocation and distribution of goods and service within a society or a given
geographic area. It includes the combination of the various institutions, agencies, entities,
decision-making processes and patterns of consumption that comprise the economic structure of
a given community.

Relative Role of Public Sector in India:

Public sector occupied a worthy place for achieving systematic and planned development in a
developing country like India. In a country like India suffering from multi-dimensional
problems, private sector is not in a position to make necessary effort for the development of its
various sectors simultaneously.

Thus, in order to provide the necessary support to the development strategy of the country, the
public sector offers the necessary minimum push for bringing the economy to a path of self
sustained growth.

Thus it is now well recognised that public sector plays a positive role in the industrial
development of the country by laying down a sound foundation of industrial structure in the
initial stage of its development.

Following are some of the important relative roles of the public sector in the economic
development of a country like India:
(a) Promoting economic development at a rapid pace by filling gaps in the industrial structure;

(b) Promoting adequate infrastructural facilities for the growth of the economy;

(c) Undertaking economic activity in those strategically significant development areas, where
private sector may distort the spirit of national objective;

(d) Checking monopolies and concentration of power in the hands of few;

(e) Promoting balanced regional development and diversifying natural resources and other
infrastructural facilities in those less developed areas of the country;

65
(f) Reducing the disparities in the distribution of income and wealth by bridging the gap between
the rich and the poor;

ADVERTISEMENTS:

(g) Creating and enhancing sufficient employment opportunities in different sectors by making
heavy investments;

(h) Attaining self-reliance in different technologies as per requirement;

(i) Eliminating dependence on foreign aid and foreign technology;

(f) Exercising social control and regulation through various public finance institutions;

(k) Controlling the sensitive sectors such as distribution system, allocating the scarce imported
goods rationally etc.; and

(l) reducing the pressure of balance of payments by promoting export and reducing imports.

Relative Role of Private Sector in India:

India, being a mixed economy, has assigned a great importance on the private sector of the
country for attaining rapid economic development. The Government has fixed a specific role to
the private sector in the field of industries, trade and services sector.

The most dominant sector of India, i.e., agriculture and other allied activities like dairying,
animal husbandry, poultry etc. is totally under the control of the private sector. Thus private
sector is playing an important role in managing the entire agricultural sector and thereby
providing the entire food supply to the millions.

Moreover, the major portion of the industrial sector engaged in the non-strategic and light areas,
producing various consumer goods both durables and non-durables, electronics and electrical
goods, automobiles, textiles, chemicals, food products, light engineering goods etc., is also under
the control of the private sector.

ADVERTISEMENTS:

66
Private sector is playing a positive role in the development and expansion of aforesaid group of
industries. Besides, the development of small scale and cottage industries is also the
responsibility of the private sector.

Finally, the private sector is also having its role in the development of tertiary sector of the
country. The private sector is managing the entire services sector providing various types of
services to the people in general. The entire wholesale and retail trade in the country is also being
managed by the private sector in a most rational manner.

Moreover, the major portion of the transportation, especially in the road transport is also
managed by the private sector. With the growing liberalisation of Indian economy in recent
years, the private sector is being assigned with much greater responsibility in various spheres of
economic activities.

Capitalism:

Capitalism or Free Market Economy is an Economic System in which private individuals own all
material means of production and all economic activities are undertaken for the purpose of profit.
The factors of production are privately owned and production takes place at the initiative of
private enterprise. People have freedom of Choice Concerning Occupation, Saving and
Investment.

Ex: UIC, Japan, Canada.

Socialism: Socialism is an economic system in which the state owns and control all means of
Production, Decision, Pertaining to Production, Distribution are made through Central Planning
the states dictates the Consumption pattern

Ex: China, Russia.

Mixed economy: In a mixed economy both Public and Private Sectors Co-exist. Some resources
and enterprises are owned and controlled by the state other economic activities are left to the
private initiative. Private sector is allowed to work for profit motive but under certain regulations
decided by the government.

Ex: India.

Merits:

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• Incentive: The Profit motive induces them to invest money even in those industry which
involves great rises.

• Efficient utilization of resources: Due to competition minimum the cost becomes essential. In
order to minimize the cost producers attempt to utilize factors of production in the best possible
manner.

• Rapid economic growth: The Capitalist system helps in rapid economic growth due to incentive
and initiative. Rapid economic growth enables people to enjoy a high standard of living.

• Capital formation: People have the incentive to save money and invest it in order to earn larger
incomes in future due to Private property and inheritance. High rates of Public savings and
investment lead to a higher rate of capital formation in the country.

• Flexibility and Adaptability: It is a dynamic system and can be adapted to the changing
environment.

• Democratic nature: People enjoy full freedom under competitive market, entrepreneurs
introduce new products new techniques of production and distribution and other improvements

Capitalism:

Features or characteristics:

• Right to private property

• Right to inheritance

• Freedom of enterprise

• Freedom of choice for consumers

• Profit motive • Competition

• Price mechanism Right to private property:

Individuals are having right to own factors of production.

Right to inheritance: This right allows the owner to transfer his property to
his heirs after his death. Right to transfer from one generation to another
generation

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 . Freedom of enterprise: Individual is free to produce any commodity and fix
up its price, subject to the laws passed by the government in public interest.

Freedom of choice for consumers: Every consumers is free to buy from any
seller and consume any commodity quantity in any.

Profit motive: Another distinctive feature of capitalism is that all economic

activities are guided by the motive of earning profits.

Competition: Profit motive induces new firms to enter the market thereby
increasing competition.

Price Mechanism: In the Capitalist system, all decisions concerning

production distribution and exchange are based on the price mechanism.

Demerits:

• Concentration of economic power: Right to private property and the law of inheritance result in
the concentration of wealth in a few hands and subsequent leads to extreme inequalities to the
incomes of the people.

• Economic Instability: Capitalism does not provide stability of the price level. Free working of
market mechanism results in business cycle wherein business booms are followed by business
depression.

• Social waste: Cut throat competition among business firm’s results in unnecessary expenditure
on advertising and human resources of the nation.

• Rise of monopoly: Big business and Giant Corporation dominates the country economy in the
capitalist system.

• Social discrimination: Capitalism leads to the division of the society into two classes haves
(rich) and haves not (poor).

Socialism:

Features of socialism:
• State ownership of means of production: All important means of production are owned by the
Government.

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• Central economic planning: The central planning authority takes all the strategic decisions concerning
the economy i.e.., what to produce etc..,

• Social welfare: Hence the profit motive is absent and maximize social welfare is main objectives.

• Equally of opportunity: Every member of the society is given equal opportunity to rise in the life

. • Classless society: Socialism is based on a classless society. i.e.., No boss and no labour. • Absence of
competition: There is no competition between the different production units

. Merits:

• Social Justice: Under socialism, there is a just and equitable distribution of national income

. • Economic stability: The problems of over production under production, idle capacity because business
cycles are eliminated because the central planning authority takes all major economic decisions.

• Higher economic growth: Economic planning facilities optimum utilization of resources there by
leading to rapid economic growth.

• Absence of class struggle: On account of state ownership of productive resources and social distribution
of income, there is no struggle between haves and have notes.

Demerits:

• Concentration of economic power in the state: Both economic and political. Power is concentrated in the
hands.

• Lack of Incentives and Initiative: In a socialist economy, People do not have incentive for hard work,
enterprise and efficiency.

• Loss of occupational freedom: In a Socialist economy, People do not enjoy full freedom to choose
occupation and employment of their looking.

• Inefficiency and low productivity: Bureaucracy in the functioning of state –owned enterprises lead to
low productivity.

• Corruption: There is great possibility of growth of corruption in a socialist economy.

Mixed economy:
Features:

• Co-existence: In a mixed economy both public sector and private sector all allowed to coexist.

• Classification of industries: All industries are classified into two or more categories. Industries of
strategic importance are reserved for the public sector. The rest of the industries are left for the private
sector.

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• Economic planning: The planning commission lays down the socio-economic objectives.

• Profit motive and social welfare: The private sector operates primarily with a profit sector seeks to
achieve social welfare.

Merits:

• Individual freedom: Mixed economy provides adequate freedom to individuals.

• Rapid economic growth: Central planning and market mechanism together helps in the rational
allocation of resources.

• Social welfare: Government undertakes policies and programmer for the welfare of the public.
Demerits:

• Economic Instability: Sometimes, violent fluctuations occur in the level of economic activity due to the
fracture of market mechanism.

• Lack of freedom: A mixed economy is a semi-controlled economy producers. Workers and consumers
all get freedom of choice but subject to some constraints.

• Inefficiency: When there are too many regulations and controls, Private sector cannot function very
efficiently.

B) LARGE, MEDIUM AND SMALL INDUSTRIES

Small Scale Industries Vs Large Scale Industries

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 BASIS FOR SMALL SCALE
LARGE SCALE INDUSTRY
COMPARISON INDUSTRY

Meaning Small scale industry is an Large scale industry

industrial undertaking in encompasses big industrial
which there is a definite units whose investment in their
capital investment in its plant and machinery is beyond
plant and machinery. the limit specified by the
Government.

Industry type Labour-intensive industry Capital intensive industry

Geographical area Small Large

covered

Skills required It requires semi-skilled It requires highly skilled

labours. labours.

Technology used Indigenous technology State-of-the-art technology

Raw materials Procured from the local Procured from various

suppliers suppliers of raw materials are
there from within and outside
the country.

Objective To generate employment To produce consumer goods

opportunities with less and capital goods within the
investment. country, to make it self reliant.

Definition of Small Scale Industries

Small Scale industries, as the name suggests are the industries wherein the
production process is undertaken at a small or say micro level. It is often set up by
private individuals, usually with the help and support of their family members and

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hiring local workers who understand the work. It uses simple machinery, tools and
equipment.

Definition of Large Scale Industries

Large scale industry refers to undertakings which have a vast infrastructure, and
employee base along with heavy power-driven machinery and huge capital
investment. To manage and operate these industries effectively, complex
management is required.

It embraces both manufacturing concerns and others that make use of both
indigenous and imported technology to manufacture the products, so as to cater the
domestic as well as international markets.

These are small enterprises which are known for the manufacturing of the products
using light machinery, and less manpower, however, it depends on the production
scale.

These industries play a crucial role in rural industrialization as well as in providing

subsidiary employment to rural people.

Its aim is to create employment for local residents while using less capital. It helps
in eradicating backwardness from rural areas, which results in decreasing regional
imbalances, as it raises the income level and improves the standard of living.

Key Differences Between Small Scale and Large Scale

Industries
The difference between small scale and large scale industries can be drawn clearly
on the following grounds:

1. Small Scale Industries are the undertakings that undertake manufacturing,

processing and conversion of goods and involves investment in the fixed
asset, i.e. plant and machinery, up to a specified amount. Conversely, large
scale industries imply those industrial undertaking which is set up to
manufacture consumer goods and capital goods on a substantial level, for
which huge investment is made in the plant and machinery.
2. Small Scale Industries are labour intensive, as their dependency on the
labour force is high, but they also require capital for its operation and
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 expansion. On the contrary, Large Scale Industries are capital intensive, as
they require huge capital investment to establish and operate it.
3. When it comes to the geographical area, small scale industries are
established in a limited area generally at the location from where the raw
material and labour supply is easily available. On the contrary, large scale
industries are set up in a vast area, indeed they are located in multiple
locations in the country.
4. Small scale industries require skilled or semi-skilled workers. As against,
skilled workers are required in large scale industries and so proper training is
given to the workers on the way in which they can operate machinery.
5. Small scale industries use indigenous (native) technology for manufacturing
the products. As against, large scale industries use advanced technology to
create the products, so as to reduce the cost and maximize profit.
6. Small Scale Industries purchase raw material from the local suppliers and
sometimes from external suppliers. In contrast, large scale industries procure
raw materials from different suppliers from within and outside the country.
7. Small scale industries aim at generating employment opportunities with less
investment. Contrastingly, the aim of large scale industries is to produce
consumer goods and capital goods within the country, to make it self reliant.

Examples

Small Scale Industry

Bakery, Cashew processing, Bread production, Biscuit making, Incense sticks

making, Coconut oil manufacturing, Candle making, Cotton buds making, Custard
powder production, Envelope making, Eraser making, Fruit bar making, Ice cream
making, Jam jelly making, Leather bag making, Microbrewery, Paper cup making,
Palm oil processing, Pickles making, Slipper manufacturing, Soap manufacturing,
Woodworking, etc.

Large Scale Industry

Tea Industry, Textile Industry, Iron and Steel Industry, Jute Industry, Cement
Industry, Paper Industry, Petrochemical Manufacturing, Oil refineries, Food
Processing, Automobile, Silk Industry, Fertilizer Manufacturing, Sugar Industry,
Paper Industry, Chemicals and Pharmaceuticals, Distilleries and Breweries, Gul
making, Metal Processing, Aviation industry, Shipbuilding, Construction, etc.

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C )ROLE OF CAPITAL FORMATION, CREDIT AND BANKLING
SYSTEM

The banking system plays an important role in the modern economic world.
Banks collect the savings of the individuals and lend them out to business-
people and manufacturers. Bank loans facilitate commerce.

Manufacturers borrow from banks the money needed for the purchase of raw
materials and to meet other requirements such as working capital. It is safe to
keep money in banks. Interest is also earned thereby. Thus, the desire to save
is stimulated and the volume of savings increases. The savings can be utilised
to produce new capital assets

Thus, the banks play an important role in the creation of new capital (or
capital formation) in a country and thus help the growth process.

Banks arrange for the sale of shares and debentures. Thus, business houses
and manufacturers can get fixed capital with the aid of banks. There are
banks known as industrial banks, which assist the formation of new com-
panies and new industrial enterprises and give long-term loans to manu-
facturers.

The banking system can create money. When business expands, more money
is needed for exchange transactions. The legal tender money of a country
cannot usually be expanded quickly. Bank money can be increased quickly
and used when there is need of more money. In a developing economy (like
that of India) banks play an important part as supplier of money.

The banking system facilitates internal and international trade. A large part of
trade is done on credit. Banks provide references and guarantees, on behalf of
their customers, on the basis of which sellers can supply goods on credit. This
is particularly important in international trade when the parties reside in
different countries and are very often unknown to one another.

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Trade is also assisted by the grant of loans by discounting bills of exchange
and in other ways. Foreign exchange transactions (the exchange of one
currency for another) are also done through banks.

Finally, banks act as advisers, counsellors and agents of business and indus-
trial organisations. They help the development of trade and industry.

Meaning of Capital Structure:

The word ‘capital formation’ is used in narrow sense as well as in a broader
sense.

However, in a narrow sense, it refers to physical capital stock which includes

machines, machinery etc.

In a broader sense, it includes non-physical capital or human resources

consisting of public health, efficiency, craft, visible and invisible capital.

According to Prof. Colin Clark, capital goods “are reproducible wealth

used for purpose of production. But capital formation refers to the net
addition made to the existing stock of capital in a given period of
time.” Therefore, it is said that capital formation involves a sacrifice of
immediate consumption for obtaining more consumable goods in future while
‘capital’ is that part of the current product which is used for further
production instead of being immediately consumed.
Here, we must make a clear cut distinction between ‘maintaining capital
intact’ and ‘capital formation’. The process is known as maintaining capital
intact when resources are used to replace the worn out assets including wear
and tear of machinery as it does not add to productive capacity of the
economy.

On the contrary, capital formation refers to increasing the stock of real capital
which obviously helps in raising the level of production of goods and
services. Therefore, the essence of the process of capital formation is the
diversion of a part of society’s currently available resources to the possible an
expansion of consumable output in future.

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In this way, the concept can be extended to cover human capital formation. In
fact, it is only real physical assets and not financial assets such as shares,
bonds, currency notes and bank deposits are included in capital formation as
they increase the productive capacity of the economy.

The quote Prof. Nurkse, “The meaning of capital formation is that society
does not apply the whole of its productive activity to the needs and
desires of immediate consumption but directs a part of it to make capital
goods, tools and instrument, machines and transport facilities plant and
equipment—all the various forms of real capital that can so greatly
increase the efficiency of productive effort.”
According to Prof. Simon Kuznets, “Domestic capital formation would
include not only additions to construction, equipment and inventories within
the country, but also other expenditure expect those necessary to sustain
output at existing lands.

It would include outlays on education, recreation and material luxuries that

contribute to the health and productivity of individuals and all expenditures
by society that serve to rase the morale of employed population.”

Significance of Capital Formation in Economic Development:

Capital formation or accumulation is regarded as the key factor in economic
development of an economy. The vicious circle of poverty, according to Prof.
Nurkse, can easily be broken in under developed countries through capital
formation. It is capital formation that accelerates the pace of development
with fuller utilisation of available resources. As a matter of fact, it leads to an
increase in the size of national employment, income and output thereby the
acute problems of inflation and balance of payment.

1. Formation of Sound Infra-Structures:

The foremost significance of capital accumulation specially in its initial
stages is that it promotes the establishment of social overheads in the poor
country as these countries need these infra-structures at a priority level. In
this way, capital accumulation goes a long way in the development of basic
capital goods in under developed production.

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2. Use of Round-about Methods of Production:
In a backward country, process of capital formation makes possible the use of
roundabout or complex methods of production which makes the division in
different stages on the basis of modern techniques and production process
leads to specialization. This further leads to rapid growth in production.

3. Maximum Utilisation of Natural Resources:

In under developed countries, there is an increase in the capacity of risk
taking by capital formation by which fresh natural resources are made
available. It is made possible through proper and thoughtful exploitation.

4. Proper Use of Human Capital Formation:

Capital formation plays an extraordinary role in the qualitative development
of human resources. Human capital formation depends on the people’s
education, training, health, social and economic security, freedom and
welfare facilities for which sufficient capital in needed. Labour force needs
up-to-date implements and instruments is sufficient quantity so that with the
increase of population there will be optimum increase in production and
increased labour is easily absorbed.

5. Improvement in Technology:
In under developed countries, capital formation creates overhead capital and
necessary environment for economic development. This helps to instigate
technical progress which make impossible the use of more capital in the field
of production and with increase of capital in production, the abstract form of
capital changes. It is seen that present changes in the capital structure lead to
changes in structure and size of technique and public is thereby more
influenced.

6. High Rate of Economic Growth:

The higher rate of capital formation in a country means the higher rate of
economic growth. Generally, the rate of capital formation or accumulation is
very low in comparison to advanced countries. In the case of poor and under
developed countries, the rate of capital formation varies between one percent
to five percent while in the latter’s case, it even exceeds to 20 percent.

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7. Agricultural and Industrial Development:
Modern agricultural and industrial development needs adequate funds for
adoption of latest mechanised techniques, input, and setting of different
heavy or light industries. Without sufficient capital at their disposal, leads to
lower rate of development thus, capital formation. In fact, the development of
these both sectors is not possible without capital accumulation.

8. Increase in National Income:

Capital formation improves the conditions and methods for the production of
a country. Hence, there is much increase in national income and per capital
income. This leads to increase in quantity of production which leads to again
rise in national income. The rate of growth and quantity of national income
necessarily depends on the rate of capital formation. So, increase in national
income is possible only by the proper adoption of different means of
production and productive use of same.

9. Expansion of Economic Activities:

As there is increase in the rate of capital formation, productivity increases
quickly and available capital is utilized in more profitable and extensive way.
In this way, complicated techniques and methods are utilized for the
economy.

This results in the expansion of economy activities. Capital formation

increases investment which effects economic development in two ways.
Firstly, it increases the per capita income and enhances the purchasing power
which, in turn, creates more effective demand. Secondly, investment leads to
an increase in production. In this way, by capital formation, economic
activities can be expanded in under developed countries, which in fact, helps
to get rid of poverty and attain economic development in the economy.

10. Less Dependence on Foreign Capital:

In under developed countries, process of capital formation increases
dependence on internal resources and domestic savings by which dependence
on foreign capital is declined. Economic development leaves burden of
foreign capital, hence to give interest on foreign capital and bear expenses of
foreign scientists, country has to be burdened by improper taxation to the

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public. This gives a setback to internal savings. Thus, by the way of capital
formation, a country can attain self sufficiency and can get rid of foreign
capital’s dependence.

11. Increase in Economic Welfare:

By the increase in rate of capital formation, public is getting more facilities.
As a result, common man is more benefited economically. Capital formation
leads to unexpected increase in their productivity and income and this
improves their standard of living. This leads to improvement and
enhancement in the chances of work. This helps to raise the welfare of the
people in general. Therefore, capital formation is the principal solution to the
complex problems of poor countries.

Process of Capital Formation:

Capital formation or accumulation undergoes three main stages:
(i) Creation of saving;

(ii) Mobilisation of saving; and

(iii) Investment of saving.

ADVERTISEMENTS:

Let us explain the process of capital formation through these three

stages:
1. Creation of Saving:
The creation of saving is the first stage of capital formation. It means that
there must be an increase in the volume of real savings, so that the sources
may be used for the production of consumption purposes and further may be
released for other purposes. Therefore, for capital formation, some current
consumption has to be sacrificed for obtaining a larger part of the flow of
consumer goods in the near future.

For instance, if a community saves nothing and consumes whatsoever it

produces, no new capital will come into existence which will result in fall in
the production of consumer goods in future with the wearing out of the
existing capital assets. Therefore, it is essential that people should save from

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the present consumption. The creation of savings depends upon the power to
save, will to save and facility to save.

2. Mobilisation of Saving:
The next process of saving is that it must be mobilised by converting into
investible funds. For this purpose, the existence of banking and other
financial institutions are must. Banking facilities give considerable help to
promote high rate of mobilisation and channelization of saving. In brief,
sound and efficient banking system enables investors to invest more and
more.

3. Investment of Saving:
The final stage is the investment of saving into capital goods. It needs a class
of efficient, dynamic, daring and skilled entrepreneurs. An able and efficient
entrepreneur is always ready to make investments for the production of
capital goods. In short, both saving and investment are crucial for capital
accumulation.

Thus, the process of capital accumulation presupposes that national income

(Y) in a given period of time should exceed the level of consumption (c). The
income (Y) is divided between consumption and saving, i.e., Y = C + S. We
are also familiar that income is equal to expenditure, Y + E. Similarly,
expenditure can be divided into consumption expenditure (c) and investment
expenditure (I). Since Y = E and C = S is equal to C + I. In other words S + I.

However, the excess of national income over consumption constitutes saving

of the community which is investment. From this the relationship between
investment (I) refers to investible surplus while capital formation is the net
addition to the existing stock of capital. If any part of the investible surplus is
used for the production of consumer goods, it fails to form capital formation.

In this way, the value of capital formation may not be equal to the value of
investible surplus in a given period. So, the pre-condition for capital
formation is the positive value of investment. But at the same time, it must be
borne in mind that it does not guarantee for capital formation. Even then, it
can be raised by transferring investible resources in the production of
consumption goods to the production of capital goods.
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.

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