Poge

Dote:

CHAPTER-2
DENAND Ano LA Of DEMANO

Mtanina
t 9ualles a LoMmodui
wih ' CoLuauLmes
a
wllin ano oalal t
purlhaAL Vauouw poAible puc duuius
pauicla piod me

Demand
divia ual emand - t Heleato qaudiues
Caaooiy hat
au inmdiizuaJ A
wallina puacaase VaúouA
phic duu
a palhiulan

ake Deand ele laHtu bes

DA0MAAu.oli hal l a l housekaldll a
p uy a vauiau ucA
paatia Aieel mL.
Demana-

tatmewt Lao
quAaLu alemandel a cemhsdi
wua all aud olacoaAA
uius
J0

Asumpliamu
he Ahould ka ad cauge
Camlin
 Page
Date:

CoWAmel.
Aoulol la change u w talz
hee
nd peens oCeudume.
ulatuolCevmoaliy howld meun wwd
Paui 'a
o populatibm Ahawd nat chauge

Deman Seholula-

analiviuual Demand Schaoul And dias

Puire

2
80

80
D

2
9.

bMakt Demand elnacdule Aud diaanam.

 Poge
-- -

Date

DA QD_
MDATB
2
5
5
6
13..

8o

2 2 3 5
DewooA Oy Dema d a

20

Keo
Slape Dewanal
Ctwe
Lau Diminiawna Haginal UtiLH
This Lao Atat ati t
CAaed eu aoldl'Hanal
nit wnadily qwex leAseA dilaahia to h

Camlin
 CoLLmey owlal Punchau
wmeanA
CDwwmuou lya
a l a q auily MU L
aacauAl
when i t uu Lalls
adolihana wwts.

Sncem
A clana a nd On acebu
alauge a incomns uasulh4 lom
L Lmahod
ellec

Substi i o Ha
a elee hat a change in ulati'u
a t i bu gc0da hs
awani olemanal

i thc = daume gbatittim

muwas www.be CAAume

xuptions o Law o Demanal

Th ww ulatiauslip blw giuu
4uauu4oltnbnd las
exCaphows lo aw
anad Hhsue a dunt ulai oulp.
P QD
5o 5 ou
 Page
Dote

/SU

S
x
SoD

kKeasens an Excaphom.

G G sal keu ntion

CLaau me ApAnolso
Apnals
lage pad incams
anol olemanal la wtich VLalls wiH u
pu Eq. Aerxe

Astil Snob Appeal Th Law a Damand

to tl ommoalites _Lluielh
Jeave yabal diamenad
CTLi also unon Nas baspicous

Expactatiena ab0ututn pui

CAawmooiy wiune oday anl

tl pple wll lauy hdnt

H lexiuling wigun
Jta pP:
Sinailanly shan c8msilnnes adiipati a
lanese pucAa a uamodiy
w w ,Hhy wl paalea Hui euchiuu
altsoday
Bmeagemc law emand oloss nat epeaal
olui eunaegenues Gke wa aniuLseku
Camlin
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Date

COdm e a expech thartgu

wauulel wol oand ewe
Pic. n u H honolduuq deui
a Loe piu
deen
will

ualilyPce Kalatiouti'p Semotumes Couume

andes at ug uu gaools a aweke
Qai Lero
veain etet.

Chanae aaiom

*Deteminanta Demano.

o u Conmooi y-Ih an invede

wladiaip bl
dennainded is alao
Knbw a de naand.

_ Canuhe=
Neame
wida
Genacla
weusasis itl ulaiL
_demnanol
wn aulli n d u i n inuons..

eios Gbols To olemnol

Lsliu

expansive Neceies n hinCa e

oleman L o Lemnao.olsyinuuasis wit
ininLema pto clouin leue
 Page
Dale

Hheltu t ucmes LemstaE

IN

LA

2
Dema ua

Puics Rlataol qeo.als

La uastittt Gaels- Thoxe qmds i dati
Jou ye Lda honca Cau
plac
Tea ano Ha.

t
Te

(OCempleman oods-_lhaA 9.olA ud auu

ouplemaull euie
hak
tget Lq Ca and Et
Camlin
 Pag --
Dote

yDemonol
uL
Not Tu niemal uladinuslip bl
9AAAAadolil ano dennsnel
SulatilL Lenwalu l
u u olemainod.

25
 Demand and Law of demand

Meaning: Demand for a commodity refers to the quantities

of a commodity which consumers are willing and able to
purchase at various possible price during a particular period
of time.
Determinants of demand/ Factors affecting demand
1. Price of the commodity: Normally, there is an inverse
relationship between the price of the commodity and its
quantity demanded. It implies that lower the price of the
commodity, the larger is the quantity demanded; and the
higher the price, the lesser is the quantity purchased.
2. Income of the consumer:
Normal goods ( NG): Normal goods are those the
demand for which increases with increase in income of
the consumer, and decreases with fall in income.
Inferior goods (IG): Inferior goods are those goods the
demand for which falls with increase in income of the
consumer.
Inexpensive necessities (IN): In case of inexpensive
necessities of life such as salt and matchbox, the quantity
purchased increases with increase in income up to a certain
level and thereafter it remains constant irrespective of the
level of income.

This functional relationship between the demand for a

commodity and the level of income is known as income
demand.
In fig. 1, income of the consumer is plotted on the Y-axis and
the quantity purchased of a commodity is plotted on the X –
axis.
The nature of relation between income and demand for
normal goods is shown by the covers NG.
The curve NG has a positive slope, i.e., it moves upward to the
right, indicating that demand for such goods increases with
increase in income of the consumer.
The relation between income and demand for inferior goods is
shown by the curve IG in fig. 1.
Demand for such goods may initially increase with increase in
income (say up to y1 level of income when OQ1 quantity is
demanded), but the quantity demanded decreases as income
increases beyond y1.
The relation between income and inexpensive necessities of
life is shown by the curve IN. as the curve shows, a consumers
demand for necessities increases as his income rises up to OY2
level. At OY2 level of income, the quantity demanded is OQ2.
Beyond OY2level of income, IN curve becomes a vertical straight
line, indicating that a further increase in income does not lead to
any increase in demand.

3. Consumer ‘s tastes and preferences: The level of demand is

influenced also by the tastes and preference of the
consumers. Tastes and preference depend on social customs,
habits of the people fashion, general lifestyle of the people
advertisement, new inventions, etc. some of these factors like
fashion keep on changing, leading to change in consumers’
tastes and preferences. As a result, the demand for different
goods changes. People switch over from the cheaper old –
fashioned goods to costlier ‘mods’ goods

4. Price of related goods.

Substitute goods: Substitute goods are those goods which
satisfy the same type of need and hence can be used in
place of one another to satisfy a given want. Tea and
coffee, coke and Pepsi are examples of substitute goods.
 Complementary goods: Complementary goods are those
goods which are complementary to one another in the sense
that they are used jointly or consumed together to satisfy a
given want, like car and petrol, gas and gas stoves. There is an
inverse relationship between the demand for a good and the
price of its complement
‘Cross demand’ or ‘cross price effect’. The cross demand
shows the functional relation between the price of a
commodity and the demand for some other related
commodity.
5. Consumers’ expectations: If consumers expect a raise in
the price of a commodity in future, they would demand
greater amount of this commodity today with a view to avoid
purchasing it at a higher price in future. Similarly, if people
expect an increase in their income, they will buy more
commodities in anticipation of a raise in their income.

6. Consumer – credit facilities: If consumers are able to get

credit facilities or they are able to borrow from the banks,
they would be tempted to purchase certain goods they could
not have purchased otherwise.

7. Demonstration effect: Demonstration effects refers to the

tendency of a person to emulate the consumption style of
other person such as his friends, neighbors.
 Demand function

Demand function.
A demand function states the relationship between the
demand for a product and its various determinants.
Dn = f (pn, p1..pn – 1, Y,T,E,H,Y, G)
Statement of the law:
The law of demand states that, other things remaining equal,
the quantity demanded of a commodity increases when its
price falls and decreases when its price rises.
Assumptions:
a. There should be no change in the income of the consumer.
b. There should be no change in the tastes and preference of
the consumers.
c. Price of the related commodities should remain unchanged.
d. The commodity should be a normal commodity.
e. Size of population should not change.
f. The denaturation of income should not change
g. There is no expectation of change in prices in future. .
The law of demand can be illustrated numerically through a
demand schedule and graphically through a demand curve.
Demand schedule:
The demand schedule is a tabular statement that shows
different quantities of a commodity that would be demanded
at different price during a given period.
1. Individual demands schedule: Individual demand schedule
is the table which shows various quantities of a commodity
that would be purchased at different prices by a household
during a given period.

Individual demand schedule for apples

2. Market demand schedule: Market demand schedule is a table
which shows various quantities of a commodity that all the buyers
(consumers) are willing to purchase at different prices during a
given period.
Demand curve and its derivation:
1. Individual demand curve: Individual demand curve for a good is
the curve that shows different quantities of the good which a
consumer is willing to buy at different prices during a given period
of time.
2. Market demand curve and its derivation from individual
demand curves: It is a curve that represents different quantities of
goods which all the consumers in the market are willing to buy a
different price during a specified period.
 oge
Date

CmAPTER
THEORYOf CONSUMeR
btHAVIOUR : MARGINAL UTIurY AND NDIEFeRPNCE
CURVE ANALV8IS

Total
elaelas totsl Aatiactie deiued
CnduMex
colhanpiu o a

Hagunal ti4.
e M_additidne udlil deuiveal
Consuptiu c On bpedat aoloihnal
Lwit

T MO
O
1
A
2
3 21 TU

9 -3

HU

MU Camlin
 Pag
Date:

Auo
Relatosluip b Total UtiG
Hangnal Útit
intualng, MU a _
As lena as TU
pasiti maximum a his p Mu
TU
MU beumnes
Lolan TU Ataui dleclnng,

LAW Of DIMINSHING MARGINAL UTILTI

hat
Stalimew Law h u Law Ata
OLwoun Dudumea a cmndoli
e4ua
tili desiedlay cSousumen
adolidnal utit V ie maqna L
clewasiuo

Aumphans=

1Au Cnainabodty muale be

2 idendical
chauge tasli aud
The should
Helenanu
3TK shoulo k Lorutinaus Cuiumphm
4. auma Ahaulok kaima
 rog --
Dcle:

Sdnd ul
aih MO

DiaQnam

MU

xplanadim
AA mo auo i
da
olensase anal an , ut? l olives h
adoliinaal u t i y dease
Aadauu Leno.al'h
wael oaiuh met h
Jut, allaloe a s xt imp
Camlin
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Date

*CONsUMeR'S EguIu BR1UM HRoUGH CARDINAL UTLITy

ApPRoAcH ONE ComModTY CAS

Meauiug A
utillly maxinilmg Cosumu wl o
eautbuuwm urte plunlhases uat mud.
aComunooli
a
L w t u Hha mangna

o CoAaalile eawas

Coudiuou MUx P
MUx Haginal Utit Ga x
Px P

Scheduu
Uila HU
2 6SO
3 6o Equli'huum
5s
5 3So
Let

Dianam

E CecuiGesuw MU P

Sao
MUX
3
O
.Eyplanationu
abov ao ove ls duagtam Coukum
e i l i bu'um Couuums
col caAL at i s poiat

1anad 2 MUx 2 Px tleu

L Aplu.

wt anc 5 MUxPxThtmeans
qcttina le Aatisaion u pe to piu.

LA 0Df Egu1- HARNAL OTLLITY

Meamn utili marinniina

M adLoca is newe anaeu4 Vausw
Csmnooltius duda

in Aam usinalutiil

Conditen MU MU MU
Px Py
MUx Hagal ubi
MU Hangual
P
MUm Macenna

Camlin
 P

She dle
Suppa Coume waut to ipand 4
Pundhasu 9 u sdi' he Xand Y
Px Ss
Py Zlo

uila MUx MUy MUx/e MU/P

86
2
3 &
3s S
S 6
3o S 3

Expenolituu lable
LDainauen Total zpmali tuu

I S w G o ax 3xS= IS
wwt s Gd Y

I|4 wta Gsod X xS 20

wwils Gan Y Xlo 20
5

TL 5 witn Gqsa X SXS S5

3 wba G YY 3x1o 30

66 w s 6XS 30
ad Y
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Date

Explanatio

Caxe 1,ie. whe ue 3 u i a aGaeex

anod iE seaing abveschadule
e a i l tbuiwm
olocs sodi cmdi
Ham

MUx = MUV MUm

Px P

win we

oay, censumen meala

squik eai G&ium Pe Aatialies
Lemdi bi om Mu MUy MUm
Px Py
Case II e ok 5nib a G
and qao Y, Cmakwme doe
tii

Coe
Coe V tak 6uiaa oalx_anal
agaia
t libiu be coul
cxpa

ndi e s n Cwve

Conlbunatuo foroal HRS

A
2 3:1

5
D

Camlin
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Date

CuA AlhasgVosiaus Cemabinahau

two LonuatolliieA
Aaiahan sumeha.

*ndlanes Map

T
TC

oiuantu map a wali wwnd

Cue Ca ans lia upasedt a
gusnlee ttalaion
 Toge

Dote:

*Manqua Rate o Qlatt btia

a uatu a s i cobum
to wline
Qnothe
ahanguug level
Aatisadiaw

9opeties uat lauenc we.

A wdternLe Cne ALbp daonuoandla m

Lt Lo
Rope haAld_m alumphm
Lammoali'

G
Au nai Lne CA is comuex tu tuaigw
hased allmiialEq
HRs

|Hiahea indlilostnc yeilals Waleas Aatialacin

mdiene CuAvL 4epnsdlita
Lnaina. uaid ylds mass Adtlacm an
Lombinadion_ lne iadilaen uve
OD
so nollesn ialinseec
Aeula oliesut leel
Aatialab
wme ea

budae Lne

Camlin
 Po9
Date

TGt
ih exRAnoiliu
Cthin Fodol S x u t 6x2o) 200
5

3 x 4 )tGx3a)
3
a xuo) t6x2
2
x o ) +(8xa =
8
(Oxo +lox 20) =Aa

budat Line.
*Bopedia
Alop inn
LAe4ua
Satio
 Page
Dale
A
Lown elibium

Meanng A QnAume maal a cilibuum wln

h maxinmiseAA i Latal utii V.
auo Ruces mndadihes.

nnditionm
HRS Py
Lheuld Cnvex aig

Daala

20

M TC3
A

Explanato
H aloavc Ca
COmeinatisu lies
bue L n L kL uclu cemkinakn D becb
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Date

h stuu hand Omy gAanloinaUn ud HL

olak C biaion A
Lah bu awy Aueh Cblinal
m Aatasdn
. kighe nditunu u L
touheA T Occ a pru T
10
CEnonahon
lno ON
DuAcha.

Lqlibwu ll attoun
ucae langtu to a p o a
indlleene Luave
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Date

CHAPTER
CLASTICTY DeMAND

P Clastia e bemano.
Meaing - Dcanu esPeuAl veeL)
uauhY dendanaleo aCamnoalik w
poA ana

Deaes a elastiuy Deaanad

LPexecHy- w elasti Domano

P -Ld o

PeectH casti tDesand

BO

Camlin
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Date

U t a Laat

P
PU

4MaLe lostic/elati

D
AP< Ao

S LeA lat'duclastic

P
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Date

Mehoda Meas mem Psuieaelabsly

Demae

on latidA
Poin Hethnd/\Geometu HelHaad
D
pp in 8me

A Col
Ccls)

Cd)
Lol

AC

= O

Camlin
 D
AD
D < AD
Col

de EAC
Col>

Ate eaaticit.

e Cie
20

uastiuh deman Aasun cn a

Aang osnnana emve
called edasiit
MEthooda
Methe Puapouoaai Hehad
A
A Ax
 Page
Date

.xpenadlit Mehod
lasti Demand Eal>) lP TEs/P TEn|
wlhen oLall in ths pu s a a Cmmooliy heaulla
w nuaak t o t a t ex poualtus and aViu
pic taod ta olecsasl tatal expenails.

dnelasubeemand-td<) Len TealPy T

a ll Us puu a Cnmasalily educes
t t u exp nd t aud
ia w Hh puu 6a Lommaou in aALA
tsta exp., it iu khaak as inelasI Demand.

Utau a (td=)--
Oan total exp. dlass net clange with a
Ruu Cmodiy.

*acdos AJedina Paiu tlauti' Demand

Nal Comnooi
Demano wcoseteA weh as edd
U elash, o t ota hard demand a

xuaues

me Spand-
Popau o
Lh Amall papahm inLam pis a

a mbolity alle u hh elaiih

Gulastic)aus viu Veka
Dolemand

Cor
 Page:
Date

P Range
Demand V l a cmmodi tanos o ineladi
tneladt
anol vuy law pitesad
alaste Lahin V Ho modeal ana

labia e uuumeai=
Cousmes aue halaitual
Cobmooites i a lennonol aelale
Cudumes
hau nelaslie olemad, ma u
hanol e lemanal i d d l e elass
elauu.
15

LucoMEe CLASTICTY Of DeAD

Deg ueupusivtnes demamded
aemmei'h tb uom
20

CLaaieslz+ Deman
aceinaa clhaa Oy Deanole
Cananda usith haug Ri
25 l4kiaL_camnaadilz
dubsttti Coraola
 Page
Date

Numenicals
us The

otie
plad

Ced)

nit

10,

O S 9

Camlin
 Page
O .

ate

- demaand
A Cemsumta

QSalteo
P OD
4 50

10 ww

. o

15

- 2 pe uuii
A a pu

25
Meaning and types of elasticity of demand

Elasticity of demand refers to the degree of

responsiveness of quantity demanded of a commodity to
a change in any of its determinants.
Price elasticity of demand:
Price elasticity of demand may be defined as the degree
of responsiveness of quantity demanded of a commodity
in response to a change in its price.
Price elasticity of demand refers to the ratio of the
percentage change in the quantity demanded of a
commodity to a given percentage change in its price.

Ep = Percentage change in quantity demanded/

Percentage change in price.

Ep= 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒d

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
Classification of price elasticity – degrees of price elasticity of
demand
1. Perfectly inelastic demand: When quantity demanded of a
commodity does not respond to a change in its price, then
the elasticity of demand is zero.
2. Perfectly elastic demand: When consumers are prepared
to purchase all that they can get at a particular price but
nothing at all at a slightly higher price, then the price
elasticity of demand for a commodity is said to be infinite.
3. Unitary elastic demand: When a given percentage change
in the price of a commodity causes an equivalent percentage
change in the quantity demanded, then the elasticity of
demand is said to be unitary (or one).
4. Elastic demand: When the percentage change in the
quantity demanded of a commodity exceeds the percentage
change in its price, the elasticity of demand is grater then
unitary
5. Inelastic demand: Demand is inelastic when the
percentage change in the quantity demanded of a
commodity is less than the percentage change in its price.
Types of elasticity and their description
Methods of measurement of price elasticity of demand:
The measurement of elasticity of demand can be looked at
from two viewpoint:
I. Point elasticity
II. Arc elasticity.
1. Point elasticity: When price elasticity of demand is
measured at a particular point on a demand curve, it is called
point elasticity.
2. Arc elasticity: When elasticity of demand is measured over
a finite range or ‘arc’ of a demand curve, it is called are
elasticity of demand.
Percentage of proportionate method:
Price elasticity of demand is measured by the ratio of
percentage change in the quantity demanded to a
percentage change n the price of the commodity.
Percentage of proportionate method
Price elasticity of demand is measured by the ratio of
percentage change in the quantity demanded to a
percentage change n the price of the commodity.
 Percentage change in quantity demanded
Ep = x100
Percentage change in price

change in quantity denamded

initial quantity x100
= change in price
inital price x100

Thus:
Ep = ∆Q X P
∆P Q
Where ep stands for price elasticity of demand.
Q Stand for initial Quantity
P stands for initial price
∆Q stands for change in quantity
∆P stands for change in price

Total expenditure method:

According to the expenditure method, elasticity of
demand can be measured by considering the change in
total expenditure incurred on a commodity as a result of
change in the price of the commodity.

1. Elastic demand: When a fall in the price of the commodity

results in increase in total expenditure, and a rise in the
price leads to decrease in total expenditure, elasticity of
demand will be greater than one.
 Demand schedule:

Elastic demand

2. Inelastic demand: When a fall in in the price of a

commodity `reduces total expenditure and a rise in its
price increases total expenditure, price elasticity of demand
will be less than one.
 Demand schedule:

3. Unitary elastic: When total expenditure does not change

with a change in the price of the commodity, the elasticity of
demand is equal to unitary.
Demand schedule:
Categories of price elasticity of demand in terms
of total expenditure:

Point method (geometric method): Price elasticity of

demand can be measured with the help of what is
known as ‘point method’.
 Ep = 𝐿𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 𝑏𝑒𝑙𝑜𝑤 𝑡ℎ𝑒 𝑝𝑜𝑖𝑛𝑡 𝑜𝑛 𝑡ℎ𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
𝐿𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 𝑎𝑏𝑜𝑣𝑒 𝑡ℎ𝑒 𝑝𝑜𝑖𝑛𝑡 𝑜𝑛 𝑡ℎ𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣e

I. On a straight-line demand curve: Suppose we want to

measure price elasticity of demand at point R on a linear or a
straight line demand curve AB, which is intercepted by both
the axes.
 Ep at point R = 𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡
𝑈𝑝𝑝𝑒𝑟 𝑙𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡

= 𝑅𝐵
𝑅𝐴
Here, ep > 1 because RB > RA.

Similarly, if we want to measure elasticity at any other

point on the demand curve, say at K,
Ep at K = 𝐾𝐵
𝐾𝐴
Here, ep < 1 (since KB < KA.)
Ratio of line segment below the point and line segment
above the point can be used to illustrate elasticity at
various points on the liner demand curve.
I. At point A (where the demand curve touches the vertical
axis)
 Ep at A = 𝐿𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 𝑏𝑒𝑙𝑜𝑤 𝐴
𝐿𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 𝑎𝑏𝑜𝑣𝑒 A
= 𝐴𝐵 = infinity (∞)
𝑂
II. At any point above the mid – point but below A, say at E Ep
at E = 𝐵𝐸 > 1
𝐸𝐴
Because the lower segment is greater than the upper
segment, i.e., BE > EA
III. At the mid – point D
Ep = at D = 𝐵𝐷 = 1
𝐷𝐴
Because the lower segment equals the upper segment, i.e.,
BD = DA
IV. At any point below the mid – point but above B, say at C
Ep at C = 𝐵𝐶 𝐶𝐴 < 1 Because the lower segment is smaller than
the upper segment, i.e., BC < CA.
V. At point B (where the demand curve touches the horizontal
axis) Ep at B = 0 𝐴𝑏 = 0
2. On the non – liner demand curve: We can measure the
price electricity of demand on a demand curve which is not
a straight line (non- linear demand curve) by using the
point method. In order to circulate price, calculate price
elasticity of demand at any point on a curved demand
curve, we have to draw a tangent to the demand curve
through the chosen point and measure the elasticity of the
tangent at this point as the ratio of the lower line segment
to the upper line segment.
 Thus, ep at R = 𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 = BR
𝑈𝑝𝑝𝑒𝑟 𝑙𝑖𝑛𝑒 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 RA

Factors affecting price elasticity of demand:

1. Availability of substitutes: A commodity with more and
close substitutes tends to have an elastic demand and more
with a few and weak substitutes has an inelastic demand.
2. Nature of the commodity: The demand for necessities is
inelastic and the demand for luxuries and comforts is elastic.
3. Proportion of the oncome spent: The smaller the
proportion of income spent on a commodity, the smaller will
be the elasticity of demand, and vice versa.
4. The nature of uses of a commodity: The grater the number
of uses to which a commodity can be put to, the grater will
be its price elasticity of demand.
5. Time factor: Price elasticity is generally low in the short
period as compared to the long period.
6. Price range: Demand for a commodity tends to be
inelastic at very high low prices, and elastic within the
moderate range of prices.

Income Elasticity of Demand

Income elasticity of demand measures the degree of

responsiveness of the quantity demanded of a commodity to a
change in income of the consumers.
Ep = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒

Cross Elasticity of Demeand

Cross elasticity of demand is defined as the percentage change
in quantity demanded of a commodity with respect to the
change in the price of its related commodity.
 Ep = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑋
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑌

Or in symbolic form :
∆𝑄𝑋
𝑄𝑋

Where,
exY stands for cross elasticity of demand of X for Y
QX stands for the initial quantity demanded of
commodity X
∆QX stands for change in quantity demanded of
commodity X
PY stands for the initial price of commodity Y
∆𝑃Y stands for change in price of commodity Y
 Date2
Pege 3 4

s mota d ol uol 0

MAus lo4nantitis o H
Manung
tomwnddy wlhien prodntuu an wlng
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hwok 4auntatywll u AuppUno n highu

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pAootunton
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thu
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30

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 clASSMALe
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pog

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 cASSMAU
Date
Page 50

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51
n Dumond
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D
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Date 3
Page

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o P.
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 Date
Poge 55

wwm Amppiy dienoas , eguilinmn A

wad'alo Paea i om P to p

want
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D
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petly
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 J

Manieu Pi ugiulatiow

t h wanummum lhgal pin w!

p atinmkas

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wanda

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D

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 classAte

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md J
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wnti

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t Ailinium_pimt and
pie hhs DP
 ASSMAte
Datz
58
page

t u win pAic a OP ww
Onmunt tus T will h a
A l o w than eqiliAum

ouo euiXxliuma p
l o o n paar a e

wle Wgts han taaliuiuwm paus

usplieN_ad Mlliuga
hs punw
Quanti_dunnandu s O9t
Quadl wil
t h a a u u a KL wstagus clAs Ampplu).
 Paontion fuwian-t howa a
natil o manimuw
pe wi o m, tOmmodaly that AAn e
produu
witt tW
inpw whun uhu kdt gwwomount
w s uud
.
o

Shok mun It hs lo peaiod of ti

usn
ww.t e amounk o0nm Anpua tallud d
th ixud laclos_2annot L ahonsd

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dnina whitl al u lartos ol produntow sa
vded and thuu l uo hud oal

10ta unumt Kusa o hu olal amounkqa

pOnnodty odutud dning, som ipiniud
pLMed

Ae&A hostust hu 6 hu otpuk pa undk

a vataldu Jaaton

ALTL

total prod.uai
hedmt-Anlus o sbangu sn uuit ola
ARUNA adeitonal

vassalll lartov
 LAu 0p VARIALE koroKTION
lamw omuialt
ALstmunt lauo: h
pAopolow tale
hat A mo Anl vo
w l i ol vnaialles arloru
M pplud lo .a.
o i n o a c l o , tokalpa
qhantily
n t i L a d atA intlouiia
psodunit ma
hli. Lnitially evnlnall at uill im
a t a dlmininllu Jati

Hsanmptions oLao
And iua
0.Th stali o trehnology has n
ALnthahgcd_

kyut_
. t i asÁund thatAOm uila AKL
aialslL
Lind anek oths aA'

i _aLunmpd thak pll thu astes_wiko_t

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aslal

Schudul
5
3
880
360 h ó á o 750 |840|
1P 100 0
Le130 130 135 O 1O
lO
AP O0 Io
40
MP loo 12DYO 160 130 10010
 80

Explaiation
Ataq I- Mag d nALAAing, mun4
u
iut utagu atai kom tu point o govigin
contuntuu til h aUnag produt 6 nduin
It this stage TP ntudasu at au imai
moumur
Aati pke pont N And m u a at a Air
-hiuna a l utuetn os Ppoint M ad A
Pout N is kuoun Aspoint o inunion au
TP Auwe dhangcsAlope in thus atag HP
tass And ALarhia s manimuum pout
Pount M

Ta hisba total paodusk gous n ineALaAun4

ut at a diminidhuna Aat, It Aaeh
h manimum p0ut TVLu this AMage_Auatho
mangunal And auease pkódurt ase diminuh
this skag ahuhT s marimuun MP D.

Agp 3 ag oldumunishing nluins

T his Atng totak psoduett stast alling. P
aluo tank alins,And MP ueomt mgatiu
 Klationuhip ulmem MP avd AP

ihhm MP s mone hanw HP mat mmau AP

Misimq
hu I MP AP that m.anb P s onutaut
h u m nPws kus thain ApP A Atas lliny

PoXnet M
Maskut
Pooolese
AP

MP

Klatnosusp Liiuen 1/ and MP_

TP n e m o u l s o an umamaims a t ,MP alue

hu
MPAtasa
n TP iwsuaus a t a dsnouin _al,

hhn TP uachw _manimu M? s 0

huw ThP Alasta Lallia MP Jrouns nugatan
 o n m wad Empo t
huo

Aoguga Dewvomd
w hu ot
wmo um
amomw o 00-du AAw
dmandud in MOnow
om
othu duind dumamd ADuln
peop
A AD C+L +( X-M)
Cduied tOwwwptuow enpundiwu
w howold
1 olnuo Xwwwunt mpunaiun
deimd OAMmmt_ Apndin
X-Menpos-impoad&

IopunAM AOnAme

ulotiommp ee deined konmwptia

enpndn md inemne

AoAMmL APC
o Aowwwptom

APCC
onaimptOw
 clASSMAte
Date
Pay I13

w onmwwntwm

MPL AC

awiM. wwtwow- st ahows hu nlationi

Jtunee wwomMe

pLORO w' tAMA taak howatholda.

APS 5
u

MAAmal opunAiy
satno o hange miotal duind awug

MPS 5
AY

Rainoanap uansen
AfC+APS L

t
 elassMAte
Date
Page

CCoa pnomt A w.
1

2 MPC + MPS

As Y
AY AY

ALgeluue lnuntatmow
Jomuwptiom memam t5Y2
oMAimptioiw
C tomawnAms komAmwptiow lwww.imo

3 aloomAmsAmmn
- MPS

S|APLAPL APSMPC MPS

- MPS ACAY|S
AC|AY
L2 -0.2 0.8
RO O.2 810
R8 O.8 0. 8 10
0.13 0.0 O8 O.2 8 10 2

ATonommona Covawmptom
 M Mops
iueonm u ads
ads
hamu
mpmrand ndecMuns
Aknunlptuow Whu mmoe
timesianu iw 0nm A0nuwwpti
wulw
eo h*t Thunn 0nAnmpthow
utow0Ons

Rnomm A

PC >NO ut
popnea o tdniumu

AwAgpap ko A 0 m m u m L A e k e a s s

witl weubae i n nsonne A poin

Punt

AA know JaRak

L +B

fhopusosaia muctioma
1h admuing in alopu apursd_Aundinsiua
Ahathighuisem uods o hgas
0
T
a.1 Alope oAaung i n indssal manual
AunL MPS s araus > dd
t_ www
hopotaos mon A APs)_nemass
wwslwmtm Expundimm
Suwutmmw ulss o tha pon of
Aggiga Ontpnkwhirw aku t.
lo o u pAanls, whinsu

mdweud wunsnl
hat itkuw whit iu w.dutak
ww.omMu

Awtonomous muumum

ntmu wlw i not edfna

w tA ll o

wounuod wwlwluw

A
 Awtonoes imm

A A

meom

Delndnaiow o aaium ouTput

AegMali uan Mad0043MAi Ap

.
CAS
AD (CLI

45°
 clAsSMAt
Date
Page 1183

Explawmom
L -Ar ad deuud
owuol akou
ww.timwt iuLONdad Htonmpio
h d
w
2.Th anililaww a pnt E
apiulkuww uml weow i
40, at 1
wul AD» AS

3.Amppo4e 0upmo pAodu ww au

exowo
w

a o Hh
Psodinea
etiw output thi
5A wwwom Jou tu uw w t dow
podntiam he& lads o all nea
1 pos wdinu i Hu tauilluiun

w tha hand Auppu monu lunl

Jouxa tlhaw aiauw wl
i s tmpndi a wo
haw paodutud
aMouut

HU haAL u hmwto thaw udnat iu-

amd h i pAou w
V
 clASSMAte
Date
Page 111

ounow owd Awmdimum Appomh

ARcoding, o thiv ppmonel ailiuunm uuelL
owww.olw iv dutannnind, t t h a t u
immeummt

2 dhu aloue dsagaw t O40 t wona

a t thiw pont AD ASs

3,At Oydl a autpntAaning ietinnmt Jy

AB hui AS2,ADb

4KuRsodmasas Ahanld mt dou tu pAedudio

inrsinn Matp nd mploun i l duusuAu

eawililaiw u Oyo

hAL u u l i a m t å nmo tham Aaug

MiAL pAadukisdaould paodsm

 Meaning of Money

Anything that is generally acceptable as a means of exchange &

at the same time, acts as a measure & store of value.
Kinds of money
1. Currency – coins and paper currency component
2. Deposit money component
Coins are token money: Token money is the money the face
value of which is more than its intrinsic (metallic value)
Currency notes: central bank issued currency that was fully
convertible into gold. It was, therefore, known as convertible
money.
Inconvertible paper money: Acts as money because people
has confidence in it as it is issued on the order (fiat) of the
government. it is called fiat money because government
has declared it a legal tender.
Deposit money or bank money: Refers to the deposits held
with the bank on the basis of which cheques could be
drawn
Legal tender money: Legal tender money may be limited or
unlimited legal tender. Limited legal tender is the money
which is accepted as legal tender only up to certain
maximum amount. It cannot be forced upon the people
beyond that limit.
Unlimited legal tender money: On the other hand, is the
money which a person has to accept without any
maximum limit.

Functions Of Money

Primary functions:
1. Medium of exchange: The most important function of
money is that it serves as a medium of exchange. Money
commands general purchasing power to purchase goods
and services which people want.
2. Measure of value: The second important function of money
is that it acts as a common ‘measure of value ‘or unit of
account. Money serves as a unit of measurement in terms of
which the values of all goods and services are measured and
expressed.
Secondary Functions:
1. Standard of Deferred Payments: Money serves as a
standard of deferred payment. Acting as a standard of
deferred payments means that a payment to be made in
future can be stated in terms of money.
2. Store of value: Money also serves as a store of value, i.e.,
people can keep their wealth in the form of money.
3. Transfer of value: Money also serves as a means to transfer
value. This function of money arises from the general
acceptability of money as a medium of exchange. Money
help us to transfer value from one person to another.
 Contingent functions

1- Maximisation of utility: A relation consumer wants to

maximise this utility (or satisfaction) while purchasing various
goods and services.
2- Employment of factor inputs: Every producer aims at
maximisation of his profits while employing various factors of
production. rates of remuneration such as wage rate are
expressed in money terms, it is money which helps the
producer to arrive at decisions with regard to the number of
units of a factor of production to be employed.
3- Distribution of national income: Production is the outcome
of combination and collective efforts of various factors of
production. Production of goods and services is rewarded not
it terms of goods & services, but in money terms.
4- Basis of credit system: It is money which provides the basis
of the entire credit system. without the existence of money,
important credit instruments like cheques, bills of exchange,
etc. cannot be used. money is at the back of all credit.
Supply of money:
Supply of money refers to the stock of money held by the
public at a point of time as a means of payments and store
of value.
1. Money supply refers to the money held by the public in a
country. The term public refers here to all economic units,
including private individuals, business firms and institution
operating in the economy. Money supply refers to money in
circulation, but the money held by the government in its
treasury, central bank and commercial bank in their reserves
is not in circulation.
2. Money supply is a stock concept and therefore, it is
measured at a point of time.
Components of money supply:
1. Currency: It includes both paper currency and coins issued
by the government and the central bank of the country.
2. Deposit money: It refers to the demand deposits held by
the public with commercial bank on the basis of which
cheques can be drawn. Demand deposits held by the public
are also called bank money.
M1 = Currency held by public + Demand deposits held by
public with the commercial banks.
M2 = Currency held by public + demand deposits held by
public with the commercial bank + Time deposits (including
saving deposits) held by public with the commercial bank.

Measure of money supply in India:

M1 = Currency notes and coins with the public (C) + Demand
deposits of the people with commercial bank (DD) + other
deposits with the RBI (OD) such as deposit of public financial
institution, deposits of foreign central banks and foreign
governments an international financial institution.
Thus, M2 = C + DD + OD

M2 = M1 + savings deposits with post office saving banks

(SD)
Thus, M2 = M1 + SD M3 = M1 = Time deposits with
commercial bank (TD)

Thus, M3 = M1 + TD

M4 = M3 + total deposits with the post office saving

organisation excluding national saving certificates (TDP)

Thus, M4 = M3 + TDP
High Powered Money- It consists of currency held by public
& the banks & deposits held by the banks as reserves with
the central bank.
M0= Currency in Circulation + Currency deposits of the
commercial bank with RBI + Other deposits with RBI
 Low a haluwOnL
Mony Mamn4 wmoFewovw

Mnao & s Ameanu

Mtanmg aumstung.
oncldNge
vaduu
sd Alow o

Kinoe o

wna soins And papA Ly

o
aN ALpo4u meny Auzlon
ponin

wotiu-lmARLA nolu hees o papi

anwmy
ExaunpluiAsntneiy as 5 10,'2b 50
AOuty wis ktaa w
LO0LOo 500
A ADunt_o mak 2AMAAsolay _pusehanss
a ailatiow
Niutnau ll papu mony

monus A ank mony t s ko thu

Depou

dssnAAuuionw o hs banks dLpou paps

wolus nd oN oAALRIpmg

fwmtians oMo
towtgen
unetions umtio
 elASSMAte
Date
PsgeD

1ima uetnw
mond
0 . Mon A
buhonge pwmhon
iMudknm o to VpuMba
peop uwant
p n e h a r i m g p o m e

whisw
euAal Adiu
nd
M00dA
nd Muo
NAOM
uinn
oioled he wulap

miaMnA
ihe vl
o_Valu 1fos s A
A
Mease akumondg

o A 0 u i O A A y ,
au Ae
Mons
arrkum
Ast o
m o LaMMenLn

Aenwdasyunmhons

A
Paymwl- Aalina
andamd o Delesud

Mony
A 'mosunouonmitnd and onvewww

anau oaddMoy asiu bom H

A
omahonoe
 CJASSMALE

Date

Ontingent fumionA

Manmiunmow o uty A dionnl o u

Awaws. o mamimM i w whlu
Pwehnuung. vaeu 9000s and Mwu fo
Ranlitun h maaiaal t U u manuw
plangs au mpotant Mol a s puk
o ommodiuus me npaAuo wm

Ealoymunk o F o Inputw T warm

h ulps proodwtn o M i e a t dis
u
koo
w t Lgand to thu umlaA ouuilD o
AOdaudtuow o nmploye.

Jntailutuon
kiwtion Nadional I e m
askou opOduttiow to tu pAodrtuam
oha hot iu
o00olaAnd i u is Mwandrd
Mnd uÄAs Junt n manty
Mmsoq0ooda

udak Alum
PAOiosth bass dthentisu
D unitahn of nmony, iunpothka
Whon uuudMouuy
Aneelt nstiumun annot
Aselil
At t uoak o l l
 AupyoMe
wld by
mal
muan
humu A
ponl ol
pesblic ak
a valut
valut
And to o
pAgnune

kovpnL Mouy pp
Awumy Ltunttnoli Jothpapu

y0nmu
dUA the
uy the
ns
Ad oounliy umun
kank
and uutlal dh met
umy i

iaolu o papu
npontan Aom4LOnUn

puldiv t w po
dpio huldAy dh

w.dadaukoprd
AonRdA o dunelopid1hu mmawAL o
iA MmLd o M
hu,

M, wwuty uld An puukliw t Demand

dupoilo huld luypuC wt aommuial

M hw mot idlyMLupud meoAw

 clasSMAte

Dete
Pege 3

wonyAmppy
wow AmpP comaL wk mwwow all hu
n a u l i n t l e whi

Lptiod A muans opaumult

unnowaS TAku wdw duinntn

Ame
wmOu4 ApA M A
M,

M, wuwy hool y pultio + Damand

p wiw sammuial
depouilattd y
Aranki T w llposia hld uus puw w

M mLasmu minl una

iutsoolntLd

iMulatäow t mmnMy
M,A wty w V+
suamertinl dpank wt kBI
dlkposls
Ctha_dpeaka KAI

Xopn pemmn Mony

ameumt
Mtiwwmliy Aepey on

n t i a l LnkmonyT a
n t i a l Bank mou
hig-p0nud mony
AA tuda Anllud
h wwonula
 clasSMAte

Date
Poge

'nan uins at honu

Yonka
Aomwuenal n d unthal Bank

Bank du{nud
purpose o ndung o dpoia oMoruy om
the pulelue Aupalall OL dunand anl
Lwtthdsoul y migno,Pakt

fMmon o Banks

1Accepance o dupoiw: hu Puimamy untno

I a n k js to Arcust Kam
o a ommreial
pulelae A Lank mcei dupoáva nom
indinsiduale m and ethuMntiuons
MuoMLLA o
Deposilw conakulur the majA

Joan hu acond pAinmay

2Avdwancin
m wwl a n k u t
unetiow othw
Lknd l o á n s Ang MduaALA Ledung
uunu o a lrankg
A h e moAl PAekall onoweu.
hom the
Bank thangu tiut

thsong sguL
3£aMatian o_hymunl ommient
hammpieiHed awn
Banks huant
Ayalaw o paymunt i th lotm D
o thus
othus
Met poymuass Mom
We c a n ad_dipost_Hiu
heyu
thsough h g uu
neka ank
 AsSMAL

Aguney uneso - oaaks phOmdu MMou

t i o u

1he t0mmuiaU anku 0lllepaymun mad

thouglahuguu,dralli On behdl u
ALtdhnus

Thyuak
uha4
And sdlluel
th
vanions
uutoms
tps oP

ccmueal ank act av timulus ud

h

1WeJaku a Aaatiow we AumMu that hu

ALany nommusial anku Aueh As Rank d
heoda Aanasa Bank l e

AeLUA Aatio _pes Mn lu aske bank.

Arpoik

ExLcAL tosla huemeN uAd n rlndang

lon
Anaavanau

u t postuemlah bank Aay Bank o Boaie-

a s N dupout o &1000
1000
lBasada, LuinAU A

phuioton t mu
5y. Lo thu tat Aake o
oloan daau y A Ma
thal thu amou
 0 Jak. komthow
ALLOmd vank amd A
aalurnd
OvM
wll

Cack lank slanto wuh von awtal dpoit whw

Adpouud uy dpoiuten 04 uult al
payinLtiuedo 0woutl o ath anh

osking oudit malion Jy tommuial lnk

Depoutt Resm Loanw

O00 00 800

(Eiu hound)

800 640
Lanana bank
CAuecuo homnd)
128 5t
ICIC bank
(Thad la ouundl)
4000
5000 (000
1oTAL

Ewwwtions oAnlsa bauk

kank o
hank ia the
1ank o A u -lukao
noliw
ank the Jegal tndu
AA
y hu u t i a th d dupatmuut
Auntsa Asack has

nols And noins

d
ASSMAte
Oate
PageAy

no Adni

L4oummmi-Luntial
ank M all t
ucal
R Audy ot
Aduiio to thu lqouemmun
ovmM
ihe
MovMMUnkl
olan
mnmnnial

onmt
h
loni eu ehal

ltKal kank has h At

bankus to Aanks Auank aal
aommsal ranks
latuonuhip with thu
thuJatis
bauk, the unaal lank
th bamks'
hummtio AA
pesosn Asal
i u M A o thu lanku
uodna o a i l

kuuos-Thu mntkali ka
LLndn o thr la

Whn ommsdiall Jank hons hauAlid

Lank To td e
thuy appAoArlh Alhu tutkal
this aniual Asiuu

ow inpoloun
os 2ud Coulnpaatim
masks Kndit ohol
A). uantww.inm Mathodu
dist
nkLatLati 1huank sat o ihu
whinhw t h
Mu iv thu inimum a i
daanti
Jubal bank us lona And
 clasSMALe
Date

arkil
mnoma
Kepo hak punthaal NaU, A
ntna ak whmeh KbI endo
h ate ol
al anka o ths somiuww
Akost pesuoda
heun

RML Kepo A M atu o muu at

with RBL Jovu0w om A0mwAa Jank.
askeol

.Opn Makuk Opuation mAA to hm al

n t PAkaha_oMO muut_dund otth
appAoed utuitis y aMntia bnk
thu monuy Dukina, piooo oom kohu
Jaul
thu tuntiaEank wold ikA u

3a LU Mo-w hr minw

aAh AL
wintauw he lowm o ank
ommwial
h pninal ank
taun
lons o kep
dupoiula i t
o h i s _bapitb
puakaa
auhal bank wh w own
s
ARARNA
6. Snalitatiut Mtlodsr
kegymumur Th
LKugualatuow ol_ MasgNalaun
Leunte o t h Allmi,
diunc doan p a n t i d d
o
add Hhe anmoum EnaunAA agin
A
t h e sLeusitits
ALNLunl& .
Banka kup this m0ngin
ay J&U
petuot thanmaulues AgdLria
the valu ol dlw Aekti
ank Mdt" ly ung dku mauginal
MaaisLanuus

Diuuk Mons
kankt
dinutions iasuld ly_he_Aulsal
luesmn
Maukale thun urding, ad
Actiuilius he ntsat lank Aan take diaut
MiAcns A4am somnmusial AanksHrdl
Minut aetlons wwey tikuthe m ouual
oisoumting
hom unsal kankshasjine,pnal

PliigPaldicika is Anothu youlhed a

bank
Alstinnel AsLdi 2oktzal h ubal

Aund alaneing, polikius may( pu o a

A tasougha tla nadia oplAaA

 Functions of commercial banks

1. Acceptance of deposits: The primary function of a commercial bank

is to accept deposits from the public. A bank receives deposits from
individuals, firms, and other institutions. Bank accepts mainly three
types of deposits.

i) Current account deposits

ii) Saving account deposits
iii) Fixed deposits account

2. Advancing of loans: The second primary function of the

commercial bank is to extend loans & advances. Lending is the most
profitable business of a bank. Bank charges interest from the
borrowers which are more than the interest they pay to their
depositors.

i) Cash credit: It is a type of loan which is given to the borrower

against his current assets such as shares, bonds, stock of goods,
etc. in this case, the entire sanctioned amount of loan by the bank is
not given to the borrower at a particular time. The banks open an
account in the name of the borrower and allow him to withdraw the
borrowed amount as and when he requires the money.
ii) Outright loans and advances: Banks provide outright loan for a
fixed period. the loans are advanced for short term. in this case,the
entire amount of the loan sanctioned is credited in lump sum to the
borrowers current account. the borrowers have to pay interest on the
entire amount he has borrowed from the bank, no matter how much
amount is actually used by the borrower.

iii) Overdraft facilities: in many case, banks provide overdraft facilities

to their customers who maintain a current account with the bank.
when a customer gets an overdraft facility from a bank, this means
that he is allowed to draw cheques in excess of the balance standing
in his credit (account) to the extent of the amount of overdraft.

iv)Discounting bills of exchange : An important from of bank lending

is through discounting or purchasing the bills of exchange is drawn
by a creditor on the debtor specifying the amount of debt and also
the date when it becomes payable . such bills of exchange Are
normally issued for a period of 90 days. this means that the creditors
cannot get it enchased from the debtors before the expiry of the 90
days’ period.
3. Facilitation of payments through cheques: Bank has provided a very
convenient system of payment in the form of cheques. we can receive
payments from others through cheques and deposit these cheques in
our bank these cheques may be drawn on some other commercial
banks, but our bank will collect payments from these banks on our
behalf.

4. Transfer of funds: Bank help in the remittance or transfer of funds

expeditiously and safely from one place to another through the use of
various credit instruments like cheques, drafts, telegraphic transfer,
email, etc.

5. Agency functions :

i) Commercial banks collect payments made through cheques, drafts,

bills of exchange, and other financial instruments on behalf on their
customers.
ii) They make and collect various types of payments on behalf OF their
customers. banks make payments of insurance premier, taxes, etc. on
behalf of their customers from their deposits.
iii) The commercial bank act as agents of their customers in the sale
and purchase of stock and shares.
6. General utility services: Commercial banks provide various
general utility services such as providing locker facilities for safe
custody of jewellery and other valuables, issuing travellers cheques
and gift cheques.

7. Credit creation: A very important and unique function of the

commercial bank is that they have the power of credit creation.

Process of credit creation

i) We take a situation, as is the case in the real word, of multiple

banking system. in other words, we assume that there are many
commercial banks such as bank of Baroda, canara bank, syndicate
bank, etc. in the country.

ii) It is assumed that minimum legal cash reserve ratio is 20 percent

thus each bank, is required to keep 20 per cent of its deposits in the
form of cash reserve with it.

iii) Excess (over 20 percent) cash reserve is used in extending loans

and advances.
iv)One particular bank, say bank of Baroda, reserves a cash
deposit of Rs 1000 from its customers.

v) For the sake of simplified presentation, it is assumed that the

amount of loan drawn by a customer of one bank somehow is
transferred in full to the second bank to the third bank, and so
on.

vi) Each bank starts with an initial deposit which is deposited by

its depositor as a result of payment received from the borrower of
the bank.

Suppose a customer of Bank of Baroda deposits an amount of

Rs1,000 in this bank. Bank of Baroda is required to keep a cash
reserve of 20 per cent to meet the demand for cash by its
depositors. The balance is the excess amount of cash, which it
uses for advancing loans. Bank of Baroda keeps a cash reserve of
Rs200 (20 per cent of Rs1,000) and gives a loan of Rs800 (Rs1,000
– 200 = Rs8,000) to one of its customers by opening an account
in his name.
This is first round of credit creation, which is equal to Rs800. This
borrower from bank of Baroda uses this amount in buying
goods from some trader and makes payment by drawing a
cheque on Bank of Baroda. Suppose this trader has his account
in Canara bank.

He will deposit this cheque of Rs800 in Canara bank to be

collected from Bank of Baroda on his behalf. As a result of this,
Rs800 will be transferred from Bank of Baroda to Canara bank.
Therefore, Canara bank has got a deposit of Rs800. Canara bank
also is obliged to keep a cash reserve of 20 per cent, i.e., Rs160
(20 per cent of Rs800). It has an excess cash of Rs640 (Rs800 –
160 = Rs640).

Therefore, Canara Bank lends this surplus amount of Rs640 to

some businessman by opening an account in his name. Thus,
the second round increase in credit is 80 per cent of the first
round increase, which is equal to Rs640.
This businessman uses this amount Rs640 in making purchases
from a manufacturer by issuing a cheque drawn on its bank –
Canara bank. If the manufacturer has an account in ICCI bank, he
will deposit that cheque in ICCI bank.
As a result, Canara bank will lose Rs640 to ICiCi bank, which will be
used by ICCI bank in keeping a cash reserve of Ra128 (20 per cent
of 640) and extending loan of Rs512 (Rs640 – 128 = Rs512) to some
of its clients. This is the third round of increase in credit, which is
Rs512 (80 per cent of the second round increase).
Thus, an initial deposit of Rs1,000 with the Bank of Baroda has
resulted in the creation of deposits by three banks amounting to
Rs1,000 + 800 + 640 = Rs2,440, and the process of credit is still
going on.

The amount of credit card by every successive bank is decreasing

continuously. The process will come to an end when the deposit
received by a particular bank is too small to generate any fresh
loan, and all the banks have used the excess reserve in extending
loans.
Table 1: Working of Credit Creation by Commercial Banks
Deposit Multiplier Formulae:

The amount of credit creation by the banking system

as a whole can be worked out by the following
formula:
Increase in deposits = 1/RR * ∆D

where RR is the required reserve ratio and ∆D is the

initial change in the volume of deposits.

In our example, New Deposit = 1/ 20% x 1000

1/ 20/100x1000
=100/20 x 1000
=5000
 Limits to Credit Creation

1- Total amount of Cash Reserve: The total amount of cash

reserves in a country determines the amount of credit that can be
created by the banks. The larger is the cash reserves available in
the economy, the larger will be the credit created by commercial
banks, and vice versa.

2- Cash reserve ratio: The power of the commercial banks to

create credit depends upon the ratio of cash reserve ratio of cash
reserves to deposits. every bank is required to keep two types of
cash reserve: one is the minimum legal reserve ratio of cash to
deposits fixed by the central bank, in terms of which every
commercial bank is bound to keep a certain proportion of its
deposits in the form of cash with the central bank.

3- Banking habits of the people: Banking habit of the people also

determine the power of the bank to create credit. if people are in
the habit of using cheques, drafts, bills, etc. in their business and
other transactions, banks need to keep a smaller amount of cash
reserves and, therefore, their power to create credit will be more.
4- Nature of the securities offered: An important factor that
limits the power of bank to create credit is the availability of
adequate securities. Banks advance loan to its customers on the
basis of some kind of collateral security, which the banks can sell
off in case is the loan is not repaid. shares and stocks, building,
and other property, life assurance policies, bills of exchange,
warehouse warrants, etc., can be used as securities.

5- Business conditions: The power of the bank to create credit

depends upon the business and economic condition in the
country. during the periods of business prosperity, investment
climate is rosy and businessman will like to undertake more
investment by taking more loans and advances from the banks.

6- Monetary policy of the bank: The power of the commercial

bank to create credit is also limited by the monetary or credit
control policy of the central bank.
 Functions of central bank

1- Bank of issue: Central bank is the bank of issue. it enjoys the

monopoly of note issue. currency notes and coins issued by the
central bank are the legal tender money.

2- Banker, fiscal agent and adviser to the government: Central

banks in all the countries act as the bankers, fiscal agent and
adviser to the government. like any commercial concern, the
government also need a bank account. As the banker to the
government, the central bank performs the same functions as
are performed by commercial banks for their customers.

3- Banker to the bank: Central banks has the same relationship

with the commercial banks as the later has with the general
public. As the bankers, bank, the central bank performs several
functions. it acts as the custodian of cash reserve of the
commercial bank. commercial banks are under statutory
obligation to keep a certain percentage of their deposits as
reserve with the bank.
4- Custodian of nation ‘s foreign exchange reserves: Another
important function of the central bank is that it is the custodian of
foreign exchange reserves and gold reserves of the country. All the
foreign exchange transactions of a country are routed through the
central bank. the central bank controls both the receipts and
payments of foreign exchange. It tries to maintain stability of the
exchange rate.

5- Lender of the last resort: The central bank also acts as lender of
the last resort. De KOCKS REGARDS this function as sine qua non
(absolutely essential function) of the central banking in view of it
being the custodian of cash reserves of commercial banks.

6- Clearing house for transfer and settlement of mutual claims of

commercial banks: This is the one of the most important function
of the central banks. the central bank acts as a clearing house for
transfer and settlement of mutual claims of the commercial banks
on each other. every day the customers of different banks of issue
cheques drawn on their banks this create the need of settling
claims of the commercial banks on each other.
7- Controller of credit: The most important function of the central
bank is to control the credit creation by the commercial bank. As
explained earlier, credit money or bank is the major component
of money supply in a country. therefore, it is essential that the
supply of credit must be regulated so as to ensure the smooth
functioning of the economy.

8- Promotional and development functions: In a developing

country the central bank not only performs the so - called
traditional functions, as explained above, but in addition it
performs various promotional and developmental function as
well. Central bank is entrusted with the responsibility of
developing and promoting a strong banking system. Central
bank discharge various function so as to promote economic
development of the country.

9- Publication of economic and statistical information: The

central bank collects economic and statistical information
relating to different aspects of the economy and publishes
periodical reports.
Credit control – Regulatory role of the central bank

Quantitative method:
1- Bank rate: The bank rate of the discount rate is the
minimum rate at which the central bank gives loans and
advances to the commercial banks or rediscount the
approved bills of exchange and government security held by
the commercial bank. repo rate the commercial banks for –
short periods against government bonds. Reserve repo rate is
the rate of interest at which the RBI barrows from
commercial banks for short period. During Inflation- Bank
Rate increases During Deflation- Bank Rate reduces

2- Open market operations: Open market operation is

another quantitative instrument at the disposal of the central
bank credit in an economy. open market operations refer to
the sale and purchase of government and other approved
securities by central bank in the money and capital markets.
During Inflation- securities are sold in the market
During Deflation- securities are purchased from the market
3- Cash reserve ratio: Cash reserve ratio is the minimum percentage
of the total deposits with the commercial banks which they are
required to maintain in the form of cash reserves with the central
bank. Statutory liquidity ratio (SLR) refers to that proportion of the
total deposits of a commercial bank which it has to keep with itself
in the form of cash reserves, gold and government securities.

During Inflation- CRR,SLR increases

During Deflation- CRR,SLR reduces

Qualitative or selective credit control methods:

1- Regulation of consumer credit: An important instrument of
selective credit control is the regulation of consumer credit. it aims
at regulating the consumer instalment credit on hire purchase
finance. A certain percentage of the price of the durable goods is
paid by the consumer as the cash – down payment and the
remaining portion of the price is financed by bank credit.
During Inflation- Down payment increases Loan amt decreases
During Deflation-Down payment decreases Loan amt increases
2- Regulating of margin requirement: The difference between the
value of the security and the amount of loan granted against these
securities is known as margin requirement.

During Inflation- Margin Requirement increases Loan amt decreases

During Deflation-Margin Requirement decreases Loan amt increases

3- Credit rationing: Rationing of credit is another instrument of

selective credit control. it aims at limiting the maximum (ceiling)
amount of bank loans and Advances as well as, is certain cases, fixing
the maximum limit of loans for specific purpose. rationing of credit
may take two forms.
The central bank may fix the maximum amount of loans and
advances which can be given by a commercial bank,
The central bank may fix the maximum ratio of loans and advances
of a commercial bank to its total deposits.

During Inflation- Quota of giving loans decreases.

During Deflation- Quota of giving loans increases.
4- Direct action: Direct action refers to various directives issued
by the central bank to commercial bank from time to time to
regulate their lending and investment activities. the central
bank can take direct actions Against commercial banks.

5- Moral suasion: Moral suasion (suasion is the short from of

persuasion) is the method of persuasion, request, informal
suggestion and advice to the commercial banks by the central
bank. central bank convenes the meeting of the heads of the
commercial bank and explains to them the need for adoption of
a particular monetary policy and appeals to them to follow this
policy.

6- Publicity: Publicity is another method of selective credit

control. the central banks express its views about various
monetary and banking policies. it may put forward its views by
using facts and figures through media of publicity. the central
bank uses this method both for influencing credit policies of the
commercial banks as well as to influence the public opinion in
the country.
 pate
Page

Loe alU, hal hO

bolaunCao Pamut k Exchangu Ka

M w
éalance o payment oak thu suny
the lakane ptkat meond af alu
eeomeie taindan tiom umw miidus o
CULL m a y AdLAdenk o u g out
dnina gdewpuuoo

SonuponLna o kalaner oPaym

ksansaskious Mlalud to enpak and unposs

400ola, ALARA mlTia amaadnens
an unlkualaual imsom

tAalnAonluons ulaung ahang

o
un asula
tuinanrial aud puyieal

400d aAM

Aalancu o xpos o Impos o

1ad
G0od
 classmate
Date
Poge G5

bolouveu wwuntAccou

wmaolt wp o iuals, nniius md

Balacr o
6akannu o ane o
Lununktcomt
Aalannu o 110n

foalaneis oApika Aorew

balameus oAapial Aianak

m
L e ku
os
om
sA O w A a n d Junoing om_al-®oa
d

RAMselnaAL
othe Auntin
Aigtw nahangu. m

Pogantnk

lar k a l a e t o
aunlonomous
pAsuaLnsA

Mamauomow ALLiptu
QAn othus hand, ayuntds,
alonenus
hkaan kao ås aanps
A ps
opaylnt
khv lalantu

dnand:unds le olemar
aldA louizm
 asSMALe
Data

ougtw dimand auway hom A0u

A0u
lh4mw
to toa li and ohlou hana.
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 Meaning of balance of payments

The balance of payments of a country is a systematic

record of all economic transactions between the
residents of one country and residents of foreign
countries during a given period of time.

Components of balance of payments

1. Current account: The current account records all
international economic transactions relating to export
and import of goods , services, unilateral transfers and
international incomes.
2. Capital account: The capital account records all
international economic transactions relating to
changes in asset – both financial and physical.
Components of balance of payment
Current account

Capital account
Current account transactions
1. Export and import of goods or merchandise: This category
includes all types of physical goods exported and imported.
2. Invisible items: these are the items which are not tangible
and cannot be seen. Hence, they are known as invisible.
These invisible namely services, unilateral transfers, and,
income.
(1). Services: It includes a large variety of non – factor services
sold to and purchased by the resident of a country from rest
of the word.
(2). Unilateral transfer: Unilateral transfers are those receipts
and payments which take place without any service in
return in the current period.
(3). Income: Income are classified into investment income
and compensation of employees. Investment income
comprise interest, dividends, profit, etc.
Capital account transactions:
1. They refer to capital receipts and payments. These
relate to international movements of long – term and
short – term capital. When the resident of a country
borrows from abroad, we say they are importing capital.
2. When the resident of a country invests abroad, we say
that they are exporting capital.
3. These capital movements are classified into two
categories, namely direct and portfolio investment.
Direct foreign investment refers to investments
undertaken in the forms belonging to other countries by
acquiring control over them.
4. Portfolio investment, on the other hand , is the form of
investment under which companies and residents of a
countries purchase shares of foreign companies or buy
bonds issued by foreign governments.
Categories of balance of payments:
Three major categories in the balance of payments
accounts are, the balance of trade the balance of current
account and the balance of capital account. Balance of
trade: Balance of trade shows the balance of exports and
imports of visible goods in a given year.
Balance of trade = Export of goods – import of goods
Balance of current account: Balance of current account is
made up visible, invisibles and transfer.
Balance of current account = Balance of trade + Balance of
invisibles + Balance of transfers.
Balance of capital account: Balance of capital account
refers to the balance of capital transfers – borrowing and
lending from abroad and sales and purchase of assets ,
( export and import of capital ) , gold and foreign exchange
from other countries.
Balance of payments: Balance of payments include total
debuts and credit relating to all the items an account of which
a country makes payments to and receives payments from rest
of the word.
Balance of payments disequilibrium:
1. Disequilibrium in the balance of payments of a country may
appear either as a surplus (favorable) or as a deficit
(unfavorable or adverse)
2. If autonomous receipts are less than the autonomous
payments, the balance of payments is in deficit.
3. If autonomous receipts are grater then autonomous
payments, the balance of payments is in surplus.
Causes of adverse balance of payments:
1. Fall in foreign demand: Balance of payments deficit may raise
because of shift in the foreign demand away from the country
‘s goods to products of other countries. This may be due to
changes in taste and fashion consumers or because of lower
price of the products of other countries.
2. Inflationary pressures in the economy: In a developing
country like India , adverse domestic inflation. A high rate of
inflation at home encourages imports by making imports
relatively cheaper.
3. Developmental expenditure: In the Developing countries ,
the balance of payments generally becomes unfavorable due
to their developmental efforts. These countries have to
depend upon the developed nations of the word for the
supply of machines, raw materials , technical know how , etc.
during the initial stages of economic development.
4. Increase in cost structure of export industries: Increase in
the cost structure of a country ‘s export industries reduces the
volume of exports by reducing the competitiveness of these
industries in the world markets. The cost structure may
increase due to higher wages , higher price of raw materials or
higher rate of inflation. This fall in exports makes the balance
of payments unfavorable.
5. Decrease in supply: A fall in supply at home also leads to a
situation of deficit in the balance of payments. Agriculture
production may fall because of natural factors like failure of
crops. Similarly , industrial production may fall due to labor
strike , shortage of raw materials and power etc
6. Appreciation in the exchange rate: The balance of
payments becomes unfavorable because of appreciation in
the exchange rate of the country. Appreciation of a country ‘s
currency increase the external value of the currency. This
makes imports cheaper and exports expensive. Consequently
, imports increase and exports fall , leading to a situation of
adverse balance of payments.
7. Increased debt burden: The developing countries of the
word need to import capital largely in the form of portfolio
investment to promote their development. This has created a
large debt burden on account of debt services like interest.
 8. Demonstration effect: Demonstration effect on the people of
underdeveloped countries is also responsible for unfavorable
balance of payments of many underdeveloped countries try to
imitate the consumption pattern , particularly with regard to
luxuries like cars , air – conditioners , etc. of the people of
developed countries. This has led to large increase in the
imports of consumer durable goods , leading to deficit in the
balance of payments.
9. Population pressure: A rapid increase in population of many
underdeveloped countries has led to increased demand for all
types of consumer goods. As a result , export surplus has fallen.
A fall in the export earnings has an adverse effect on the
balance of payments.
10.Political factors: Political factor are also responsible for
making the balance of payments unfavorable. First , political
turmoil and instability in a number of countries – many Africans
countries , gulf countries , Afghanistan , etc. – have adverse
effect on their balance of payments.
 Measures to correct disequilibrium
in the balance of payments
1. Depreciation: Under the flexible exchange rate system, change
in the rate of exchange will automatically adjust the balance of
payments. Depreciation of the countries currency will wipe out
deficits in the balance of payments. Depreciation of currency
means a rise in the price of foreign currency or , which is the same
things, fall in the price of domestic currency. Suppose 1 used to be
exchanged for Rs 55 earlier , but now it exchanges for Rs 60 . this
means that Indian rupee has depreciated.
2. Devaluation: A country can devalue its currency to wipe out
deficit in the balance of payments. This makes imports expensive
to domestic consumers and its exports cheaper in foreign
countries.
3. Import control: Imports may be kept in check through the
adoption of a wide variety of import control measures such as
quotas and tariffs. The government may for , example , decide
that only 90 per cent of last year ‘ s volume of imports can be
imported this year. The government may also increase the import
duties or tariffs.
4. Export promotion: the government may pursue various
export promotion measures to stimulate exports. First , it may
reduce export duties so as to encourage exports. Seconds,
cash assistance and subsidies can be given to exporters o
stimulate exports. thirdly , various facilities like quality control ,
provision of market information and arranging exhibitions of
exportable goods in foreign countries can be provided to
promote exports. Fourth , goods meant for export can be
exempted from various taxes as an incentive to the exporters.
5. Exchange control: Another important method of correcting
disequilibrium in the balance of payments is exchange control
or exchange restrictions. The government may try to hold
complete control over all dealing in foreign exchange by
directing all the exporters to sell their foreign exchange
earnings to the central bank and all the importers to buy
foreign exchange from the central bank.
6. Production of import substitutes: Steps may be taken to
encourage the production of import substitutes. This will save
foreign exchange in the short – run by replacing the imports by
their import substitutes.
7. Monetary policy: A tight monetary policy can be effectively
used to reduce expenditure , and thereby , correct deficits in the
balance of payments. The centralbank can reduce the volume of
credit by raising the bank rate , by selling the approved
securities in the open market and by raising cash reserve ratio.
8. Fiscal policy: A restrictive fiscal policy can be successfully used
to wipe out balance of payments deficit by reducing the total
expenditure in the economy. The restrictive fiscal policy is
characterized by increase in taxes and decrease in government
expenditure.
9. Capital import: Deficit in the trade balance can be corrected
in the short – run by borrowing capital from the individuals and
governments of other countries as well as by borrowing from
international financial institutions like world bank, IMF , etc.
Foreign exchange:
Meaning of exchange rate: foreign currencies and claims on
them in the from of bank deposits, cheques , etc. payable in
those currencies is known as foreign exchange.
Exchange rate system – fixed and flexible exchange rate
Fixed exchange rate system: In a fixed exchange rate
system, the rate of exchange is officially fixed by the central
bank of the country by official action.
Flexible exchange rate system: In a flexible exchange rate
system, exchange rate is left free to be determined in the
foreign exchange market by the forces of demand and
supply. Clean floating, central bank stands aside completely
and allows exchange rate to be freely determined in the
foreign exchange market. Under managed floating or dirty
floating, central bank intervenes to buy and sell foreign
currencies in an attempt to influence the exchange rate.
Concepts of Depreciation, Appreciation,
Devaluation and Revaluation

Depreciation refers to a fall in the free – market value of

domestic currency relative to the currencies of other
countries in the foreign exchange market.
Appreciation means a rise in the free – market value of
domestic currency relative to currencies of other countries
in the foreign exchange market.
Devaluation refers to an action undertaken by the central
bank to decrease the value of domestic currency relative to
the currencies of other countries under a system of fixed
exchange rate.
Revaluation refers to an action undertaken by the central
bank to raise the value of domestic currency relative to other
currencies under a system of fixed exchange rates.
Determination of exchange rate in a free market
(under flexible exchange rate system )

The equilibrium exchange rate is determined at the point

where the demand for and supply of foreign are equal. Demand
curve DD shows how many dollars India demands at different
rates of exchange, and the supply curve SS shows how the
supply of dollars’ changes as the exchange rate varies.
The demand and supply curves of foreign exchange is
intersecting each other at point E0.
The equilibrium exchange rate is r0 and QQ of foreign
exchange is demanded and supplied.
At the exchange rate r0 the Indian demand for dollars
equals the American supply of dollars, and the foreign
exchange market is cleared.
If the price of dollar in terms of Indian rupee is low i.e. r1 the
demand for dollars exceeds the supply of dollars by AB
amount.
There will be excess demand of dollars. Some people who
require dollars to make payments to the USA will be unable
to obtain dollars.
Therefore, the price of dollars will rise. The value of dollar vis
– a-vis the rupee will appreciate or, what is the same things,
the value of rupee vis’- a-vis the dollar will depreciate.
Conversely, at the rate of r2 the quantity of dollars
supplied exceeds the quantity demands by GH. In
view of the excess supply of foreign exchange
(dollars), the value of domestic currency will fall, i.e. ,
the value of domestic currency ( Indian rupee ) will
increase.
This will lead it a fall in the exchange rate from Or2 or
Or0 the price of dollar will fall or rupee will appreciate.
Where the two curves intersect, the quantity
demanded of dollars equals the quantity supplies ,
and the exchange rate is in equilribium
 FISCAL POLICY

Public finance:
Public finance is the study of revenue and expenditure of
the government at the centre, state and local levels.
Meaning of fiscal policy:
Fiscal policy is defending as the policy under which the
government uses the instruments of taxation, public
spending and public borrowing to achieve various
objectives of economic policy.
Instruments of fiscal policy – There are mainly three
instruments of fiscal policy, namely taxation, public
expenditure and public borrowing (debt).
Meaning of taxes: ‘’ A compulsory contribution from a
person to the government to defray the expenses incurred
in the common interest of all, without reference to special
benefit conferred’’.
Types of taxes:
Direct- direct tax is that tax whose burden is borne by the
same person on whom it is levied.
An indirect tax is that tax which is initially imposed on
and paid by one individual, but the burden of which is
passed over to some other individual who ultimately.

Proportional, progressive and regressive taxes:

1. Proportional taxation: A tax is called proportional when
the rate of taxation remains the same as the income of
the taxpayer increases.
2. Progressive taxation: A tax is called progressive when
the rate of taxation increase as the taxpayer ‘s income
increases.
3. Regressive taxation: A regressive tax is one in which
the rate of taxation decreases as the taxpayer ‘s income
increases.
4. Digressive taxation: A tax is called digressive when the
rate of progression in taxation does not increase in the
same proportion as the increase in income.
Public expenditure – meaning:
Public expenditure refers to the expenses incurred by public
authorities – central government, state government and local
bodies – for its own maintenance as also for the meeting of
collective needs of the citizens and / or for promoting their
economic and social welfare.
Importance of public expenditure –:
The importance of the public expenditure emerges from the
following facts.
Effects of public expenditure on production:
1. Public expenditure helps in generating income for various
individuals and firms as result of purchase of goods and
services and factor services from them. This helps in increasing
the purchasing power of the people.
2. Public expenditure can help in increasing production in the
economy by increasing the efficiency of the people. Public
expenditure on education, medical services. Sanitation and
cheap housing facilities increase the productive efficacy of the
people at large, which leads to increase in production and
income of the people.
3. Public expenditure can be used to create human skills
through education and trainings.
4. Public expenditure can be used as a means of
producing essential raw materials and other important
inputs in the public sector. This people in removing
various shortage, like shortage of steel and fertilisers so as
to ensure smooth production.
5. Public expenditure is helpful in promoting the
development of basic and key industries such as capital
goods industries.
6. Public expenditure incurred in providing social security
schemes such as old – age pension unemployment
allowance, sickness benefits, free education and medical
facilities, etc. increase the purchasing power of low
income groups and, hence their ability to work.
Effect of public expenditure on investment:
1. Confidence in the minds of the investors, and hence, it
encourages them to undertake investment.
2. Public expenditure can be directly used to create social
overheads in the form of human capital.
3. Creation and maintenance of economic overheads such as
power, irrigation, transport and communication, would
motivate the producers to undertake investment.
4. This government may provide financial assistance and
subsidies to the private sector and thereby simulate
investment provision of subsidies fertilisers and electricity has
helped in the development of agriculture sector in India.
Effect of public expenditure on income distribution:
1. Public expenditure can be so devised as to help the poor
sections of the society and thereby reduce inequality of
income. Welfare measures like free education , free medical ,
facilities and social security schemes like old – age pensions,
unemployment relief etc. can be given top priority to help the
poor. Public expenditure incurred in providing subsidies on
article of common consumption like food grains can also help
the poor person and thereby improve income distribution.
In India public expenditure has helped in reducing inequalities
of income in the country through various welfare and social
security schemes.
2. Public expenditure can be effectively used in reducing
regional disparities as well. Subsidies and financial assistance
may be given to the producers to set up industries in the
backward regions.
Effect of the public expenditure on economic growth:
1. Public expenditure promotes economic development directly
by developing economic overheads and infrastructure and by
establishing capital goods industries, basic and key industries,
etc.
2. Public expenditure may stimulate economic development
indirectly by providing education, training and research
facilities. Public expenditure on education and training , public
health and social security schemes increases efficiency and skill
of people , and thereby contributes to economic development.
3. Public expenditure in the form of subsidies can help in
stimulating agriculture and industrial development.
4. Public expenditure policy can be effectively used to
reduce glaring disparities in income and wealth as well
as to reduce regional disparities economic development.
Repaid economic growth with social justice was
accepted as the most important objectives our five years
plans. This called for an increase in the role of
government.
Public expenditure and economic stability

1- During the period of depression, the government is

expected to raise its expenditure. Increase in public
expenditure, largely in the from of direct public
investment on a massive scale will add directly to
aggregate demand in the economy and will thereby
result in increasing in output and employment.
2- During the period of depression, the government is
expected to raise its expenditure. On the other hand
during the period of booms ( characterised by inflation )
, there is the needs of curbing excess demand. This can
be done by reducing public expenditure while
maintaining the same level of taxation and borrowing.
Public debt : Public debt is the debt which the
government owes to its subjects or to the nationals of
other countries.
Methods of debt redemption:
1- Repudiation of debt: Repudiation means refusal to
pay a debt by the government. When the government
repudiates public debt, it does not recognize its
obligations to pay of the loan.It refuses to pay the
interest as well as the principal amount of debt because
of financial constraints.
2- Refunding: Refunding is the process by which the
government raises new bonds to pay of the maturing bonds.
Thus, the government takes a fresh loan to repay and old loan.
In this case, the money burden of the debt is not liquidated but
is postponed to some future date.
3- Debt conversion: Conversion of public debt means exchange
of new debt for the old debt. In this method, the loan is actually
not repaid , but he form of debt is changed. The process of
conversion consists of converting a high – interest debt into low
a low –interest.
4- Budgetary surplus: Sometimes the government is able to
generate a surplus in its budget. It can use this budget surplus
to pay off its debt to the people. A policy of surplus budget may
be followed annually for paying off public debt gradually. The
government may use the budgetary surplus to purchase back
its own bonds and securities from the market.
5- Terminal annuities: Under this methods, the government
pays its debt in equal annual instalments, which include interest
as well as the principal amount of debt. The annual payments
are called annuities.
The governments is not required to repay the entire debt at a
time, but the burden of debts is reduced every year.
Thus, it the method of repayments of loans in instalments.
6- Sinking funds: Sometimes, the government establishes a
separate fund, known as sinking fund for the purpose of
repayment of its debt. The governments credits ( deposits )
certain amount of its revenue every year for the repayment of
outstanding debt.
7- Capital levy: Capital levy refers to a very heavy tax on property
and wealth. It is a once – for – all tax imposed on capital assets of a
certain value. A capital levy is just like a wealth tax as it is imposed
on rich and propertied individuals on a progressive scale.
8- Export surplus: The method discussed above are used to repay
internal debt. But external debt need as to be repaid normally in
foreign exchange. It can be done by creating an export surplus. If
foreign loans are invested in those industries which produce
exportable goods, the loans may be easily repaid.
Deficit financing: Deficit financing means meeting the deficit
between government expenditure and revenue through the
creation of new money
 Government budget

Meaning of government budget:

The budget of the government is an annual financial statement
describing in detail the estimated receipts and purposed
expenditure and disbursement of the government under
various heads for the financial or fiscal year (1st April to 31st
march)

Types of government budget in India

1. Union budget: Union budget is the budget prepared by the
central government for the country as a hole.
2. State budget: State budget is the budget prepared by the
state government such as the budget of the Delhi
government, budget of the government, of Tamil Nadu etc.
Components (structure) of the government budget:
Accordingly, budget necessarily presented in two parts,

1. Revenue budget
2. Capital budget
1. Revenue budget: Revenue budget shows revenue
receipts of the government and the expenditure meet from
these revenue receipts.
Thus, revenue budget consists of:
(a) Revenue receipts and (b) Revenue expenditure
Revenue receipts of the government are all those receipts
which are non –redeemable.

Revenue expenditures relate to expenditures incurred by the

government on day – to – day normal functioning of the
government and interest payment on government debts.

2. Capital budget: Capital budget comprises capital receipts

and capital expenditure of the government.
Capital receipts are the receipts of the government which
create liabilities or reduce assets of the government.
Capital expenditure are those expenditures of the
government which lead to creation of physical and financial
assets or reduction of financial liabilities.
 Revenue receipts

Revenue receipts are divided into two heads, namely

receipts from tax revenue and receipts from non – tax
revenue.

1. Receipts from tax revenue: A tax is a compulsory

charge or payment imposed by the government on
individuals and corporations.
The individual has no choice in the matter of paying tax.
The central government in India imposes sic main taxes,
namely personal income tax, corporation tax, customs
duties, union excise duties, services tax and expenditure
tax.

2. Receipts from non – tax revenue: Besides tax, the

central government gets revenue from other sources
which are collectively called non – tax revenue. The main
sources of non – tax revenue are as under.
1. Interest receipts
2. Dividends and profit
3. Revenue from services provided by the government
4. Grants - Aid

Capital receipts

Capital receipts are classified into the following heads.

1. Recovery of loans and advance

2. Market loans
3. Special deposit
4. Small savings
5. Provident funds
6. External assistance
7. Disinvestment proceeds
 Types of budget deficit

Revenue, fiscal and primary deficit – meaning

and implications

1. Revenue deficit:
Revenue deficit = Revenue expenditure – Revenue
recites.
Revenue deficit refers to the excess of revenue
expenditure of the government over its revenue
receipts.
Implications of revenue deficit:
1. Revenue deficit indicates the government’s current
financial status.
Revenue deficit means dissaving on government
account. This implies that resources have to be
borrowed from other sectors of the economy to cover
the excess expenditure of the government. This
reduces the resources available for private investment.
This has adverse effect on economic growth.
2. Higher borrowing put pressures on revenue
expenditure in the form of interest payments. This
further adds to problem of deficit. This may impose
undue burden on the future generations because
they have to bear the pinch of the interest burden.

3. Since borrowed funds are generally incurred to

finance consumption expenditure of the
government, a high level of revenue deficit causes
inflationary pressure in the economy.

2.Fiscal deficit: Fiscal deficit is the excess of total

expenditure of the government over its revenue and
capital receipts excluding borrowings.

Thus,
Fiscal deficit = Total budget expenditure – Revenue
receipts
– capital receipts (Excluding borrowing)
 Implications of Fiscal deficit:

1. Fiscal deficit is the key indicator of budgetary deficit in

India; it is a comprehensive measure of fiscal imbalance in
the economy. It measures the total resources gap of the
govt. It indicates the extent to which the govt is living
beyond its means. It shows the total borrowing
requirements of the government from all sources – market
loans from financial institutions public borrowings under
various small savings schemes, borrowings. A large fiscal
deficit implies a large amount of borrowings.

2. Fiscal deficits have serious implications for the economy.

Govt. has to borrow to meet this deficit. This increases the
future liabilities of the govt. in the form of payment. of
interest and payment of loans. Payments of interest
increases revenue expenditure. This may increase the
revenue expenditure. This may increase the revenue deficit.
This may lead to more borrowings and more interest
payments. Therefore, the govt is required to borrow more to
pay interest and repay old loans. This is what is known as
‘debt trap ‘.
3. High fiscal deficit generally leads to wasteful and
unnecessary expenditure by the government.
4. A large fiscal deficit may lead to inflationary pressure
in the economy.

3. Primary deficit:
Primary deficit refers to the difference between fiscal
deficit and interest payments by the governments on
its borrowing. Primary deficit = fiscal deficit – interest
payments Primary deficit indicates the real position of
the government finance as it excludes the interest
burden in respect of loans taken in the past. It shows
how much the government is borrowing to meet its
expenses other than interest payments. It is a measure
of fiscal discipline of the government, i.e. the way the
government is conducting its financial affairs.
National income and Circular flow of income

National income :

National income is defined as the money value of all final goods

and services provide by the normal residents of a country,
whether operating within the domestic territory of the country
or outside, in a year.

Final goods and services:

Final products are those goods and services which are sold to
the final users during the year.

Intermediate products are those goods and services which are

used by the producers as inputs into a further stage of
production.

Double counting is the error which arises in national income

estimation if we add up the total input of all the sectors in the
economy, instead of adding up the output of final goods and
services only.
Transfer payments are unilateral payments for which no
productive services are rendered in return in the current
period. The recipients of these transfer payments do not make
any contribution to current production in return for these
payments.

Normal residents are those persons who ordinarily reside in a

country in which they live and whose economic interest lies in
that country.

Domestic territory refers to the geographical or political

boundary of a country, excluding foreign embassies and
international institutions (like UN, WHO offices, etc.) located
within the geographical territory, and including the embassies
of this country located outside its geographical territory, and
including the embassies of this country located outside its
geographical territory. The money value of final goods and
services produced in a year by the production units located
within the domestic territory of a country is called domestic
product or domestic income.
Real flow :

Real flow consists of flow of factor services and flow of

goods and services among different sectors of an
economy.

Money flows :

Money flow consist of flow of money incomes for factor

such as money wages, rent, interest, etc. and money
expenditure incurred on the purchase of goods and
services.

Household Sector -

Households are the main factors of production - land,

labour and capital. They sell the
services of these factors to producers and in return
receive their income.
Business sector or firms -
Firms hires services of factors of production from households to
produce commodities that they sell to households, other firms
government or to other countries.

Government -
Government is taken in the sense of ‘general government’ so as
to exclude government commercial enterprises. General
government gets its income largely through taxes imposed on
households and business sectors in the form of direct and
indirect taxes. It buys goods and services from the producers and
factor services from the households.

Rest of the world -

Different sectors of the economy have transactions not only with

each other but also with foreign countries, i.e., rest of the world. A
country exports goods and services to other countries and
similarly it imports goods and services from other countries. In
the same way, factor services move across the border of a country
and the firms of this country may purchase some factor services
from other countries.
EQUILIBRIUM CONDITIONS

2 SECTOR MODEL
S=I

3 SECTOR MODEL
S+T=I+G

4 SECTOR MODEL
S+T+M=I+G+X