CHAPTER 1: INTRODUCTION

MEANING OF MACROECONOMICS
• The word "Macro" comes from the Greek word "Makros," which means large. In
macroeconomics, "large" refers to the entire economy of a country.
• Macroeconomics is a branch of economics that studies economic problems at a
national or overall level. It focuses on issues that affect all the people in a country.
It focuses on:
• Jobs – Employment and unemployment.
• Growth – How much the country produces.
• Prices – Why things become expensive (inflation).
• Recession – When businesses slow down and people lose jobs.
• Government Role – How the government helps the economy.

DIFFERENCES BETWEEN MICROECONOMICS AND MACROECONOMICS

1. What They Study
• Microeconomics studies problems of limited resources and choices at an
individual level (person, family, business, or industry).
• Macroeconomics studies the same problems but at the national or whole-
economy level.
2. Economic Terms Used
• Microeconomics uses terms like individual demand and supply (how
much people buy and how much businesses sell).
• Macroeconomics uses terms like aggregate demand and aggregate
supply (total demand and total supply in the entire economy).
3. Who Makes Economic Decisions
• Microeconomics focuses on individuals and businesses, like buyers and
sellers, who make choices to maximize their own profit or happiness.
• Macroeconomics focuses on government and large institutions like RBI
(Reserve Bank of India), SEBI (Securities and Exchange Board of
India), and TRAI (Telecom Regulatory Authority of India), which aim to
improve the overall economy.
4. Degree of Aggregation

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 • Microeconomics studies small groups like one business or one industry
(low DOA).
• Macroeconomics studies large groups like the entire economy or different
sectors like agriculture, industry, and services (high DOA).
5. Different Assumptions
• Micro and macroeconomics make different assumptions.
• Microeconomics assumes that total production and jobs remain fixed.
• Macroeconomics assumes that the way income is shared among people
remains fixed.
6. Main Focus
• Microeconomics focuses on how resources (like money, land, and
workers) are used efficiently.
• Macroeconomics focuses on how much is produced and how many
people are employed in the whole economy.
7. Method of Study
• Microeconomics studies specific markets using partial equilibrium
analysis (studying one thing at a time).
• Macroeconomics studies the economy as a whole using general
equilibrium analysis (studying how everything is connected).
8. Micro-Macro Paradox (Opposite Effects at Different Levels)
• What is good for one person or business may not be good for the whole
economy.
• If one person saves money, they will have more for the future.
• But if everyone in the country saves money and spends less, businesses
will sell less, factories will produce less, jobs will be lost, and the economy
may suffer.

SCOPE OF MACROECONOMICS (WHAT IT STUDIES)

Macroeconomics is the study of how the whole economy works. It includes these
important topics:
1. National Income & Related Measures
• Macroeconomics starts with understanding the total income of a country.

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 • It looks at things like GDP (Gross Domestic Product) and NDP (Net
Domestic Product), which measure how much a country earns.
2. Employment & Unemployment
• It studies jobs and unemployment in the economy.
• The Keynesian Theory of Employment explains why people lose jobs and
how to solve it.
3. Money & Banking
• Macroeconomics explains how banks create money and give loans.
• It also looks at how the Central Bank (RBI in India) controls the money in
the country.
4. Prices, Inflation & Deflation
• It studies why prices of things go up (inflation) or down (deflation).
• This helps to understand how these price changes affect the economy.
5. Government Role & Budget
• Macroeconomics looks at how the government uses its budget to influence
the economy.
6. Exchange Rate & Balance of Payments
• It studies how a country’s money value (exchange rate) is decided and
managed in the global market.
• It also looks at the balance of payments, which is how much money flows in
and out of the country.

SIGNIFICANCE OF MACROECONOMICS (WHY IT IS IMPORTANT)

Macroeconomics is important for several reasons:
1. Describes the Economy
• It gives a detailed picture of the economy.
• By looking at national income (how much money the country makes), we
understand how much work is happening in different sectors.
• It shows the level of unemployment and helps find ways to fix it.
• The government budget shows how the government controls the
economy.
2. Helps with Growth and Development

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 • Macroeconomics provides a plan for economic growth and improvement.
• It helps the government make policies to grow the economy by
understanding its needs and resources.
3. Keeps the Economy Stable
• It helps to keep the economy stable through good money and government
policies.
• The Central Bank helps control money, and the government controls
spending and taxes.
4. Shows the Country’s Economic Standing
• Macroeconomics helps show how the country is doing compared to
other countries in the world.
• The Balance of Payments (BoP) tells us how much a country is
exporting and importing.
5. Solves Problems like Poverty and Pollution
• It helps understand and address problems like poverty and pollution.
• By using macroeconomic models, we can find solutions to these problems.
6. Helps Make Good Policies
• Information about the economy (like how much people buy, how much they
invest, etc.) is used to make policies that help the economy grow.
• Macroeconomics helps us understand challenges the economy faces and
find ways to fix them.

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 CHAPTER 2: SOME BASIC CONCEPTS OF MACROECONOMICS

WHAT ARE GOODS?

Goods are things that satisfy our needs and wants. They can be seen, touched, and
used (like food, clothes, and cars).
Classification Of Goods
Goods have different features and can be grouped in two main ways:
1. Final Goods and Intermediate Goods
2. Consumption Goods and Capital Goods

• Final consumer goods are products that are ready for people to use. These goods
are used by consumers. Example: Bread and butter, which are eaten by people.
• Final producer goods are products that are ready for producers (like farmers or
businesses) to use. Example: Tractors and harvesters, which farmers use to grow
crops.

➢ All Machines Are Not Capital Goods

Not all machines are considered capital goods. The difference depends on who is using
the machine.
For example:
• A sewing machine in a tailoring shop is a capital good because it helps the
tailor produce clothes.
• The same sewing machine in a household is not a capital good. It is just a
durable consumer good for personal use.
So, when we talk about capital goods, we need to know who is using the machine:
• If it’s used by a producer (like a business), it’s a capital good.
• If it’s used by a household (for personal use), it’s just a consumer good.

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 1. Intermediate Goods 2. Final Goods

Intermediate goods are not final products Final goods are completely ready to be used by
because they are still being used in production. people or businesses.
They are not ready for consumers yet. 1. They are finished products and not part
1. They stay inside the production process of any further production.
and are not directly used by people. 2. They are not used as raw materials to
2. They are used as raw materials to make make other goods.
other products within the same year. 3. Businesses do not resell them to earn
3. Businesses can resell them to make a profit within the same year.
profit within the same year. 4. No more value needs to be added to
4. More value needs to be added to these these goods.
goods before they become final products. 5. Money spent on these goods is called
5. Money spent on these goods is called final expenditure (C + I).
intermediate cost or intermediate 6. These goods are counted in the
consumption. country’s national income.
6. These goods are not counted in the Example:
country’s national income because they • Bread bought by a family to eat.
are not final products. • Furniture purchased for home use.
Example:
• Wheat used by a bakery to make bread.
• Wood used to make furniture.

➢ Same Good May Be Final or Intermediate

A good can be either a final good or an intermediate good depending on how it is
used.
For example:
• Sugar used to make biscuits is an intermediate good because it’s being used to
make something else.
• Sugar used by people in milk or tea is a final good because it is ready to be
consumed.
Consumer Goods
Consumer goods are things people buy for personal use. They can be divided into four
types:
1. Durable Goods – These last for many years and are expensive. They can be
used again and again.
Examples: TV, car, scooter, washing machine.

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 2. Semi-Durable Goods – These last for about a year or slightly more. They are
not very expensive.
Examples: Clothes, furniture, crockery, electric goods.
3. Non-Durable Goods (Single-Use Goods) – These are used only once and cannot
be reused. They are usually low-cost.
Examples: Bread, milk, petrol, ink, LPG gas.
4. Services – These are non-physical goods that help people in different ways.
Examples: Services of a doctor, lawyer, or house helper.
➢ All Capital Goods Are Producer Goods, But Not All Producer Goods Are Capital
Goods
Producer goods are things used to make other goods. They are of two types:
1. Raw materials – These are used up in making other goods and cannot be reused.
Example: Wood used to make furniture. Once the wood is used, it cannot be used
again.
2. Fixed assets (Capital goods) – These are durable and can be used again and
again in production.
Example: Machines in a factory, which are used for a long time to produce goods.
So, all capital goods are producer goods because they help in production.
But not all producer goods are capital goods, because raw materials are also
producer goods, but they are used only once.

Difference between Consumption Goods & Capital Goods

3. Consumption Goods 4. Capital Goods
1. Used for Direct Satisfaction – These goods 1. Not for Direct Use – These goods do not
fulfil human needs directly. directly satisfy human needs.
2. Bought for Personal Use – People use them 2. Used by Producers – People don’t use
at home after buying. them at home; they are used to make
3. Spending on These Goods – The money other goods.
spent on these goods is called consumption 3. Investment Spending – Money spent on
expenditure. these goods is called investment
4. Improve Quality of Life – More production expenditure.
of these goods makes life better for people. 4. Helps Economic Growth – More capital
Examples: Food, clothes, furniture, TV, and goods increase production and help the
mobile phones. economy grow.
Examples: Machines, tools, factories, and
equipment.

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CONSUMPTION EXPENDITURE
In macroeconomics, consumption expenditure means the total money spent on
consumer goods in an economy.
Who are the Consumers?
There are three main types of consumers:
1. Households – Buy goods for their personal use (food, clothes, etc.).
2. Government – Buys goods for public services (for soldiers, school meals, etc.).
3. Non-Profit Organizations – Buy goods for charity (NGOs, temples, mosques,
etc.).
When we add up the spending of all these groups, we get the total consumption
expenditure in the economy.
CONCEPT AND COMPONENTS OF INVESTMENT
❖ What is Investment?
Investment means an increase in the total capital used for producing goods and
services.
The formula is:
I = ΔK
• I = Investment
• k = Capital stock (the total amount of capital)
• ΔK = The change in capital during the year.
❖ Two Types of Investment
1. Fixed Investment
• Fixed investment means the increase in fixed assets like machines, factories, or
equipment used by producers in a year.
Example:
• In the beginning of 2019, a producer has 8 machines.
• By the end of 2019, the producer has 10 machines.
• So, the increase in fixed assets is 2 machines. This is the fixed investment for
2019.

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Fixed investment is also called fixed capital formation, which means adding more
long-lasting capital goods (like machines) that are used repeatedly in production over
many years.
❖ Significance of Fixed Investment
Here’s why fixed investment is important:
1. Increases Production Capacity: Fixed investment helps producers increase
their ability to make more goods.
2. Leads to More Output: When producers can make more, the overall output in
the economy goes up.
3. Promotes Economic Growth: More output means the economy grows faster,
which is known as GDP growth.
2. Inventory Investment
Producers keep a stock of goods at any given time. These goods can be:
1. Finished Goods – Goods that are made but not yet sold.
2. Semi-Finished Goods – Goods that are still being made.
3. Raw Materials – Basic materials used to make products.
The change in these stocks during the year is called inventory investment.
❖ Significance of Inventory Investment
Inventory investment mainly involves:
1. Raw Materials – These are important because:
• They ensure there is always enough material to keep production going.
• Producers can avoid buying raw materials every day, which protects them from
price changes or shortages in the market.
2. Finished Goods – These are important because:
• They allow producers to meet future demand for their products.
Gross Investment, Net Investment, And Depreciation
• Gross Investment means the total amount of capital goods produced during the
year. This includes:
1. Capital goods used to replace old or worn-out capital (this is called
depreciation).

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 2. Capital goods used to add to the existing capital (this is called net investment).
So:
• Gross Investment = Net Investment + Depreciation
• Net Investment = Gross Investment - Depreciation
❖ Significance of Net Investment:
Net investment is important for the economy because:
1. It increases the total amount of capital in the economy, which means more tools
and machines are available to workers. This helps workers become more efficient.
2. It creates jobs. Unemployment is often caused by not having enough capital (tools,
machines, etc.), so increasing net investment helps reduce unemployment.
3. It leads to more production and helps the economy grow faster. More capital
allows businesses to produce more, which helps increase the country's GDP.
Here’s the difference between Gross Investment and Net Investment
1. Gross Investment includes all the capital goods produced in a year, including those
used to replace old or worn-out goods, while Net Investment is only the capital
goods that add to the economy’s total capital (excluding replacements).
2. Gross Investment = Net Investment + Depreciation. Depreciation is the value lost
when capital goods wear out or become outdated. Net Investment is the part of the
investment that increases the economy's capital.
3. Gross Investment shows the total amount spent on capital goods, while Net
Investment shows how much the capital stock actually grows after replacing old
goods.
Concept Of Depreciation
When fixed assets like machines or equipment are used, their value decreases over time
due to:
1. Normal wear and tear (just from using them).
2. Accidental damages (damages beyond regular repairs).
3. Obsolescence (when they become outdated because of new technology or
changes in demand).
This loss of value is called depreciation, also known as the consumption of fixed
capital. It happens over time, and to keep production going, these assets need to be
replaced. To do this, businesses set aside money each year for replacements.

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❖ Significance of Depreciation Reserve Fund
A depreciation reserve fund helps replace old assets like machines. Without it,
businesses can't invest in new assets, leading to lower overall investment in the
economy. This causes a drop in production, income, and jobs, leading to an economic
slowdown. This can create a cycle of low income, low demand, and low output, called a
low-level equilibrium trap.
DIFFERENCE BETWEEN EXPECTED OBSOLESCENCE AND UNEXPECTED
OBSOLESCENCE
Expected Obsolescence
1. It happens when fixed assets lose value due to new technology or changes in
demand.
2. It is included in depreciation.
3. It is managed using a depreciation reserve fund.
Unexpected Obsolescence
1. It happens when fixed assets lose value due to natural disasters or economic
crises.
2. It is not included in depreciation; instead, it is a capital loss.
3. It is managed through insurance of fixed assets.
DIFFERENCE BETWEEN CONSUMPTION OF FIXED CAPITAL AND CAPITAL LOSS
Consumption of Fixed Capital
1. It means the loss of value of fixed assets while they are being used in production.
2. This happens due to (a) normal wear and tear, (b) accidental damage, and (c)
expected obsolescence.
3. It is managed through a depreciation reserve fund.
Capital Loss
1. It means the loss of value of fixed assets when they are not in use.
2. This happens due to (a) natural disasters (earthquakes, floods, fire, etc.) and (b) a
drop in market value during an economic recession.
3. It is managed through insurance of fixed assets.
STOCK AND FLOW

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Stock
1. Stock means the value of something at a particular moment in time.
2. It is not related to time; it is measured at a specific point.
3. A higher stock of capital leads to a higher production of goods and services.
Flow
1. Flow means the value of something over a period of time.
2. It is related to time and is measured per hour, month, or year.
3. A higher flow of income increases the stock of wealth.
FOUR SECTORS OF THE ECONOMY
1. Household Sector – This sector includes people who consume goods and
services. They also own resources like land, labour, and capital.
2. Producer Sector – This sector includes businesses and firms that produce goods
and services. They buy or hire resources from households to produce these
goods.
3. Government Sector – The government works in two ways:
▪ As a welfare provider (e.g., maintaining law, order, and defence).
▪ As a producer (e.g., running government-owned businesses).
4. External Sector (Rest of the World) – This sector deals with trade (import and
export) and the movement of money between the home country and other
countries.
INTERSECTORAL FLOWS
All sectors of the economy are connected and depend on each other. This is called
intersectoral interdependence. Here’s how they are linked:
• Households need goods and services from producers for their daily needs.
• Producers need households to provide land, labor, capital, and
entrepreneurship to make goods.
• Government collects taxes from households and producers to run the country.
• Households and producers depend on the government for services like law,
security, and administration.
This interdependence creates two types of flows:

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 1. Money Flow – When money moves between sectors (like paying wages or buying
goods).
2. Real Flow – When actual goods and services move between sectors (like food,
clothes, and machines).
CIRCULAR FLOW OF INCOME
In every economy, 3 main activities keep happening again and again:
1. Production of goods and services
2. Income generation (people earn money)
3. Expenditure (spending that money)
These three steps happen in a cycle—like a circle with no beginning or end.
1. Phase of Production (Making Goods and Services)
• Production means adding value to things.
Example: Wood worth ₹5,000 is turned into chairs worth ₹10,000.
So, value added = ₹5,000. That’s production.
• This phase is done by producers (businesses or firms).
• Producers use:
1. Land
2. Labour
3. Capital (money/machines)
4. Entrepreneurship (business ideas)
All these are provided by households (people).
• Along with raw materials, these factors are used to make products.
• People always have needs, so production never stops.
2. Phase of Income Generation (Distribution of Money)
• When people give their land, labour, capital, and skills to producers, they are paid
in return:
What People Give What They Get (Income)
Land Rent
Capital (Money) Interest

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Labour (Work) Wages/Salaries
Entrepreneurship Profit

• These are called factor incomes for households.

• So, the money earned from selling goods and services (value added) is converted
into income for people.
3. Phase of Disposition/Expenditure (Spending Income)
• When people spend their income, this is called expenditure.
Two types of spending happen:
➢ Consumption Expenditure:
People (households) buy things for personal use.
➢ Investment Expenditure:
Businesses buy tools, machines, etc., to make more goods.
• This spending creates demand, which again leads to more production.
❖ Summary: The Never-Ending Circle (Triple Identity)
• All 3 phases are connected and go in a loop:
Production → Income → Expenditure → Demand for goods → More Production
• This cycle never stops, which is why it’s called circular flow.
• In a two-sector economy (only producers and households):
Production = Income = Expenditure
This is called Triple Identity.
❖ Assumptions of the Circular Flow Model
1. The economy has only two sectors – households and producers.
2. Households spend all their income, meaning there are no savings.
3.The economy is closed, so there are no exports or imports.
4. There is no government in the economy.
❖ Importance of the Circular Flow Model
1. Helps Calculate National Income – The model helps measure a country's total
income by adding up earnings like rent, wages, interest, and profit. It can also be
measured by the total value of goods and services produced or the total money spent on
them.

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2. Shows How Sectors Depend on Each Other – It explains the interdependence
between households and producers. Households need goods and services from
producers, while producers need resources from households.
Note: The circular flow of income is also called the circular flow of money.

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 CHAPTER 3: MONEY

MEANING OF MONEY
• Money is anything that people commonly accept in exchange for goods and
services.
• Example:
a. A rupee is money in India.
b. A dollar is money in the USA.
• It helps people to buy and sell things easily.
• Money was created to solve the problems of the barter system.
• Today, money plays many important roles in the economy.
• That’s why it is said: "Money is what money does."
Before Money: Barter System
• In old times, there was no money. People used the barter system.
• In the barter system, goods were exchanged for goods.
Example: A cobbler gave shoes and got wheat in return.
• Problems with the barter system:
a. It was hard to find someone who had what you wanted and wanted what you had.
b. It was not suitable for large or modern economies.
Evolution of Money
1. First, people used gold and silver coins as money.
2. Then, coins made of mixed metals were used.
3. Paper currency (notes) came later.
4. After that, plastic money like debit and credit cards became common.
5. Now, people use digital or electronic money (online banking, UPI, etc.).
Functions of Money
1. Medium of Exchange – Money is used to buy and sell goods.
2. Store of Value – Money can be saved and used in the future.

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 3. Measure of Value – The value or price of goods is measured in money.
4. Standard of Deferred Payments – Money is used for payments made in the
future (like EMIs or loans).
• Money was created to solve the problems of the barter system.
• Today, money plays many important roles in the economy.
• That’s why it is said: "Money is what money does."
BARTER SYSTEM OF EXCHANGE
• In the barter system, people exchanged goods for goods, not for money.
• Example: A farmer with extra rice could give rice to a cloth maker in return for
cloth.
• But for this to work, two conditions must be met:
1. The cloth maker must want rice.
2. The farmer must want cloth.
• This is called double coincidence of wants – both people must want what the
other has.
C-C Economy (Commodity for Commodity Economy)
• C means commodity (goods).
• In a C-C economy, people exchange one good for another.
• It is also known as the barter system.
• There is no money used in this system.
Problems of Barter System (Drawbacks)
The barter system had many problems. Money helped to remove these problems:
1. Double Coincidence of Wants
• It was hard to find someone who wanted what you had and had what you
wanted.
• This made exchange difficult and limited.
• Money solved this problem by acting as a common medium. Now you can sell
your product to anyone and use the money to buy anything else.
2. No Common Measure of Value

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 • In barter, there was no standard to measure the value of goods.
• Example: How many cows equal one car? No one knows for sure.
• Money solved this by becoming a common unit of value like ₹ or $.
3. Difficult Future or Contractual Payments
• Today, we can pay salaries like ₹10,000 per month.
• In barter, it was hard to decide future payments. Would you pay in rice? Cows?
Chairs?
• Money solved this by making future payments and contracts easier and clear.
4. Storage and Transfer of Value
• In barter, saving was done by storing goods like grains or animals.
• These could spoil, get stolen, or be hard to store and carry.
• Money solved this by being easy to save, store, and transfer from one place to
another.
FORMS OF MONEY
There are different forms of money. The main types are:
1. Fiat Money and Fiduciary Money
2. Full Bodied Money and Credit Money
Fiat Money and Fiduciary Money
• Fiat money is the money that is issued by the government. It includes notes and
coins that people are legally required to accept in exchange. Example: ₹10 note or
₹1 coin in India.
• Fiduciary money is the money that people accept as a medium of exchange
because of mutual trust, not because the government says so. Example: A cheque.
When someone gives a cheque, the receiver accepts it based on trust that it will
be paid.
Full Bodied Money and Credit Money
• Full bodied money means money in the form of coins whose metal value is the
same as their face value. Example: During British rule in India, ₹1 coin was made
of silver. The value of the silver was also ₹1.
• Credit money means the face value of money is more than the value of the metal
used to make it. Example: Today’s ₹1 coin is made of cheap metal, and its metal

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 value is much less than ₹1. People won’t melt it because the metal is worth less
than ₹1.

Full Bodied Money: Money Value = Metal (Commodity) Value

Credit Money: Money Value > Metal (Commodity) Value

SUPPLY OF MONEY (MEANING)

• Supply of Money means the total amount of money held by the people of a
country at a particular point of time.
• It is a stock concept, because it refers to the total money available at a specific
time, not over a period.
What Is Not Included in Money Supply
• Money supply does not include:
1. Money held by the government
2. Money held by the banking system
• These are suppliers of money, so their money is not counted as part of the
supply.
• Only the public’s money is counted in the supply of money.
Measures of Money Supply in India
India has 4 measures of money supply:
• M1
• M2
• M3
• M4
(Only M1 is discussed in the syllabus. Others are for general reference.)
M1 Measure of Money Supply
Formula:
M1 = C + DD + OD
Where:
• C = Currency with the public (coins + paper notes)

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 • DD = Demand deposits with commercial banks (like savings or current accounts,
withdrawable anytime)
• OD = Other deposits with RBI
What are "Other Deposits" (OD)?
Includes:
• Demand deposits of institutions like NABARD
• Demand deposits of foreign central banks and foreign governments
• Deposits of international institutions like IMF and World Bank
Not Included in OD:
• Deposits of Indian government with RBI
• Deposits of Indian banks with RBI

Net Demand Deposits vs Gross Demand Deposits

• Gross Demand Deposits: Includes claims between banks (like one bank owing
money to another).
• Net Demand Deposits: Excludes inter-bank claims; only includes money held by
the public.
• Only net demand deposits are used to measure money supply.

Term Deposits vs Demand Deposits

Feature Term Deposits Demand Deposits
Time Period Fixed (e.g. 1 year) No fixed time
Withdrawal Not easily withdrawable Can withdraw anytime
Cheque Use Cheques not allowed Cheques allowed
Examples Fixed deposits Saving & Current accounts

Only Demand Deposits are counted in M1 money supply.

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Who Supplies Money?
1. Reserve Bank of India (RBI)
• Main supplier of money in India
• Uses Minimum Reserve System to issue currency
❖ Keeps ₹200 crore as reserve
❖ Out of this, ₹115 crore must be in gold
2. Commercial Banks
• Cannot issue currency (notes or coins)
• Supply money through demand deposits
• This is called Bank Money
3. Government of India
• Issues ₹1 notes and all coins through the Ministry of Finance

Bank Money and High-Powered Money

• Bank Money:
➢ Refers to demand deposits with commercial banks
➢ People can use this money by writing cheques
• High-Powered Money (also called Monetary Base):
Includes:
1. Currency held by the public
2. Vault cash of banks (cash in bank branches)
3. Cash reserves of commercial banks with RBI
Note:
• Only the currency held by the public is included in money supply.
• Vault cash and bank reserves with RBI are not included because they are held by
money suppliers.

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 CHAPTER 4: BANKING

MONEY CREATION BY COMMERCIAL BANKS

What is Money Creation?
• Commercial banks cannot print currency (only RBI can do that).
• But they can create money through demand deposits.
• This is called money creation or credit creation by banks.
How Do Commercial Banks Create Money?
Let’s understand the step-by-step process:
1. People deposit money (cash) into banks.
• This is called a Primary Deposit.
2. Banks keep a part of this money as Cash Reserve (as required by RBI).
• Example: If CRR = 10%, bank keeps ₹10 from every ₹100 deposit.
3. The remaining money is given out as loans to borrowers.
4. But instead of giving cash, banks credit the borrower’s account (just make an
entry in the computer).
• This is called a Secondary Deposit.
5. Borrowers use this loan amount via cheques, which act like money in the
economy.
6. These cheques circulate in the economy just like actual cash.
7. Thus, Primary Deposits + Secondary Deposits = Demand Deposits
• This total demand deposit is considered as part of money supply.
8. Since all depositors don’t withdraw their money at once, banks are able to lend
again and again, creating more money.
Key Terms Explained
• Primary Deposit: Cash deposit made by people in the bank.
• Secondary Deposit: Loan amount credited in borrower’s account (not in cash).

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 • CRR (Cash Reserve Ratio): Percentage of total deposits banks must keep as cash
reserve with RBI.
• Demand Deposits: Total deposits that people can withdraw anytime using
cheques.
• Bank Money: Money created by banks in the form of demand deposits.
Example of Money Creation (Step-by-Step)
Let’s assume:
• Only one bank exists.
• Initial deposit = ₹1,000
• CRR = 10%
Round 1:
• Bank receives ₹1,000.
• Keeps 10% = ₹100 as reserve.
• Loans ₹900 → borrower deposits this again in the bank.
Round 2:
• Now, ₹900 is deposited.
• Bank keeps 10% = ₹90
• Loans ₹810 → deposited again
This process continues...
Final Result:
• Total money created = ₹10,000
• Why? Because
Money Created = Initial Deposit × (1 / CRR)
⇒ ₹1,000 × (1 / 0.10) = ₹10,000
Summary: Factors Affecting Money Creation
1. Cash Reserve with Banks
• More cash → More loans → More money created
2. CRR (Cash Reserve Ratio)
• Higher CRR → Less money to lend → Less money creation

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 • Lower CRR → More money to lend → More money creation
3. Excess Vault Cash
• If banks keep extra cash (more than CRR), their ability to lend and create
money decreases.
CRR AND CREDIT MULTIPLIER
• CRR stands for Cash Reserve Ratio, which is the percentage of total deposits that
commercial banks must keep with the Reserve Bank of India (RBI).
• In India, the CRR is decided by the RBI, not by the commercial banks themselves.
It is also known as the Legal Reserve Ratio (LRR).
• Commercial banks are required to keep the necessary cash reserves with the RBI,
though they can keep extra reserves as 'vault cash' with themselves.
Credit Multiplier Formula
The credit multiplier is the number of times commercial banks can create credit (or
money) based on their cash reserves with the RBI. The formula for the credit multiplier
is:
Credit Multiplier(k)=1/CRR
Example:
If the CRR is 10%, the credit multiplier would be:
k=1/10%=1/0.10=10
This means that commercial banks can create up to 10 times the amount of credit for
every unit of cash reserves they hold with the RBI.
For example, if the banks' cash reserves are ₹10,000, they can create:
Credit Creation=₹10,000×10=₹1,00,000
Thus, the commercial banks can create ₹1,00,000 in credit from ₹10,000 in cash
reserves.
Conclusion:
• The credit multiplier shows how much money the commercial banks can create
with their cash reserves, based on the CRR fixed by the RBI.
• The higher the CRR, the lower the ability of commercial banks to create money
(or credit).

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 THE CENTRAL BANK
The central bank is the highest bank in a country. It controls the entire banking system
and is the only bank that can issue currency (notes). It manages the supply of money in
the economy and acts as a banker for the government. In India, the central bank is the
Reserve Bank of India (RBI).
Functions of the Central Bank
1. Issuing Notes:
The central bank has the exclusive right to issue currency notes. This means only the
central bank can print money, and these notes are accepted as legal money in the
country.
2. Banker to the Government:
• The central bank manages the accounts of the government.
• It acts as the agent of the government by buying and selling government
securities (like bonds).
• It also advises the government on policies related to the money market.
3. Bankers' Bank and Supervisory Role:
• The central bank acts as a "bankers' bank." This means it deals with other
commercial banks, just like commercial banks deal with their customers.
• It accepts deposits from commercial banks and provides them loans.
• It also offers a "Clearing House" service, which is a system that helps banks
process cheques without transferring cash.
• The central bank supervises the commercial banks to ensure they follow the
rules, like the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
4. Lender of the Last Resort:
If a commercial bank is unable to get financial help from other places, it can turn to
the central bank as the last option. The central bank lends money to these banks in
emergency situations to keep the banking system stable and avoid a financial crisis.
5. Custodian of Foreign Exchange:
The central bank manages the country's foreign exchange reserves (currency from
other countries). It also ensures the stability of the exchange rate (the value of the
country's currency in the international market) by buying and selling foreign
currency when needed.

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6. Clearing House Function:
The central bank helps clear cheques between banks. For example, if Bank A receives
a cheque from a customer drawn on Bank B, the central bank helps settle the
payment between the two banks without cash transfers. This process reduces the
need for cash and makes banking more efficient.
7. Control of Credit:
The central bank controls the supply of credit in the economy. This means it can
increase or decrease the amount of money available in the market, depending on
whether there is inflation (too much money) or deflation (too little money). By
controlling credit, the central bank helps keep the economy stable and ensures that
it grows in a balanced way.
CENTRAL BANK AND COMMERCIAL BANK
Feature The Central Bank A Commercial Bank
Role The apex bank (the "bank of all A financial institution
banks"). dealing with the public.
Function Accepts deposits from commercial Accepts deposits from the
with banks and loans them money. Does not general public and provides
Deposits deal with the general public. loans.
Money Regulates the supply of money in the Creates money by offering
Supply economy. credit (loans).
Control
Foreign Holds the country’s foreign exchange Deals in foreign exchange
Exchange reserves and stabilizes the currency for profit, but does not hold
exchange rate. reserves.
Currency The only authority to issue currency Cannot issue currency.
Issuance (notes).
Focus Focuses on economic growth and Focuses on maximizing
stability. profits.

CONTROL OF MONEY SUPPLY BY THE RBI (CENTRAL BANK)

The RBI controls the supply of money in the economy using different tools. These tools
are divided into two types:
1. Quantitative Instruments

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2. Qualitative Instruments
These tools help either reduce the money supply when there is inflation or increase it
when there is deflation.
(A) Quantitative Instruments of Credit Control
These tools focus on the overall supply of money in the economy.
1. Bank Rate:
• It’s the interest rate at which the RBI lends money to commercial banks.
• When the bank rate increases, interest rates in the market go up. This makes
borrowing more expensive, reducing the demand for credit and money supply,
which helps control inflation.
• When the bank rate decreases, interest rates fall, making borrowing cheaper. This
increases the demand for credit and money supply, which helps control deflation.
2. Open Market Operations (OMO):
• The RBI buys and sells securities (like government bonds) to manage liquidity
(cash).
• Selling securities takes cash out of the economy, reducing the supply of money
and controlling inflation.
• Buying securities puts cash into the economy, increasing the supply of money
and controlling deflation.
3. Repo Rate:
• It is the rate at which the RBI gives short-term loans to commercial banks by
buying government securities.
• Increasing the repo rate makes borrowing expensive, reducing money supply
and controlling inflation.
• Decreasing the repo rate makes borrowing cheaper, increasing money supply
and controlling deflation.
4. Reverse Repo Rate:
• It is the rate at which the RBI accepts deposits from commercial banks (through
government securities).
• Increasing the reverse repo rate encourages banks to park more money with
the RBI, reducing their ability to lend and controlling inflation.

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 • Decreasing the reverse repo rate encourages banks to lend more, increasing the
money supply and controlling deflation.
5. Cash Reserve Ratio (CRR):
• The minimum percentage of a bank’s total deposits that must be kept with the
RBI.
• Raising the CRR means banks have less money to lend, reducing the supply of
money and controlling inflation.
• Lowering the CRR means banks have more money to lend, increasing the supply
of money and controlling deflation.
6. Statutory Liquidity Ratio (SLR):
• The percentage of a bank's assets that it must keep in liquid assets (like cash,
gold, or government bonds).
• Raising the SLR reduces the amount of money available for lending, controlling
inflation.
• Lowering the SLR increases the amount of money available for lending,
controlling deflation.
(B) Qualitative Instruments of Credit Control
These tools focus on specific sectors of the economy, controlling the supply of money in
certain areas.
1. Margin Requirement:
• It’s the difference between the value of the collateral (like a house) and the loan
granted.
• Increasing the margin requirement reduces the demand for loans, controlling
inflation.
• Decreasing the margin requirement increases the demand for loans,
controlling deflation.
2. Rationing of Credit:
• The RBI sets limits (quotas) on how much credit commercial banks can provide
for different business activities.
• Introducing credit rationing limits the supply of money, controlling inflation.

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 • Withdrawing credit rationing increases the supply of money, controlling
deflation.
3. Moral Suasion:
• The RBI advises banks to be more careful about lending.
• During inflation, banks are advised to restrict loans, and during deflation, they
are encouraged to lend more.
DID YOU KNOW?
(i) Moral Suasion is a mix of persuasion and pressure.
(ii) The RBI (Reserve Bank of India) tries to convince commercial banks to follow its
instructions.
(iii) If persuasion doesn't work, the RBI applies pressure as the main bank of the
country.
(iv) If pressure also doesn't work, the RBI can take direct action, which could include
removing the bank's recognition.
(v) Moral suasion is both a quantitative and qualitative tool of monetary policy, but
it is usually considered a qualitative tool.

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 CHAPTER 1: INDIAN ECONOMY ON THE EVE OF INDEPENDENCE

HOW THE BRITISH EXPLOITED INDIA’S ECONOMY

Under British rule, India’s economy was heavily exploited in three main sectors:
agriculture, industry, and international trade.
1. Exploitation of Agriculture
• The British introduced the zamindari system, making zamindars (landlords) the
owners of the land.
• Farmers (tillers) had to pay high taxes but earned very little, leaving no money
for investment in farming.
• Zamindars spent their money on luxury instead of improving agriculture.
2. Exploitation of Industry
• Indian handicrafts, famous for their quality, were destroyed by British policies.
• Heavy taxes were imposed on Indian exports, reducing foreign demand.
• British goods were imported duty-free, reducing local demand for Indian
products.
3. Exploitation of International Trade
• Raw materials were taken from India without tax to support British industries.
• British goods were imported duty-free, forcing Indians to buy British products.
• India was turned into a supplier of raw materials and an importer of British
finished goods.
CONDITION OF THE INDIAN ECONOMY ON EVE OF INDEPENDENCE
Before gaining independence in 1947, India’s economy was weak and
underdeveloped due to British rule. Here are its key features:
1. No Economic Growth (Stagnant Economy)
• The economy was not growing, and people remained poor.
• Between 1860-1925, per capita income (income per person) grew only 0.5%
per year.
• Poverty was widespread, and famines and diseases were common.

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2. Very Poor Economy (Backward Economy)
• India's per capita income in 1947-48 was just ₹230.
• Most people lacked food, clothing, and shelter.
• Unemployment was a big problem.
3. Weak Agriculture
• 72% of people worked in agriculture, but it contributed only 50% to GDP.
• Low productivity: Wheat production was only 660 kg per hectare, and rice
665 kg per hectare.
• India struggled to produce enough food for its population.
4. Weak Industry
• No big industries, and machine production was very low.
• Cottage industries were destroyed by British policies.
• India depended on imports from Britain for machinery and tools.
5. Extreme Poverty
• Most people were too poor to afford two meals a day.
• Lack of jobs increased poverty.
6. Poor Infrastructure
• Electricity generation in 1948 was only 2,100 MW.
• Railway length was 53,596 km.
• Few roads were built (only 1.55 lakh km of pucca roads).
7. High Dependence on Imports
• India imported most machinery and defence equipment.
• Even daily-use items like sewing machines, bicycles, and medicines were
imported.
8. Mostly Rural Population (Limited Urbanization)
• In 1948, only 14% of people lived in cities, while 86% lived in villages.
• Few job opportunities outside farming made rural poverty worse.
9. Semi-Feudal System

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 • The economy was not fully capitalist or feudal, but a mix of both.
• Landlords (zamindars) owned land, and farmers had low productivity due to
old methods.
10. British Exploitation (Colonial Economy)
• Heavy taxes on Indian industries forced people to buy British goods.
• Raw materials were taken from India without tax to help British industries
grow.
• Indian artisans were mistreated, leading to the destruction of handicrafts.
AGRICULTURE IN INDIA ON EVE OF INDEPENDENCE
Before India gained independence, the agriculture sector was in poor condition due
to British rule. Here are the key features:
1. Low Production and Productivity
• Production (total crop output) and productivity (output per hectare) were very
low.
• Farmers had no good tools or fertilizers, and no motivation to grow more.
2. Uncertainty in Farming
• Farming was completely dependent on rainfall.
• No proper irrigation (wells, canals) was developed under British rule.
• Good rainfall = good crops, bad rainfall = crop failure.
3. Farming Only for Survival (Subsistence Farming)
• Farmers grew crops only for their own food, not for selling.
• No extra crops to sell in the market = no income.
• This kept farmers poor and agriculture backward.
4. Landlords (Zamindars) vs. Farmers (Tillers)
• Landlords (zamindars) owned the land and took a large share of crops as rent.
• Farmers (tillers) worked hard but got only a small amount to survive.
• Farmers were always in debt, while zamindars lived luxuriously.
5. Small and Scattered Land
• Farmers had very small pieces of land in different places.

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 • Difficult to farm efficiently, leading to high costs and low production.
6. Unfair Land Revenue System (Zamindari System)
• British government made zamindars the permanent landowners.
• Zamindars had to pay a fixed tax to the British.
• To collect more money, zamindars forced heavy rents on farmers.
• Farmers lost land, became labourers, and earned very little.
7. Forced Commercial Farming
• Farmers were forced to grow cash crops (cotton, jute, sugarcane, indigo) instead
of food crops (rice, wheat).
• Reason: British factories needed raw materials like indigo for textiles.
• Problem: Farmers had to buy food from the market but had no money due to
debts.
• This led to lifelong debt and agriculture stagnation.
INDUSTRIAL SECTOR ON EVE OF INDEPENDENCE
Before India gained independence, the industrial sector suffered severe damage due
to British rule. This is called Systematic De-industrialization, which means:
1. Traditional Handicrafts Were Destroyed due to unfair British policies.
2. Modern Industries Could Not Grow because of a lack of investment.
1. Destruction of Handicrafts
Before British rule, Indian handicrafts were famous worldwide for their quality and
craftsmanship. However, British policies led to their decline:
a. Unfair Tax Policies
• British goods were imported into India without taxes (tariff-free).
• Indian goods were heavily taxed when exported.
• This made Indian handicrafts expensive, while British machine-made
products became cheaper.
b. No Support from Kings and Nobles
• Before the British, Indian rulers (nawabs, rajas, emperors) supported local
artisans.

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 • After British rule, these rulers lost power, and craftsmen lost their financial
support.
c. Competition from Machine-Made Goods
• British factories produced cheap, high-quality machine-made products.
• Indian handicrafts couldn’t compete with these products.
• Many Indian craftsmen lost their jobs and businesses.
d. Change in Consumer Demand
• British culture influenced Indians, and people started preferring British
products over Indian ones.
• This reduced demand for traditional Indian goods.
e. Introduction of Railways
• Railways helped British goods reach all parts of India quickly and cheaply.
• But for Indian products, markets shrank even further.
• More local industries collapsed as a result.
2. Slow Growth of Modern Industry Before Independence
During British rule, modern industries in India grew very slowly. It was only in the
late 19th century that some industries started developing. However, this growth was
very limited.
1. Development of Some Industries
• A few industries were started by Indian business owners.
• These included iron & steel (Tata Iron & Steel Company - 1907), sugar,
cement, and paper industries.
• These industries grew because of a shortage of goods worldwide during
World War I and II.
2. Limited Role of the British Government
• The British only developed industries that helped them, such as railways and
communication systems.
• These industries made it easier for British goods to reach Indian markets.
3. No Development of Capital Goods Industry

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 • Capital goods industry makes machines and equipment needed for further
industrialization.
• India had no such industry before independence.
• This prevented real industrial growth in the country.
➢ Key Characteristics of Industry Before Independence
1. Handicraft industries were destroyed by unfair British tax policies.
2. Modern industry grew very slowly and was mainly focused on railways.
3. No capital goods industry existed, making further industrialization difficult.
4. India’s economy remained backward, with no major development in industries.
FOREIGN TRADE DURING BRITISH RULE
India was famous for foreign trade since ancient times. Romans even called India "the
sink of the world's bullion" (meaning a country where a lot of wealth flowed). Before
British rule, India exported finished goods like fine cotton, silk, textiles, iron, wooden
goods, ivory, and precious stones.
However, under British rule, India was forced to become:
A supplier of raw materials (like cotton, jute, and sugar)
A buyer of British-made finished goods
This was due to unfair trade policies imposed by the British.
Key Features of India's Foreign Trade Before Independence
1. Exporting Raw Materials, Importing Finished Goods
• India became a supplier of raw materials like raw silk, cotton, wool, jute, and
sugar.
• At the same time, India imported finished goods from Britain, such as cotton
and woollen clothes, and industrial equipment.
• This made the Indian economy backward because industries could not
develop.
2. British Monopoly Over India's Trade
• The British controlled India's exports and imports.
• More than 50% of India’s trade was with Britain.
• Raw materials from India helped British industries, while British-made goods
dominated Indian markets.

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3. Trade Surplus, But No Benefit to India
• Surprisingly, India's exports were higher than imports (a trade surplus).
• But this was not a sign of development because India was exporting only raw
materials, not industrial goods.
• The extra money from exports was not used to improve India. Instead, the
British used it to:
Pay for their government expenses in India
Fund British wars
• This led to a huge loss of wealth, keeping India poor and undeveloped.
DEMOGRAPHIC CONDITIONS DURING BRITISH RULE
During British rule, India's population showed clear signs of poverty and
backwardness. Here are some key points:
1. Birth Rate and Death Rate
• Both birth rate (BR) and death rate (DR) were very high – about 48 births and
40 deaths per 1,000 people.
• This showed that poverty was widespread, and people did not live long.
2. Infant Mortality Rate (IMR)
• The infant mortality rate (number of babies dying before turning 1 year old per
1,000 live births) was 218 per 1,000.
• Today, it is only 32 per 1,000, showing big improvement.
• A high infant mortality rate meant poor healthcare and extreme poverty.
3. Life Expectancy
• Life expectancy (average age a person could live) was only 32 years.
• Today, it is 69.4 years.
• This showed that people did not have proper healthcare, nutrition, or
knowledge about diseases.
4. Literacy Rate
• Only 16% of people could read and write.
• Female literacy was even lower at 7%, showing gender inequality.
• This proved India’s social and economic backwardness.

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➢ Demographic Changes in India (Population Growth Pattern)
• 1921 was a turning point in India's population growth and is called the "Year of
Great Divide."
• Before 1921, population fluctuated (sometimes increased, sometimes
decreased).
• After 1921, India's population kept increasing without decline.
Population Trends Before Independence
Year Population Change
1901 Census Decreased by 0.04 crore (23.87 crore → 23.83 crore)
1911 Census Increased by 1.38 crore (23.83 crore → 25.21 crore)
1921 Census Decreased by 0.07 crore (25.21 crore → 25.14 crore)
1931 Census Increased by 2.76 crore
1941 Census Increased by 3.96 crore
1951 Census Increased by 4.24 crore

➢ Effects of Population Growth on India

• More people = More expenses on basic needs (food, healthcare, education,
etc.)
• Less money left for development and industries
• India's economy remained poor and stagnant
➢ After 1951: Population Explosion
• Before 1951, population growth was slow and manageable.
• After 1951, population grew rapidly, creating problems like unemployment
and poverty.
OCCUPATIONAL STRUCTURE ON EVE OF INDEPENDENCE
Occupational structure means how people were divided into different types of jobs—
agriculture (farming), industry (factories, mining), and services (business,
transport, government jobs, etc.).
Since accurate data for 1947 is not available, the numbers from 1951 are used.
1. Agriculture—The Main Job for Most People
• Around 72.7% of people in India worked in agriculture.
• In developed countries, very few people depended on farming:

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 • England & USA – Only 2%
• Japan – 12%
• Germany – 4%
• This shows India was backward because most people worked in farming instead
of industries or services.
2. Industry—A Very Small Job Sector
• Only 9% of people worked in industries like factories, mining, and
construction.
• In other countries, many more people worked in industries:
• USA – 32%
• England – 42%
• Japan – 39%
• This proves that India had very little industrial development before
independence.
3. Unbalanced Economic Growth
• A country is considered developed when all job sectors (farming, industry, and
services) grow equally.
• But in India, farming dominated, while industries and services were very
small.
• This unbalanced growth made India’s economy weak and backward.
INFRASTRUCTURE ON EVE OF INDEPENDENCE
Infrastructure means the basic facilities that help a country grow, such as transport,
communication, electricity, banking, education, healthcare, and housing.
Before independence, India's infrastructure was poor and mainly developed to benefit
British rule rather than the Indian people. Here’s how:
1. Railways
• The British built railways in India not to help Indians but to transport British
goods to different parts of the country.
• This helped increase sales of British products in India.
2. Ports

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 • Ports were developed to send raw materials (like cotton, jute, and indigo) to
Britain.
• At the same time, they were used to import finished British goods into India.
3. Post & Telegraph
• The British improved communication systems like post and telegraph.
• This was not for public benefit but to help British officials manage India more
efficiently.
4. Roads
• Roads were built not for public transport but to carry raw materials from
villages to ports.
• This made it easy for the British to send materials to their factories in Britain.
IMPACT OF RAILWAYS IN INDIA
➢ Positive Effects
1. Bigger Market
• Railways helped expand trade within India.
• Exports and imports increased because goods could be moved faster.
2. Agriculture Became a Business
• Farmers could sell their crops in faraway places, not just in their villages.
• They started treating farming as a business instead of just growing food
for survival.
3. People Travelled More
• Railways made it easy to visit different places in India.
• This helped people from different regions connect and understand each
other better.
4. Helped During Famines
• Food could be sent quickly to areas suffering from food shortages.
• This saved many lives by stopping people from starving.
➢ Negative Effects
1. Helped British Exploit India

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 • Raw materials (like cotton, jute, and wheat) were taken easily from Indian
farms to British factories.
2. Made India a Market for British Goods
• British-made products were easily sent to different parts of India
through railways.
• This made Indian businesses weaker, as people started buying British
goods instead of local products.
3. Railways Benefited the British More
• The main purpose of railways was to help the British government and
businesses, not to improve life for Indians.
POSITIVE AND NEGATIVE IMPACTS OF BRITISH RULE IN INDIA
The British ruled India mainly for their own benefit—their goal was to exploit India's
wealth and resources. However, some side effects of their rule had positive
outcomes for India.
➢ Positive Impacts of British Rule
1. Farmers Started Thinking About Profits
• Before British rule, farmers grew crops only for their own survival.
• Under British rule, they were forced to sell their crops in the market.
• This made them think about market prices before deciding what to grow.
2. More Jobs & Employment
• The British built railways, roads, and factories, creating new jobs.
• People found work in railway stations, industries, and trade.
3. Better Control Over Famines
• Faster transport helped move food to areas affected by famine.
• These reduced deaths caused by food shortages.
4. Use of Money Instead of Barter System
• Before British rule, people exchanged goods instead of using money.
• The British introduced a money-based economy, which made trade easier.
• This helped businesses grow and led to large-scale production.

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5. A Strong Administrative System
• The British created laws, courts, and a government system.
• After independence, India used this system to run the country efficiently.
➢ Negative Impacts of British Rule
1. Destruction of Indian Industries
• Before British rule, India was famous for its handicrafts and textiles.
• The British imposed high taxes on Indian goods but allowed duty-free
imports from Britain.
• This destroyed Indian industries and made India dependent on British goods.
2. Poverty and Exploitation
• The British took India's wealth and used it for their own benefit.
• They forced Indian farmers to grow cash crops (like cotton and indigo) instead of
food, leading to famines and hunger.
3. Heavy Taxation on Indians
• Indian farmers and workers paid high taxes, while British officials enjoyed
luxury.
• Many farmers lost their land because they could not pay taxes.
4. Divide and Rule Policy
• The British created tensions between Hindus and Muslims to keep their
control over India.
• This led to communal violence and later contributed to the partition of India in
1947.
5. Education for Their Own Benefit
• The British introduced English education, but only to train Indians for low-level
jobs in the government.
• Traditional Indian education and learning declined.

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Contact: +91 93687 85783 (Dhama Classes) 42