PART A: INTR ODU CTO RY MAC ROE CON OMI CS

--~-- - - . -·- .
Chap ter-1: Intro duction -~·-·-
.. --- - •. - - -~-....
-,

■ Concept of Macroeconomics
econom ic
Macroeconomics is defined as that branch of econom ics which studies
econom y
problems or econom ic issues (like unemp loymen t and poverty) at the level of an
as a whole.
■ Scope of Macroeconomic~
t of
(i) Estima tion of nationa l income and related aggregates is the basic elemen
macroe conom ics.
y.
(ii) It studies the theories related to employm~nt (or ~nemp l;ymen t) in the econom
l price
(iii) Theory of money (how money supply impacts the level of output, and the genera
level) is an importa nt component of macroeconomics.
a key
(iv) Theory of general price level (i.e., inflationary and deflationary gaps) is also
component of macroeconomics.
in the
(v) It studies how government budget impacts the level of econom ic activity
economy.
(vi) BoP and exchange rate determination is also a vital element of macroeconomics.
■ Significance of Macroeconomics
income,
(i) It provides a detailed description of the economy via estimation of national
study of unemployment and government budget.
of
(ii) It offers a roadmap of growth and development by assessing the needs and means
the -economy.
.
(iii) It helps achieve economic stability through appropriate monetary and fiscal policies
(iv) Knowledge of exchange rate and BoP reveals performance of the econom
y in relation to
the rest of the world.

Sample Papers
-
I
I
I

■ Final Goods . . ... .

Final goods are those goods which have crossed the boundary line of production and
ready for use by their final users. Example: Car used by the households, machine used b ahre
. · . Yt e
producers.
■ Intermediate Goods
Intermediate goods are those goods which are within the boundary line of production and
not ready for use by their final users. These goods are purchased for further sale, or are to::
used as raw material by the producers. Example: Wood purchased by a carpenter to m k
chairs o~ wood purchased by a timber merchant for resale. . ae
■ Consumption Goods or Consumer Goods _
Consumption goods (or Consumer goods) are those goods which are directly used for th
satisfaction of human wants. Example: Ice cream and milk used by the households. e
■ Capital Goods '· , .: -
Capital goods are those goods which are used as fixed as?ets by _the producers in the
production of other goods and services. Example: Tractors used by the farmer's.·
■ Concept and Components of Consumption Expenditure ?

Consumption expenditure is the aggregate consumption expenditure in the eco~omy.

• Components: (i) Consumption expenditure by the households, (ii) _-Consumption
expenditure by the government, (iii) Consumption expenditu~e byJthe non-profit private .
,.. •· • l I

institutions. ••
r" ·-: ,,.....

■ Concept and Components of Investment .•

I '• j, '
Investment is a process of addi~g t<? the stock of capital. • ,
• Components:
(i) Fixed Investment is the increase in the stock of fixed assets (like plant and
machinery) of the· producers during an accounting year. . -
(ii) Inventory Investment is the increase in the inventory stock of the producers during
an accounting year. - ••
■ Concepts of Gross Investment and Net Investment
' ,

• Gross Investment refers to the expenditure by the producers (during an accounting year)
on the purchase of new assets, as well as expenditure on the replacement of existing fixed
assets (owing to their depreciation) during·an accounting year.
Gross Investment = Net investment + Depreciation ' •
• Net Investment refers to expenditure by the producers on the purchase of new assets only.
. Net Investment = Gross investment - Depreciation
.
■ Concept of Depreciation
Depreciation (also called consumption of fixed capital) refers to loss in the value of fixed assets
(capital goods) in use, on account of (i) normal wear and tear, (ii) accidental damages, and
(iii) expected (or foreseen) obsolescence.

Economics-XII I
 stock and Flow Variables
1
ent) are classified
All variables in ec~nomics (like income, consumption, capital and investm
either as stock variables or flow variables. ' •
les: Capital and
• Stock variables are those which are measured at a point of time. Examp

I wealth.
• Flow variables are those which are measured ~ver a specified'
period of time.

I;
1
Examples: Income per month, investment per year.
lntersectoral Flows
1
of money among
1
''
lntersectoral flows refer to flow of goods and services as well as the flow
'real flows' while
different sectors of the economy. The flow of goods and services are called
as money flows)
the flow of money is called 'money flows'. These flows (both real as well
the other. These
,,j
point to intersectoral interdependence or the dependence of one sector on
l exc~anges, and
·- intersectoral interdependences ?re sa_tisfied through a system of mutua
and services.
mutual exchanges lead to intersectoral flows of money as well as of goods
economic activity
These flows are the essence for modern economic activity as the entire
from households
revolves around these intersectoral flows. To illustrate, factor services flow
e, factor incomes
to the producers without which production activity is not po.ssible.· Likewis
is not possible.
flow from producers to the households without which consumption activity
■ Circular Flow of Income " I
.._
' • ~

unending flow of
1 "\,
~.

Circular flow of income (also called circular flow of money) refers to the
nt ·sectors of
the activities of production, income generation; and expenditure acrC)SS_ differe
tion) render their
the economy. It shows how household (the owners of the factors of produc
payments in
factor services to the producers (or the producing units) and in return receive
and profit for
terms of factor incomes (rent for land, interest for capital, wages for labour
and wages) is
entrepreneurship). It also shows how income (in the form of rent, interest, profit
entire process
spent on the purchase of goods and services from the producing units. In the
from one sector
of production, income generation and expenditure, money flows continuously
or circular flow
to the other. The process never stops; hence is called ~i~cular flow of money
of inc'ome.
■ Value Addition and Income Generation
wood fort 500,
In economics, 'value addition' is the synonym of production. If Mr. X buys
which is what
converts it into a chair and sells it for f 800, value added = f 800 - f 500 = f 300
production means.
Who adds value? Value-addition is done by the factors of production,
viz., land, labour,
the factors
capital and entrepreneurship. Accordingly, all value added is distributed among
that income
of production as factor incomes, viz., rent, wages, interest and profit. It implies
generated must be identical with value added during a period of time .

Sample Papers
 Chapter-3: National Income and Re1ilted AQQ~!;!_~~~:-.=._-=-:J
■ Normal Residents of a Country
Normal residents of a country are the people who (i) normally reside in the country concer
for a period of one year (or more), and (ii) whose centre of economic interest lies in that coun~~
■ Domestic Territory of a Country
Domestic territory of a country is the economic territory of the country in' which econ~rn·
activities of the country generate its domestic income. ic

■ Domestic Income and National Income

• What is common in them?
Both domestic income and national income include factor incomes only (rent, interest
profit and wages). . '
• What is the difference?
While domestic income is the sum total of factor incomes generated within the domestic
territory of a country, national income is the sum total of factor incomes generated by
normal residents of a country, within th~ domestic territory or in the rest of the world.
■ Net Factor Income from Abroad
Net factor income from abroad is the difference between the factor income earned by ;ur
residents from abroad and factor income earned by non-residents in our country.
... & • .,

• Domestic Income does not include net factor income from abroad.
• National Income includes net factor income from abroad
■ Gross and Net Concepts
Generally, gross variables in national income accounting are inclusive of depreciation, like gross
investment which is the sum total of net investment and depreciation. Net variables are exclusive
of depreciation. ·-
GDP - Depreciation = NDP
■ Market Price and Factor Cost
Market price includes the impact of indirect taxes (taxes on goods and services) and subsidies.
While indirect taxes raise the market price, subsidies tend to lower it. Factor cost refers to the
cost of factors of production, independent of net indirect taxes (Indirect taxes - Subsidies).
Market Price - Net indirect taxes = Factor Cost
■ Nominal and Real GDP ',
• Nominal GDP refers to GDP calculated at the current prices (prices prevailing during the
year of estimation).
• Real GDP refers to GDP calculated at the prices prevailing during the base year (which
often is the year of comparison).
• Conversion of Nominal GDP into Real GDP: .>

Nominal GDP
. I d
Pnee n ex
x 100 =Real GDP

·11111i.=..
, ' ~ - •• 22 Economics-XII
. ' ,,·..
\

::t.:..:·. ..,..
;,·- ,.
 ,. .
• GDP and Welfare
implying higher level. of welfare.
often, GDP is taken as a~ in?e~ ~ social welfare; higher GDP
0
index of welfare. There are as
However, th ere are certain hm,tat,ons/demerits of GDP as an
under:
osition of GDP, (iii) Non-monetary
• Limitations/~emerits: (!) _Distribution of income, (ii) Comp
exchanges, (1v) Externalities.

. ~7
-· _ .. ◄.
.....
- .. "'

--i -.. •

-,,,'"~,.,_,.J
f
.._ - ~ • - • - : JU,.,,._~..:~~ -.......: ,

1
Methods o( Calculating National Income
of calculating national income:
Circular flow of income model suggests three different methods
e Method, and (iii) Expenditure
(i) Value Addition Method, also called Product Method, (ii) Incom
Method. •
Method (or Product Method)
I
j
1 Value Added
According to this method, domestic income is calculated ~s
domestic product. Domestic
as the sum total of value added
! product (or Gross Value Added at market price) is estimated
the country, during the year of
by all the producing units within the domestic territory of
i
t
,,3
accounting (= market value of final goods and services produ
ced in an economy during the
~

'
I
period of an accounting year).
iI added at market price by
! Gross value added at market price is conyerted into net value
at market price is converted
deducting depreciation from 'gross value added'. Ne~ value added
j

I
i
into net value added at factor cost by deducting net indirect
from abroad is added to net value added at factor cost to find
taxes. Finally, net factor income
national income.
t
• Problem of Double Counting and ways to Avoid it:
cers is added up without
l The problem of double counting occurs if output of all the produ
used as an input by the
f
l considering the fact that output of one producer may have been
r than output of different
l other. It can be best avoided by adding up value added, rathe
firms.
(referring to
Value Added = Value of output - Intermediate consumption
l expenditure on intermediate goods and services)
■ Income Method
sum total of factor incomes
According to this method, domestic income is calculated as the
within the domestic territory
(compensation of employees+ rent+ interest+ profit) generated
r income from abroad is added
of a country during the period of an accounting year. Net facto
to domestic income to find national income.
■ • Expenditure Method
the sum total of expenditure
According to this method, domestic product is estimated as
the purchase of final goods
(consumption expenditure and investment expenditure) on
country, during the year of
and services produced within the domestic territory of the
.
estirhation.

Sample Papers
 Expenditure on final Goods = Market value of the fmal goods and services p d
·m the economy durmg
• the penod
• of an accou rot· Uced
n •ng Year
= GDPMP = GVAMP
Gross value added at market price is converted into net value added at market .
deducting depreciation. Net ~al~e added at ~arket price is c~nverted into net value :~~c: by
factor cost by deducting net indirect taxes. Finally, net factor income from abroad is dd d at
net value added at factor cost to find national income. a ed to

FIGURE 1 National Income and Related Aggregates

. - net factor GDP
,.__·_i_nco_m_e_fro_m_a_b_ro_a_d.....:,(fa:.:ctor cost)

yiltt \£,
\ :, \
I
11111.hit~ \~CJ,
-H"~ ~ 3-g..

j
~ -0 0)
\ ,;:.
• O
' :,
--
d,~1~ ~
{W at -.~ GNP
~~rket Pnce 1) (market price}
r~- C?v'"" ---:~--- --· c\! ( '
1~ / Gross~ j + net factor income
~ f\e\ ,~\t~t'(\
I

L~~~~~fl from abroad_ g r.Pt'(\e 6

n,.:.
NNP(tactor cost) \n auto~ ...••·> NOP
~ a. e,C:> [National Income] .....•········ .../(factor cost)
a. E ,~~ p., J.&....,_ _ _ _.;....a... ••
«l ::::, r\. . >..~
• 0 •,"'
0 1/) ,,~ ,••' ,,t::J
+ C: •§_V
,~~ .:J) ,••
~V ,••
, I
• ~-i-V
0 •••• W
~ c-::, ,• ./ ec}. &ee:,
>·~
(.)

/ .>··· . , . J ~ff- .J>~

,i~
•• )( ~ <:,
, ~
,,.... •, /

NNP . ·• • - net factor ; I NDP ,

(market pnce) income from abroad (market price)

..: -,

Chapter-5: Money
■ Barter System of Exchange
Barter system of exchang~ is a system in which goods are exchanged for goods. Money as a •
medium of exchange does not exist. • • • • • •
• Principal Drawbacks of the Barter System:
(i) It requires double coincidence of wants: Between two individuals, each one wants to
buy that commodity which the other wants to sell. So that, each individual sells one
commodity and buys the other at the same time. • • • ••
(ii) It lacks common unit of exchange.
■ Concept of Money
Anything which is commonly accepted as a medium of exchange (like notes and coins) is
called money.
·111E .
'. . - 24
~
Economics-XII 1

i::~::.-
:111·-···-·'(1.:: ''""""""'""
........;.,ii,i'
 • Types/Forms of Money
rnment (notes and coins in
(i) Fiat M~ney: It is th e money issued by order of the gove
circulation).
trust between the payer and the
(ii) Fiduciary Money: It is the money backed with mutual .
payee (cheques and drafts).
e commodity value is equal to
j (iii) Full Bodied Money: It is the money in terms of coins whos •• •
the money value as and when these are issued.
t is more than commodity value.
~ (iv) Credit Money: It is the money of which money value
I
(
i • Functions of Money
I
,' (i) It serves as a medium of exchange.
ssed in terms of money).
1
I (ii) It is a standard measure of value (value of goods is expre
J fer of value (from one place to
(iii) It serves as a means for the store of value as well as trans
the other). . .
made in some future date).
(iv) It is a standard for deferred payme~ts (payment to be
1 supply of Money
with the people as well as demand
It is a stock concept. It is the total currency and notes
be noted that while estimating
deposits of the commercial banks· at a point of time. It may
ts which act as ·money.
total money .supply we include all such financial instrumen .

and Deposits
Supply of Money = Currency held by the People + Net Dem
• held by Commercial Banks

Chapter-6: B~nki~ - ,__ -.. . . . ,_ -~-- .--.,~ ,~ -_ :-- --~ --~ · _·. _ .-·~-~. :i
....,_ - ----- . . . .- .. - ~ · · - - - ·- - - 1 ! . -
....&
.
~ ~ , , , -......... - :.!....."t. C
.
.1._............~ . ,__,...:.....&. --.-A.L~--....
...~"-..J, ...,-_;.A ._...__.,.... _ ~.;;..;.....:;..A ,....,I.-.J .......~ ~
... ......,___--J

■ Commercial Banks
from the people and make advances.
These are those financial institutions which accept deposits
• Primary Functions of Commercial Banks are:
(i) Accepting deposits, and (ii) Advancing loans.
■ Money/Credit Creation by Commercial Banks
reserves. Money created is many
Commercial banks create money on the basis of their cash
s.
times more than the cash reserves of the commercial bank
s. It depend on CRR (Cash Reserve
This is also called credit creation by the commercial bank
rve Bank of India). Higher the CRR,
Ratio) as fixed by the central bank of the country (like Rese
lower the credit creation and vice versa.
■ Credit Multiplier
er of times cash reservr=s of the
Credit multiplier is the reciprocal of CRR. It shows the numb
nd deposits.
commercial banks (with RBI) multiply to be equal to dema
1
k=-
CRR
ntage of demand deposits of the
(Here, k = Credit multiplier; CRR = Cash reserve ratio: a perce
commercial banks to be kept with RBI as cash reserves.)

Sample Papers
 1
Thus if CRR = 5% Credit multiplier= -5% = 20.
I I

. . 1· 1
Likewise if CRR = 10%, Credit mult1p Ier = - - = 10.
I 10%
[Note: Credit multiplier reflects the maximum amount of credit that the commercial b k
create on the basis of CRR (also called legal reserve ratio).] . an scan legally

■ Central Bank
Central bank is an apex banking institution which controls and manages the enf b .
system in the country. It is a bank of all the banks as well as a bank of the govern;:nt.anking
• Functions of Central Bank:
(i) Bank of issuing notes,(ii) Bankertothegovernment, (iii) Banker's bank and supervis
(iv) Lender of the last resort, (v) Custodian of foreign exchange, (vi) Clearing house firyr?le,
(vii) Control of credit. nction,
■ 'Control of Credit' Function of the Central Bank
The central bank controls the creation of credit by the commercial banks by -exercising •t
. IS
monetary poIicy. · · , . • •
Instruments of monetary policy are broadly classified as: ••
(A) Quantitative Instruments: (i) Repo rate, (ii) ~ank rate, (iii) Reverse repo rate, (iv) Open
market operations, (v) CR~ (Cash Reserve R_atio), (vi) S~R (Stat~t~ry Liquidity Ratio).
(B) Qualitative
. Instruments: (i) Margin
. . requ·i_rement,
, ..
(ii) Rationing of credit, (iii) Moral
suasion.

,:.•-· - ..... --.-.,. -=-~-., -·- ··- ·-- ----~..-..-.............---~ -~ - - - - ---, i,---- - .... ~ " -_...,--,,-J ....,,,'$"""- ·--c> ...,,_.... --..,-_,....--- ... "".~""'1"

Chapter-7: Aggregate Demand, Aggregate Supply·a·nd • •• •• - • 1

t . ,,

:
l
. . . RelatedCo~c~pts ..... -' · • .. :.·.. ·, . ·_,.·;~j__-_:·:~----~: • -~
. ....._ ...... _"-...:....x... . ~ 4.-.........-..... ~ - - - - _____.....__ -.-.... .__ _ _ .J,......_ .......... _ ... _,- .....J_.,._._~ _ _ _.___ • I L ' -...... _ __,,,, ....... ~ •• ..: - _._ ..... - - 1 . . . - ...... c , , . ._ _. _ . . _ _ . -.. -..:.,L .... ,.__,;,.-- ~-.......- ~..~-~-~~

■ Concept of Aggregate Demand I -• -

Aggregate demand is the sum total of expenditure that the people plan to incur (or desire to
incur) on the purchase of goods and services produced in the economy (during the period of
an accounting year) corresponding to different levels of income. • •
1 ' ' /1 -

Total Expenditure (Aggregate Demand) is. measured

. as the sum
.
total of ·consumption
expenditure (C) and investment expenditure (I). Hence,
AD=C+I
It is important to note that, in the context of macroeconomic equilibrium, AD always refers to
'desired AD' or planned AD. It is also called ex-ante AD.
• Components , J

AD = C + I + G+ (X - M)
Here, AD = Aggregate demand; C = Household consumption expenditure; I = Priv~te
investment expenditure; G = Government expenditure (including government consumption
expenditure and government investment expenditure); X - M. = Net exports.

Economics-XII I
 ■ Concept of Aggregate Supply
Aggregate supply refers to flow of goods and services as planned by the producers during a
period of time, generally one year. At the +2 level, AS may be treated as identical with GDP.
It is indicated by a 45° line from the origin when GDP is shown on the X-axis and AS on the
Y-axis.
■ Consumption Function
Consumption function is the functional relationship between consumption (C) and income (Y).
Consumption is positively related to income, i.e., rise in Y causes a rise in C and vice versa.
However, there is always some minimum level of c, irrespective of the level of Y which is called
autonomous consumption. Thus,
C = C+bV
Here, C = Constant C or the minimum level of C.
b = The rate at which C increases when there is a rise in Y. This is called MPC (marginal
propensity to consume).
■ Saving Function
Saving function is the functional relationship between saving (S) and income (Y). Saving
increases as income increases. Implying that saving is positively related to income.
However, since there is always some minimum level of consumption even when income
is zero, it implies that there must be some negative saving (indicated by - C in the saving
function) when Y = 0. [Because, Y = C + S. And, if C = 5 when Y = 0, S must be equal to - 5
(= - C) when Y = 0]. Thus,
S = -C + (1-b)V
Here, -C = Constant S (indicating S when Y = 0).
1 - b = The rate at which S increases when there is a rise in Y. It is called MPS (marginal
propensity to save).
■ Propensity to Consume
Propensity to consume refers to the ratio between consumption (C) and income (Y). It has two
aspects, viz., (i) APC, and (ii) MPC.
• Average Propensity to Consume
Average propensity to consume (APC) refers to the proportion of total income going to
consumption expenditure. It is measured as the ratio between total consumption (C)
and total income (Y). Thus,
C
APC=-
V
• Marginal Propensity to Consume
Marginal propensity to consume (MPC) refers to the proportion of additional income going
to consumption expenditure. It is measured as the ratio between change in consumption
(~C) and change in income (~Y). Thus,

MPC= ac
av
1w·
.=.1 1
r-- Sample Papers
27 \ ,\~~
 ■ Propensity to Save . . • "" : • .,_ _
Propensity to save refers to the ratio between saving (S) and income (Y). It has two aspects .
(i) APS, and (ii) MPS. . • 1
• '" <
• Average Propensity to Save
Average propensity to save (AP_S) refers to the pro~ortio n of total i_ncome that Qoes
saving. It is measured as the ratio between total saving (S) and total incom_e (Y). Thus t
s
APS=y
J •
I

• Marginal Propensity to Save

Marginal pro~ensity to save (MPS) ref~rs to the proportio n ?f add_itional income_that Qoe
to saving. It 1s measured as the ratio between change in saving (dS) and change i
income (dY). Thus,
- j (

- 'MPS= AS ~
AV

• Concept of Short Run

In the context of macroeconomics, short run is defin~d as a period _of time when 'technology
as a factor (affecting the level of output) remains constant: Accordingly, level of output i
determined exclusively by the level of 'employment in the economy (briefly employment o
labour). Higher level of employment causes proportionately higher level of output and vice versa
So long as there is unemployment in the economy (implying the existence of excess capacity)
general price level is assumed to remain constant even when output level is increased.
■ · Equilibrium Output/Equilibrium GDP ,, : : ,
Equilibrium output/Equilibrium GDP refers to a situation when in an economy:

•
AD = AS
'· I
·: • ', ;~J
•
• I , -
[Aggregate Demand = Aggregate Supply] .J

I •

So that, all that the producers wish to produce (or plan to produce) during the year is exactly
equal to what the buyers wish to spend on the purchase of goods and services during the year
. ' • . ,. l I • \ ......

Since, AD = C + I, , and AS = C +_ S
We can write the equation of equilibrium output/equilibrium GDP as under: .
Equilibrium Output/Equilibrium GDP = C + S = C + I
Or, S =I
Thus, equilibrium output/equilibrium GDP is achieved when:
AD=AS I•, ,

Or
S=I

·•1111~ ,
- 28 Economics-X
}"tt'H!'!~!P

~,,::;
 ■ Ex-post and Ex-ante AS and AD (or s and I)
In national income accounting,
(C + S) = (C + I) always
Or, S = I always
But this equality refers to the equality between ex-post AS and AD or between ex-post S and
I which is an accounting identity. Ex-post means 'actual' or 'realised' and actual S is always
equal to actual I.
In the context of equilibrium level of income/output, what matters, is the equality between
ex-ante AS and AD, or between ex-ante Sand I. Ex-ante m_eans 'planned' or 'desired' or 'intend'.
Equilibrium is struck only when planned AS= planned AD (or planned S = planned I). It refers to
a situation where AS as planned by the producers for the year ahead is equal to AD as planned
by the consumers and investors for the year ahead.
■ Concept of Investment and its Type
Investment refers to expenditure that increases the stock of capital. It is also called capital
formation.
• Types of Investment
(i) Induced Investment is related to the cost of investment (rate of interest) as well as
the level of income in the economy.
(ii) Autonomous Investment is not related to the cost of investment or the level of
income in the economy.
■ Concept of Multiplier
Investment multiplier (briefly called multiplier) is the ratio between change in income and
change in investment.
K= av
ill
Where, K = Multiplier;~Y = Change in income; ~I = Change in investment.
Keep the Basic Fundas In Mind

~)-Higher MPS implies lower multiplier (K), as K;:: M~S .

1 , 1 ....
,,
•t -
..
,
f, .~

(ii) Higher MPC implies higher multiplier (K), as K = _ ~~C . /' ·~

1
(iii) Generally, 1 2: MPC ~ O; therefore, Kc! 1.

< •

Chapter-9: Problem af Deficient Demand and Excess Demand

■ Meaning of Full Employment Equilibrium and Underemployment Equilibrium
• Full Employment Equilibrium refers to that situation in the economy when AS = AD
(or S = I) along with fuller utilisation of resources.

• Sample Papers
 • Underemployment Equilibrium refers to that situation in the economy when AS :: A
S=I) even when resources are under-utilised. •• ; • Dfor
-■ Meaning of Voluntary Unemployment and Involuntary Unemployment
• Voluntary Unemployment refers to a situation when people are not willing to work at
or are not willing to work at the existing wage rate. .. ai1,
• Involuntary Unemployment refers to a situati~n when people ar~, w_il_ling to ~ork at th
existing wage rate, but are not getting work owing to lack of demand in the market. e
■ Meaning of Full Employment and Natural Rate of Unemployment,
• Full Employment refers to a situation when all t.hose wh? ar~ able t~ vy~rk an~ are Willing
to work (at the existing wage rate) are getting work, that 1s, SL= DL.
• Natural Rate of Unemployment r~fers to t~e ~minimu~. rate ~of unempl_~y~ent Which
always exists in the economy even ·when labour market 1s 1~. a sta.~~ of equ1ll?num:
■ Meaning of Excess Demand/Inflationary Gap and Defici,e'nt Qema~~/~eflatio~ary Gap .
• ' • • ' 1 • . " .,

• • Exce~s Demand/Inflationary Gap occurs when A..D. >;~S ,C.?~resp_o~di_~? to f~II e~ployment
level in the economy. • · • • ,. •
• Deficient Demand/Deflationary Gap occurs when AD < AS. corr~~ponding to full
employment level in the economy. :~ :./ • •• • • • ·, · •
Situations of excess demand and deficient demand point towards instability in,;economy.
) i

■ ~orrection of Excess Demand and Deficient Demand: Fis~al and Monetary Policies
• Fiscal Policy refers to the revenue and ··expenditure ·pc>licy of the· government to control
the situations of inflation or deflation in the economy. 'Ii is pursued by the government of
the country. •
• Monetary Policy refers to the policy of controlling inflationary and deflationary situations
in the economy through increase or decrease in the flow of credit in the 'economy. It is
pursued by the central bank of the c_ountry.
■ Components of Fiscal Policy
(i) Government expenditure, (ii) Taxes, (iii) Public borrowing/Public debt, (iv) Borrowing from
RBI (the Ceritral Bank). . .
■ Components of Monetary Policy
(i) Bank rate/Repo rate, (ii) Reverse repo rate, (iii) Open market operations, (iv) CRR (Cash R
Ratio), (v) SLR (Statutory Liquidity Ratio), (vi) Margin requirement, (vii) Credit r t_es~rve
...) M • • a 1on1ng,
(v111 ora 1suasion.

s~~~~~~-v~r~_!!l~~~iB~cJ~~[~'~~-!~~~-~~~~o~~----~ -• ~.
-~-7
~~.........~....-.-..J

■ Meaning of Government Budget·

Government budget is a statement of the estimates of the government re .
, . f h fi .I I • . ce1pts and
government expenditure during the_ pen~d o t e inanc1a year. t unvells/r~veals the fiscaf
· policy (budgetary policy) of the government for th~ year to come. •

Econon,·
ICS-X/1 •
 1 Objectives of the Government Budget
(i) To accelerate GDP in terms of the flow of goods and services in the economy.
(ii) T~ ~r~n:1ote the ~evelopment of backward regions of the country with a view to
m1rnm1s1ng the regional disparities.
(iii) Reallocation of resources with a view to maximising social welfare.
(iv) Abundant provision of public goods (particularly in terms of law & order and defence), so
that the people of the country live in a peaceful environment.
(v) Redistribution of income and wealth with a view to reducing the gulf between the rich
and the poor.
(vi) Investment in public enterprises with a view to generating employment opportunities.
1 Receipts and Expenditure of the Government-Revenue and Capital
• Revenue Receipts: These are those receipts (i) which do not cause any reduction in assets
of the government, and (ii) which do not create any liability for the government (Example:
Tax receipts of the government).
• Capital Receipts: These are those receipts: (i) which create a corresponding liability for the
government (Example: Loans raised by the government), and (ii) which cause reduction in
assets of the government (Example: Disinvestment).
• Revenue Expenditure: It is that expenditure of the government: (i) which does not cause
increase in government assets, and (ii) which does not cause any reduction in government
liability (Example: Expenditure on old-age pensions).
• Capital Expenditure: It is that expenditure of the government: (i) which causes increase in
government assets (Example: Expenditure on construction of roads), and (ii) which causes
reduction in government liability (Example: Repayment of loan by the government).
■ Budgetary Deficit and its Estimation-Revenue Deficit, Fiscal Deficit and Primary Deficit
• Revenue Deficit:
It is the excess of revenue expenditure over revenue receipts.
Revenue Deficit = Revenue expenditure - Revenue receipts
• Fiscal Deficit:
Fiscal deficit is the excess of total expenditure (revenue + capital) over total receipts
1

(revenue+ capital other than borrowings).

Fiscal Deficit= Total expenditure (Revenue expenditure + Capital expenditure) - Total
receipts other than borrowings (Revenue receipts + Capital receipts other
than borrowings)
• Primary Deficit:
It is the difference between fiscal deficit and interest payments.
Primary Deficit = Fiscal deficit - Interest payment

Sample Papers
 f Structure of Government Budget

Budget Receipts :{ Budget Expenditure

:-: •._; . . . -~ (•.: '. ".' ~-

Capital Fe~;..,_.Ex..._p....
en_d..,itu""'re~· · •• ' Capit~I Ex...p~....
en--- evenue
r;:en:-- enditure
Receipts ample: Subsidies : ample: Exp
t~eipts ._...,..,.._ _- ! ' . and defence n land & buildi
.. purchases]

f(Example:
. s ·, • ;, WilS-.

Tax Receipts . Recovery

~ Income • • [Revenue
.I of Loans . .
tax, GSTI .. : .. • ~ .. •: ~ .... .... expendtture
• • •. ; I . -~ '! l • +.
4 ~. •
pttal expendit
Non-tax Receipts
[Example: Fee,
·f ,.•'f>lt 1S;:fe: irb

Borrowing
and Other
°re t t . i·
... ,:i,:

.
••••
..

~
,.
....

-,.
•
~ ,.

•.
•• f
. .
. .

• _·,. :_.
.• ~
.•
. Revenue receipts
Fines] Liabilities . ' ,.. ... . . Capital receipts
. . ., .. . ...
.
-~ . ~
. ., .
other than
, borrowings)
~
:~5: ~'h•·.- •. t ·ece • ..,....• • -•
.'·\ A.,. ..+.
. .. 41w:-'.
Other Receipts .• -· ;f Primary Deficit •
[Example: Sale • . •• • [Fiscal defictt
. . of shares of ·., •.
• •, a government ·.i •
•• undertaking] . ~- •'
.·;;; ' ...;.:·?\1:-::,
Note: Government expenditure is also classified as plan and non-plan expenditure. •
Plan expenditure relates to specified plans and programmes of development.
Example: Expenditure on construction of a fly-over. • .. • •' •• • ,•
Non-plan expenditure does not relate to plans and programmes of development.-~ ...
Example: Expenditure on salaries and p_ensions.

J " • \(: 1, •

chapter:i1 =i=orefgn--Ex,iia.ng·e-Rate~,;'::;~:.~·;:~;;::.~/~:~\;~./~=·r·;:;·_~ ~ - ~-/~,~~-~,:.: ··-.J

•It • ,"--.
1

~ .... ---..·---. -•---.::~·-..-.-.... -:· - _.... _-...... ___ ~ - ~ - - - ~ .........l...:...._..~.••. - ...... ~w...........~. .-• .....:...~~ .,,, -i-.........-..;,l..,,+:,;.,..,.,......._~.~~~-~~-.:J
' ( , & ~.......

• Meaning of Exchange Rate

Exchange rate refers to the rate at which one currency exchanges for the other in the
, • , •. i , L.,( ·:
1
\/ j; •·I_,-~· I \ . . L,-':.:.\ ,;· f''

, .. , ~· ~ •• ~ , ,' ,;1.: ( tr .~ : · I

international exchange market, also called international money market.

..;, • '1· ·1 ~ .,... .' .

Example: One US dollar exchanges for sixty Indian rupees. Accordingly, the exchange rate= 1: 60.
; I • .) J , \ i' , • ,-,

• Types of Exchange Rate: Fixed and Flexible (Vari~~I.~)· . :t . ' .. .! ',: ': •. . .. . 1_. ••
• Fixed Exchange Rate . . j~ ,"~ .1 -~•j •
1.r

• • f ·~ i • • •
91
, .~. •~ ,,•.: I ~• •

Fixed exchange rate is related to gold standard. If 1,000 Indian rupees buy a gram of gold
and twenty US dollars buy a· gram of gold, the ·ex·change~rate ·between dollar and rupees
would be= 20: 1,000 = 1 : 50. • •
Merits and Demerits of Fixed Exchange Rate i, . ' I 1
I '
Merits _ . .
(i) It ensures stability in the internation.al ~oney ';,,arket and promotes mobility of
capital.
(ii) It works as a built-in check on inflation in the economy.
(iii) It offers an environment for the growth of international trade.

Economics-XII
 (iv) It helps formulation of stable macroeconomic poli~ies.
(v) It facilitates auto-adjustment of BoP.

l Demerits
(i) It needs to be supported with huge reserves of gold. -, ,.
(ii) It restricts the movement of capital in the international money market.
(iii) It discourages venture capital.
(iy) It may not be t~e equilibrium rate of exchange.
l (v) It makes it hard to combat recession/depression.
(vi) It restricts economic growth.
1 Flexible (Variable) Exchange Rate

l
j
·'
Flexible (Variable) exchange rate depends on . the supply and. demand for different
currencies in the international exchange market'. It varies along with variations in supply
and demand.
Merits and Demerits of Flexible Exchange Rate , ,,
' I • •

Merits
(i) It does not require gold reserves. .
f (ii) It promotes international mobiiity of liquidity_- ' • ·,
i

I (iii) Venture capital is encouraged.

(iv) Optimum resource allocation is achieved. •• •
J

lt Demerits
(i) It causes instability in international money market~
It
(ii) A stable monetary policy becomes difficult.
' (iii) Bilateral trade agreements become difficult.
(iv) Domestic economy more prone to external shocks.
■ Determination of Exchange Rate
i,
!
• Determination of Fixed Exchange Rate: Fixed exchange rate is determined by the
j government of the country.
'

II • Determination of Flexible Exchange Rate: Flexible exchange rate is determined by the

forces of demand and supply in the fo'reign exch.ange market.
I •

t,
'

■ Managed Floating
{ Managed Floating, also called Dirty Floating, is a system of floating exchange rate (where
j exchange rate is determined by the forces of demand and supply) but occasionally, the float is
1
l managed by the central bank of the country by way of sale and purchase of foreign exchange
'
j
l
in the international money market. Managed floating is an attempt to keep the exchange rate
i within the desired limits.
'i
} ■ Spot and Forward Markets of Foreign Exchange
f • • Spot Market relates to all such transactions in foreign exchange which are completed/
fulfilled at the spot, and are not carried forward for any future date. ,
• Forward Market relates to all such transactions in foreign exchange which are committed
at a point of time but are to be completed/fulfilled at some future date.

Sample Papers
 ■
Meaning of Balance of Payments Account
which show receipts and payments of fore1gn .
Ba lance of payments is a set of accounts . . .h h
exchange of a country on account of its economic transactions wit t e rest of the world.

I! ■
Components of Balance of Payments Account
Broadly, there are two components of balance of payments account:
-•, •

(i) Current Account Balance of Payments.

(ii) Capital Account Balance of Payments.
• Current Account Balance of Payments includes:
(i) Merchandise (referring to export and import ~f go~ds).
(ii) Invisibles, including:
(a) non-factor services (referring to export an~ import of services),
(b) income (arising out of factor services), and
(c) current transfers.
• Capital Account Balance of Payments includes:
, ~ I
..,
(i) Borrowing, including: , '

(a) external commercial borrowing, and

(b) external assistance. . '-'
I 1 •
(ii) Investments, including: ' , I

(a) FOi (Foreign Direct Investment), and

.,
(b) portfolio investment.
- l
(iii) NRI deposits,
• l.:;., I

(iv) Banking capital,

(v) Short-term debt, and , I

(vi) Other capital. ' ' j~ I

r

■ Visible and Invisible Items of

.
International. Trade
,.
' .I~ ,I '
. . -

• Visible Items refer to the export/impo rt of goods. . ✓ . ': i

!
$ •

• Invisible Items refer to the export/impo rt of services (factor and non-factor services) as
well as current transfers. 'l ' I \ •·' I :

■ BoP Surplus and Deficit ...

• Balance of Payments Surplus refers to the excess of receipts over and above the
payments of a country of foreign exchange on account of autonomou s transactions with
rest of the world. ('ii.. ,i•;.,.....
. •• · ., . ; -J4~, w

• Balance of Payments Deficit refers to the excess of payments over and above the receipts
of a country of foreign exchange on account of autonomou s transaction s with rest of the
world. • Ji
,-
.1 ..
, •.
, : _ . , 1 . . •·\J..
• ., • ' •
I I ,- I f •

1r.=.
· 34
I

r, ~ ~ Economics-XII •
\\
\".

.. . ..... ·-
HthtH,u,,u
~ '
 Autonom~us and Accommodating Items of BoP
• 1 Autonomo~s Items refer to
such BoP transactions which are determined by considerations
of profit. It is due to these transactions that BoP deficit/surplus arises. .
1 Accommodating Items refer to such BoP transactions
which are not determined by
considerations of profit. It is due to these transactions that BoP deficit/surplus is corrected.

PART B: INDIAN ECONOMIC DEVELOPMENT

Il .. . I .

I Q,apter-1:f~-~~-E~O~offlYOn the_EVe 0(1n~epe~~~~=-~=1

l
f
I overall Features of Indian Economy o~ the Eve of 1~dependence
(i) A stagnant economy, showing insignificant rise in GDP.
(ii) A backward economy, showing dominance of primary sector in relation to secondary
l and tertiary sectors.
'
(iii) Agriculture, the principal source of livelihood. -
•

I ,

(iv) Bleak industrialisation and the lack ~f large-scale industry. J.,

(v) Heavy dependence on imports, indicating l~w level of domestic output. ,
(vi) Limited urbanisation, indicating dependence on agriculture as the principal source of
livelihood. • - • • ·-~, '-:' · • •• • -i - • ,

I• ....,. ~

(vii) Semi-feudal economy, indicating concentration of economic power and widespread

i poverty. : • •·-.• C - I I • • • ·- I I I , .. •• I •

! ■ Principal Features of Agricultural Sector on the E~e' of Independence

i (i) Lo~ production (total output) a~d productivi~y (output per he~~are of land).
I (ii) Exploitative Land Settlement System which led to exploitation of the farmers.
!
:
(iii) Forced commercialisation of agriculture based on advance payments to the farmers (to
grow specific crops). . - - ~-- - : - . -
(iv) Lack of investment in agricultural infrastructure. ... •
(v) Huge 'economic divide' between owners. of the soil and tillers of the soil.
(vi) Small and fragmented holdings.
(vii) Subsistence outlook of the farmers. ! : •1 I

■ Principal Features of Industrial Sector on the Eve of Independence

(i) Decay of Indian industry due to discriminatory tariff policy of the State (British
Government). • •
(ii) Disappearance of princely courts which used to inspire the production of Indian 1

handicrafts. •
(iii) Competition from machine-made British products which led to the fall in demand for the
Indian handicrafts. • •
(iv) New patterns of demand which further contributed to the fall in derpand for the Indian
handicrafts. •

Sample Papers